Today, a friend sent me two seemingly unrelated items: the copy of Bill Ackman's annual letter that's making the rounds, and an interesting, well-researched bull thesis on Ferrari (NYSE:RACE). Despite the two having nothing to do with each other - to my knowledge, Ackman doesn't own any Ferrari shares, although he does apparently own one of the cars - it felt like deja vu when I read one after the other.
The conundrum of valuing Ferrari has been well-discussed: we all know car companies suck and aren't worth very much multiple-wise, and we all know super-premium brands are (usually) worth a lot more multiple-wise. How, then, do you reconcile the two? For now, the bears on Ferrari seem to be winning, but this may reflect spin-off dynamics more than anything else. On the other hand, bullish investors, including the one whose report I read, believe that the company should trade at a super-premium multiple to reflect the brand value, similar to companies like Hermes (OTCPK:HESAF) or Manchester United (NYSE:MANU).
The comparison between this assumed additional premium for "brand value" and commentary in Ackman's letter regarding a premium for "platform value" is striking. In reflecting on a challenging 2015, Ackman stated:
Our biggest valuation error was assigning too much value to the so-called "platform value" in certain of our holdings. We believe that "platform value" is real, but, as we have been painfully reminded, it is a much more ephemeral form of value than pharmaceutical products, operating businesses, real estate, or other assets as it depends on access to low-cost capital, uniquely talented members of management, and the pricing environment for transactions.
The similarity here is the idea of assigning value to something you can't measure. While the concept sounds appealing, I believe the correct approach to valuation in the case of Ferrari is the one Aswath Damodaran took here. Ferrari is worth what it can earn and no more. What it can earn already incorporates the value of the brand.
To this end, I would also point out that there are plenty of "very valuable" brands out there - Coca-Cola (NYSE:KO), Intel (NASDAQ:INTC), Ford (NYSE:F), Disney (NYSE:DIS), etc. All of them could (and some of them do) sell t-shirts to plenty of people who gladly advertise their brand for free because it resonates. Yet all of these businesses are valued on the basis of the cash flows their brand can generate. Applying a premium multiple above and beyond that justified by the already premium margins/growth afforded by the brand is double-counting its value. Disney's brand leads to pricing power, which shows up in its growth rate and margins and thus in the fundamental valuation - and the same goes for Ferrari, which already generates substantially higher and less cyclical margins than the average automaker.
In the case of Ferrari, there are actually numerous aspects of the bull thesis I find interesting. It doesn't seem unreasonable to assume that they could sell a decent number of additional Ferraris without diluting the brand, and it's also remarkable how stable sales were through one of the worst recessions in history. If bulls' arguments on incremental margins are correct, then Ferrari could generate significant incremental cash flows relative to what it currently does.
That said, there's certainly a cap to the long-term growth rate if you want to keep the brand exclusive - and with that, it's hard to justify super-premium multiples for the super-premium brand. Just as Ackman got burned (at least for now) by paying up for "platform value" that didn't materialize, I think Ferrari bulls should consider whether it's reasonable to expect Ferrari to trade for a multiple, in the long term, that double-counts the "brand value". This would seem to apply to platform value as well - if you believe the business can invest future cash flows (or incremental leverage capacity) at an above-average ROE, then that would be baked into the fundamental valuation. It's not separate.
I haven't done enough independent research to have an educated opinion on whether or not Ferrari can ramp production significantly enough, at high enough incremental margins, to justify a higher valuation than it trades at today. I think it's particularly important to dig into how much of incremental demand would be from areas like the Middle East or China, given oil prices and the woeful stock market in China (that may drive some sort of wealth/confidence effect in the next few years). That said, my initial takeaway here is that basing an investment on the assumption of a very high terminal multiple is not the right move here.
With all that said, I think Ferrari is an interesting company to work on, if for no other reason than it's certainly a very unique asset with no good public comparables that I can think of. Given that lack of easy comparability, it's the sort of stock whose valuation may reach levels (on either the upside or the downside) that don't make a lot of sense. If anyone has a well-constructed bear thesis independent of valuation - i.e., why Ferrari wouldn't be able to ramp production at high incremental margins, or some other critical factor that affects the future of the business - I'd certainly love to hear it.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.