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TB0459

Michael H. Moffett

Ferrari: Valuing The Prancing Horse

While we will continue to pursue a low volume production strategy and maintain our reputation for
exclusivity, we intend to respond to growing demand, both in emerging markets as well as in response
to demographic changes and the growth in the size and spending capacity of our target clients. We
believe we can grow in a controlled manner while preserving the exclusivity of our brand by continuing
to focus on distinct market segments and maintaining a strong pipeline of new car launches.
– New Business Netherlands N.V., Form F-1, U.S. Securities
and Exchange Commission, Ferrari Prospectus, p. 79.

Project Owl—the code name for the initial public offering (IPO) of Ferrari—was over.
Officially, in all of the documents filed with authorities like the U.S. Securities and
Exchange Commission, the company had been called New Business Netherlands N.V.,
now to be renamed Ferrari N.V. The prancing horse had opened at the top end of its
target price range—$52 per share in the U.S.—raising nearly $1 billion for Ferrari’s
owner, Fiat. Like most IPOs, the share price of RACE (the ticker symbol for Ferrari)
settled in the weeks following the launch. But now many analysts and mutual fund
managers were all asking the same thing: Was Ferrari a promising equity or simply
another of the equity eye candy IPOs to hit the market in recent years?

The Ferrari Legacy

If you can dream it, you can do it.
– Enzo Ferrari
Ferrari was the namesake of Enzo Ferrari. An automotive engineer his entire life, Enzo worked with Alfa Romeo
for many years, performing every possible function including lathe instructor, test driver, racing driver, and
eventually, serving as the director of the Alfa Corse racing division.

In 1929, Enzo founded Scuderia Ferrari in Modena, Italy. Scuderia was a racing stable, where owners could
drive and compete with their own cars. Enzo left Alfa Romeo in 1939 to open his own firm, Avio Costruzioni
on Viale Trento Tieste in Modena (the plant was eventually moved to Maranello). After the forced hiatus during
the Second World War, Ferrari launched the 125 S in 1947, and on May 25, 1947, the Ferrari 125 S won its
first race, the Rome Grand Prix. Ferrari has since won more than 5,000 races worldwide.

The financial pressures of sustaining the growing high-powered Ferrari family of cars resulted in Enzo
partnering with the Fiat Group in 1969; Fiat initially taking a 50% interest, then increasing it to 90% in 1988.
Enzo’s remaining 10% ownership was passed to his son in that same year with his death. It was now the Fiat
Group and its family interests that sustained Enzo Ferrari’s legacy. That legacy was now led by Fiat’s new CEO,
Sergio Marchionne.

Core Characteristics
Ferrari believed it possessed a number of core pillars, characteristics that formed the foundations of its value and
value-growth potential.1
• An iconic brand with superior, enduring power, benefiting from a loyal customer base.
• Global access to growing wealth creation.

1
New Business Netherlands N.V., Form F-1, U.S. Securities and Exchange Commission, Ferrari Prospectus, p. 24.
Copyright © 2016 Thunderbird School of Global Management, a unit of the Arizona State University Knowledge Enterprise.
This case was written by Professor Michael H. Moffett with the research assistance of Jeeku Saha, MBA ’16, for the sole purpose of
providing material for class discussion. It is not intended to illustrate either effective or ineffective handling of a managerial situation.
Any reproduction, in any form, of the material in this case is prohibited unless permission is obtained from the copyright holder.
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• Exceptional pricing power and value resilience.

• Racing heritage.
• Leading-edge engineering capabilities.
• Flexible and efficient development and production process.
• Strong and resilient financial performance and profile.
• Superior talent.

And in the end, leadership at Ferrari intended to achieve profitable growth by pursuing, in its own words—
controlled growth in developed and emerging markets.

Powerful Brand
Ferrari is the world’s most powerful brand. The legendary Italian carmaker scores highly on a wide
variety of measures on Brand Finance’s Brand Strength Index, from desirability, loyalty, and consumer
sentiment to visual identity, online presence and employee satisfaction. Ferrari is one of only eleven
brands (including Google, Hermès, Coca-Cola, Disney, Rolex, and F1 racing rivals Red Bull) to be
awarded an AAA+ brand rating and has the highest overall score.
Though Ferrari is the world’s most powerful brand, being a niche, luxury brand with an officially
capped production, it is perhaps unsurprising that it is some way off being the world’s most valuable.
Its US$4 billion brand value puts it 350th in brand value terms. David Haigh continues, “Apple
also has a powerful brand, rated AAA by Brand Finance. However, what sets it apart is its ability
to monetize that brand.”2

Ferrari’s brand—powerful, yet not one of the most valuable—was part of its enigma. Management at Ferrari
saw this as a true market differentiator. Shares in Ferrari would not be valued in the marketplace like traditional
automotive shares, but rather as shares in a powerful, sustainable, luxury good. But as Brand Finance noted, a
powerful brand was not the same thing as a valuable brand. Markets would decide that.

Limits to Growth
We pursue a low-volume production strategy in order to maintain a reputation of exclusivity and
scarcity among purchasers of our cars and deliberately monitor and maintain our production volumes
and delivery wait-times to promote this reputation.
– New Business Netherlands N.V., Form F-1, U.S. Securities
and Exchange Commission, p. 22.

Like other rare elements, Ferrari’s value was linked to its scarcity. As illustrated in Exhibit 1, Ferrari had
methodically controlled volume sales, averaging just 4.24% per year over the 1997-2014 period. Sales growth
had been even slower in recent years, even the post-2009 crisis period. Total sales volume in 2014 was 7,255
cars—an astonishingly small number by any automobile standard.

Scarcity premiums. In terms of preserving Ferrari’s value, this relative scarcity was both good news and bad news.
The good news was that leadership had clearly maintained the product’s relative scarcity in a global economy
that had grown faster and wealthier at a much more rapid rate. According to a recent study, the number of
high net-worth individuals (HNWIs) and their wealth, the target demographic segment for Ferrari sales (at least
historically), had grown 8.6% per annum for nearly 30 years.3

The countries driving Ferrari’s sales reflected that wealth creation. Sales volumes in 2014 were roughly 45%
Europe/Middle East/Africa (EMEA), 35% the Americas, 11% Asia Pacific (APAC), and 9% Greater China. This
global sales mix seemed to be shifting slightly away from EMEA, with China and APAC garnering the gains.
(Global sales volumes are detailed in Appendix 4.) Diving deeper, four countries made up 60% of this global
HNWI population: the United States, Japan, Germany, and China.

2
http://brandfinance.com/news/ferrari—the-worlds-most-powerful-brand/.
3
Capgemini/RBC World Wealth Report, 2015. HNWIs are defined as an individual having investable assets of USD 1
million or more, excluding primary residence, collectibles, consumables, and consumer durables.

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Exhibit 1. Ferrari’s Sales Volumes

Source: New Business Netherlands N.V., Form F-1, U.S. Securities and Exchange Commission, Ferrari Prospectus, p.31.

In its prospectus, Ferrari was quite bullish on HNWIs in China. Although China made up only 9% of
current sales, the growing wealth and taste for luxury goods in China was promising. China already made up a
very large piece of the total sales (2014) for a number of luxury goods producers: Hermes—25%; LVMH—28%;
and Prada—30%.4 If that were the case for Ferrari, the company could see growing demand pressures. But there
were skeptics, as a number of analysts worried that the Chinese economy was already beginning to slow.

The bad news about this relative scarcity through slow growth was that 4% was not a promising growth
rate for an equity if sales and earnings did indeed follow volume growth rates. Publicly traded shares generated
income for investors two ways, through dividend yields and capital gains. But with no plans to offer dividends,
Ferrari’s value proposition relied exclusively on hoped-for capital gains. Investors in equities typically demanded
double-digit rates of return.

Differing perspectives on growth had also caused serious debate within Ferrari. Ferrari’s longtime
Chairman, Luca De Montezemolo, had left the firm suddenly in early 2015, reportedly over his opposition
to the IPO. Montezemolo believed the IPO would force the firm to grow sales volumes at a much more rapid
rate. (Montezemolo did receive a €15 million severance payment.) His resignation came only one month prior
to Fiat’s announcement of Ferrari’s IPO. Ferrari’s CEO, Sergio Marchionne, had repeatedly stated publicly that
Ferrari’s future was as a business, not art: There comes a point when exclusivity, if it becomes unreachable, is no longer
exclusivity, it’s like you’re reading a fiction novel…let’s not fool ourselves, we are in the business of selling cars to people.

Regulatory limits. There was an even more challenging limit to future growth: European Union (EU) and U.S.
government emission and mileage limitations. Ferrari was classified by the EU as a small volume manufacturer
(SVM), and therefore subject to much less stringent emission requirements. The EU has, however, been revising
these restrictions for the 2017-2021 period, and continued risks and threats to Ferrari persist. Ferrari will be
submitting its emissions plan for the 2017-2021 period in the coming year.

Under current U.S. law, as long as an automobile manufacturer sold fewer than 10,000 units globally per
year, it was not subject to U.S. gasoline mileage targets and restrictions. If Ferrari broke that 10,000 unit barrier,

4
“The Ferrari Bond: Initiate Overweight at $56 PT,” Morgan Stanley, December 7, 2015, p. 9. Morgan Stanley also noted
that although China was important for many luxury goods makers, Ferrari had a relatively low level of exposure to the
Chinese market at this time.

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however, the car could not be sold in the U.S. market without the company altering its product mix to reach
fleet mileage targets. That would mean launching models with smaller engines and better mileage.

In its prospectus, Ferrari noted that it had petitioned the EPA for alternative standards for the 2017-2019
period, and would thereafter apply to the National Highway Traffic Safety Administration (NHTSA) for company-
specific standards under the combined average fuel economy (CAFÉ) clause. In both cases, Ferrari noted that it
expected “to benefit from a derogation from currently applicable standards.”5 In addition, it was rumored that
development of an electrically powered version was underway, which would aid in meeting fleet targets. Porsche,
for example, had just announced a purely electrically powered model.

Financial Performance
Ferrari’s financial results, summarized for the 2012-2014 period in Exhibit 2, revealed several unique features.
First, the company had a relatively small product portfolio, consisting of eight vehicles that accounted for 70%
of total revenue. Its sales and rentals of engines was exclusively to Maserati (it had supplied engines to Maserati
since 2003), and its other sponsorship income was tied to Formula 1 racing.

Exhibit 2. Results of Operations (for the years ending December 31)

Percentage Percentage Percentage
of net of net of net
Millions of euros 2012 revenues 2013 revenues 2014 revenues
Cars and spare parts € 1,695 76.2% € 1,655 70.9% € 1,944 70.4%
Engines 77 3.5% 188 8.1% 311 11.3%
Sponsorship, commercial
385 17.3% 412 17.6% 417 15.1%
and brand
Other 68 3.1% 80 3.4% 90 3.3%
Total net revenues € 2,225 100.0% € 2,335 100.0% € 2,762 100.0%
 
Net revenues 2,225 100.0% 2,335 100.0% 2,762 100.0%
Cost of sales (1,199) -53.9% (1,235) -52.9% (1,506) -54.5%
Selling, general and administrative (243) -10.9% (260) -11.1% (300) -10.9%
Research and development (431) -19.4% (479) -20.5% (541) -19.6%
Other expenses, net (17) -0.8% 3 0.1% (26) -0.9%
EBIT € 335 15.1% € 364 15.6% € 389 14.1%
Net financial income (expenses) (1) 0.0% 2 0.1% 9 0.3%
Profit before taxes 334 15.0% 366 15.7% 398 14.4%
Income tax expenses (101) -4.5% (120) -5.1% (133) -4.8%
Net profit € 233 10.5% € 246 10.5% € 265 9.6%
Source: Form F-1 Registration Statement, New Business Netherlands N.V., p.52

Yet, Ferrari’s R&D expenses were exceedingly high compared to any other automobile manufacturer, as
illustrated by Exhibit 3.6 Where R&D expenses as a percentage of sales averaged less than 5% for most of the
global industry, Ferrari’s were over 20%. Porsche, a distant second, was only 11%.7

Ferrari’s premium pricing and minimalist cost structure resulted in a gross margin that was more like a Silicon
Valley internet firm than an automobile manufacturer. As illustrated in Exhibit 4, Ferrari’s gross margin—net
revenues less direct costs—was 45.5% in 2014, more than double that of any other major automobile company.
That large gross margin in turn generated an extremely large operating margin (EBIT as a percentage of sales) of
14.1%, again the highest in the industry.

The spread between the two margins, gross less operating, was—at 31%--delivering financial results
far beyond an automaker. That same spread averaged only 12% amongst a peer group of luxury automobile
5
New Business Netherlands N.V., Form F-1, U.S. Securities and Exchange Commission, Ferrari Prospectus, p. 43.
6
Note that Exhibit 3 includes R&D expenses as occurring on the income statement as well as other R&D expenditures
that are capitalized, and therefore run through the cash flow statement as opposed to income.
7
“Ferrari IPO: Why This Engine Runs Too Rich,” by Abheek Bhattacharya, The Wall Street Journal, October 20, 2015.

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manufacturers, and was twice that of other major players.8 This despite the fact Ferrari was dwarfed by the others
in terms of size in vehicles sold, employees, revenues, or even total profits.

Exhibit 3. R&D Expenditures as a Percentage of Revenue

Source: The Wall Street Journal and company reports. Expenditures includes R&D expenses and capitalized expenditures.

The growing debate was whether Ferrari could maintain those margins over the next five to seven years as it
continued to grow volume sales. Some analysts argued that as volume sales grew, R&D expenses as a percentage
of revenues would not grow as fast, as the company enjoyed scale benefits of previous investment. That, if true,
would translate into a growing operating margin for the company. Other analysts, however, argued that the
company would struggle to maintain its current investment and expense structure as it worked hard to maintain
its performance edge and brand value.

Exhibit 4. Comparison of Financial Margins of Selected Automotive Manufacturers, 2014

Millions of €, $, and ¥ Ferrari Volkswagen GM Toyota Ford Fiat Daimler BMW Audi
       
Revenues € 2,762 € 202,458 $155,929 ¥25,691,911 $135,782 € 96,090 € 129,872 € 80,401 € 53,787
       
Gross profits € 1,256 € 36,524 $17,847 ¥5,703,666 $12,266 € 12,944 € 28,184 € 17,005 € 9,372
Gross margin 45.5% 18.0% 11.4% 22.2% 9.0% 13.5% 21.7% 21.2% 17.4%
       
Operating profits € 389 € 12,697 $1,530 ¥2,292,112 $2,023 € 3,223 € 8,789 € 9,118 € 5,150
Operating margin 14.1% 6.3% 1.0% 8.9% 1.5% 3.4% 6.8% 11.3% 9.6%
       
Profit after tax € 265 € 11,068 $4,018 ¥1,823,119 $3,187 € 632 € 7,290 € 8,707 € 4,428
Net margin 9.6% 5.5% 2.6% 7.1% 2.3% 0.7% 5.6% 10.8% 8.2%
       
       
Gross Margin-Operating 31.4% 11.8% 10.5% 13.3% 7.5% 10.1% 14.9% 9.8% 7.8%
Margin
Vehicles 7,255 10,212,562 9,925,000 9,032,000 6,323,000 5,640,000 2,500,000 2,117,965 1,741,100
Employees 2,858 592,586 216,000 330,000 187,000 225,587 279,857 116,324 68,804
Vehicles/employee 2.5 17.2 45.9 27.4 33.8 25.0 8.9 18.2 25.3
Source: Calculations by author based on company annual reports.

The IPO
Ferrari’s IPO on Tuesday, October 20, 2015, was by all standards a huge success. Of the 189 million shares
authorized in Ferrari’s incorporation, 17.2 million (9.1%) were sold to the public. At a launch price of $52 per
share, Fiat raised $894.4 million. The over-subscription allowance raised another $28.6 million, bringing the
total to $923 million.
8
“Ferrari Does Not Stand for ‘Fix It Again Tony’,” ADW Capital Management, LLC, August 2015, p. 8.
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One of the drawbacks associated with the IPO was that the capital raised was not targeted for reinvestment
into the business, as was common in many IPOs, but rather to compensate existing owners (Fiat) for reducing
their interest. For a company that believed in investing in technology, this was a loss.

Valuing Ferrari
There are two basic valuation methodologies applicable to Ferrari: discounted cash flow (DCF) and valuation
with comparables.

DCF Valuation
A baseline discounted cash flow (DCF) valuation of Ferrari is presented in Exhibit 5. Based on the income items
provided by Ferrari and previously presented in Exhibit 2, the DCF valuation is driven by top-line growth. The
analysis is based on a 10-year outlook, assuming 2015 as year 0.

Volume growth. Ferrari’s leadership team assured investors of slow volume growth, explicitly committing to just
under 9,000 units by 2019. That translated to an annual growth rate of 4.4% beginning with the 2015 volume
of 7,500.

Price growth. Ferrari has provided some insight into the potential of automobile price growth, repeatedly noting
it was “committed to raising the average price point” of its products. Assuming that the scarcity discipline towards
volume growth is maintained, and attention is focused on maintaining a four-month waiting period for orders,
the baseline analysis assumes that price may grow 2% per year. It is possible, however, that more aggressive annual
price increases of 3% to 4% may be achievable.

Other revenues. Ferrari’s income from the sale of engines to Maserati, rental incomes, and sponsorship associated
with the brand are all expected to grow a moderate 3% per year. Formula 1 income, a small component that
leadership believes is critical to the brand, is only expected to grow 1% annually.

Cost of sales changes and gross margin. Ferrari purchases from a small set of suppliers working under relatively
long contracts. It employed 2,858 workers, and turnover was low. Labor costs and costs of sales were expected
to grow at 2.1% per annum in the baseline analysis.

SG&A and R&D expenses. This was in the eyes of many the second most critical valuation component behind
that of volume sales. If SG&A and R&D expenses both only grew at 2.0% and 2.5%, respectively, per annum,
reflecting what many analysts believed to be the company’s cost discipline and strategy moving forward, Ferrari’s
operating margin would indeed grow considerably over the 10-year forecast period.

Depreciation and capex. In its prospectus, Ferrari noted that there would likely be little additional investment in
plant and equipment necessary for expanding volume production in the coming years. The company considered
itself inherently agile, production increases were nominal in size, and sufficient capacity existed.

At the same time, historical financial statements indicated continuing capital investments in both PP&E
and intangible assets (intellectual property and related engineering knowledge). Ferrari included depreciation
in its line item for research and development on its income statement (Appendix 1). Depreciation expenses had
totaled €120 million in 2013, €126 million in 2014, and were expected to total €130 million in 2015. The
DCF baseline analysis assumed no growth from 2015 levels in line with management’s direction. However,
many analysts believed capital investment has to grow, at least in line with direct costs, if Ferrari is to maintain
its technological edge. Capex and depreciation were assumed equal in size in the valuation analysis.

Net working capital. Ferrari’s net working capital (NWC) was unusually long in duration due to its dealer network
financing program. Ferrari provided extremely low-cost loans to its dealerships (independently owned businesses)
to aid in their purchase of the automobiles for resale. The loans were typically secured by the titles to the cars
or other collateral. Total receivables, trade receivables for the cars themselves, and receivables from financing
activities, loans to the dealerships, had averaged 180 days of sales in 2014. Ferrari’s hand-crafted manufacturing

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 Exhibit 5. Discounted Cash Flow Valuation of Ferrari (Baseline Analysis)
Forecast periods 0 1 2 3 4 5 6 7 8 9 10
Millions of Euros Assume 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025
Automobile sales:
Ferrari sales volume (units) 6,922 7,255 7,500 7,830 8,175 8,534 8,910 9,302 9,711 10,138 10,584 11,050 11,536
Sales volume growth 4.4% 4.4% 4.4% 4.4% 4.4% 4.4% 4.4% 4.4% 4.4% 4.4% 4.4%
Ferrari average sales price (€) € 239,093 € 267,953 € 273,312 € 278,778 € 284,354 € 290,041 € 295,842 € 301,759 € 307,794 € 313,950 € 320,229 € 326,633 € 333,166
Sales price growth 2.0% 2.0% 2.0% 2.0% 2.0% 2.0% 2.0% 2.0% 2.0% 2.0% 2.0%
Car sales and spare parts € 1,655 € 1,944 € 2,050 € 2,183 € 2,324 € 2,475 € 2,636 € 2,807 € 2,989 € 3,183 € 3,389 € 3,609 € 3,843

Revenues (millions of euros):

Cars and spare parts € 1,655 € 1,944 € 2,050 € 2,183 € 2,324 € 2,475 € 2,636 € 2,807 € 2,989 € 3,183 € 3,389 € 3,609 € 3,843
Engine sales to Maserati and rentals 3.0% 188 311 320 330 339 350 360 371 382 394 405 418 430
Sponsorship, commercial and brand 3.0% 412 417 430 443 456 470 484 498 513 529 545 561 578
Other Formula 1 and financial income 1.0% 80 90 91 92 93 94 95 96 97 98 99 100 101
Total net revenues € 2,335 € 2,762 € 2,891 € 3,047 € 3,213 € 3,389 € 3,575 € 3,772 € 3,981 € 4,203 € 4,438 € 4,687 € 4,952

Cost of sales (1,235) (1,506) (1,536) (1,568) (1,601) (1,635) (1,669) (1,704) (1,740) (1,777) (1,814) (1,852) (1,891)
2.1% 2.1% 2.1% 2.1% 2.1% 2.1% 2.1% 2.1% 2.1% 2.1% 2.1%
Gross margin € 1,100 € 1,256 € 1,355 € 1,479 € 1,612 € 1,754 € 1,906 € 2,068 € 2,241 € 2,426 € 2,624 € 2,836 € 3,061
Gross margin (%) 47.1% 45.5% 46.9% 48.5% 50.2% 51.8% 53.3% 54.8% 56.3% 57.7% 59.1% 60.5% 61.8%

Selling, general and administrative 2.0% (260) (300) (306) (312) (318) (325) (331) (338) (345) (351) (359) (366) (373)
Research and development 2.5% (479) (541) (522) (535) (548) (562) (576) (591) (605) (620) (636) (652) (668)
Other expenses, net 2.0% 2 (26) (27) (28) (28) (29) (29) (30) (30) (31) (32) (32) (33)
EBIT € 363 € 389 € 500 € 604 € 717 € 838 € 969 € 1,110 € 1,261 € 1,423 € 1,598 € 1,786 € 1,987
EBIT margin (%) 15.5% 14.1% 17.3% 19.8% 22.3% 24.7% 27.1% 29.4% 31.7% 33.9% 36.0% 38.1% 40.1%

Discounted Cash Flow Analysis

EBIT € 604 € 717 € 838 € 969 € 1,110 € 1,261 € 1,423 € 1,598 € 1,786 € 1,987
Income tax expenses 33.5% (202) (240) (281) (325) (372) (422) (477) (535) (598) (666)
Net operating cash flow after-tax 402 477 557 644 738 838 947 1,063 1,187 1,321
Add back depreciation 2.0% 130 133 135 138 141 144 146 149 152 155
Capex 2.0% (130) (133) (135) (138) (141) (144) (146) (149) (152) (155)
Changes in net working capital* 180/70/130 (72) (76) (81) (86) (92) (97) (103) (110) (117) (124)
Terminal value (& growth rate) 0.0% - - - - - - - - - 13,784
Free cash flows for discounting € 330 € 400 € 476 € 558 € 646 € 741 € 843 € 953 € 1,071 € 14,982

Cost of capital (WACC) 8.6860%

Present value of cash flows € 10,269
Less market value of debt (510) Use Terminal Value? (0 no, 1 yes) 1
Equity value (millions of €) € 9,759 Terminal Value as % of NPV 61%
Shares outstanding (millions) 189 $ per €
Value per share € 51.64 which at 1.100 equals $56.80

Note: Changes in net working capital (NWC) estimated assuming 180 days for A/R, 70 days Inventory, and 130 days for A/P for the 2015 through 2025 period.

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had averaged inventory levels of 72 days of cost of sales, and trade payables at 130 days of cost. The baseline
DCF analysis therefore assumed 180/70/130 days in A/R, inventory, and A/P going forward.

Terminal Value. Most valuations assume a business like Ferrari will continue to operate for many years. Instead
of building 50 or 100 years (columns) of cash flow calculations in a spreadsheet, most valuations use a terminal
value (TV) to approximate that continuing cash flow far into the future.

For calculation purposes, the TV in Exhibit 5 uses the typical perpetuity calculation form. In an attempt to
be conservative with the TV, net free cash flow (NFCF)—the sum of net operating cash flow after-tax plus
depreciation, capex, and changes in working capital—is assumed to grow at 0% for all years past 2025. The TV
for the baseline case, using the corporate cost of capital (discussed below) as the discount rate and assuming a
0% perpetuity growth rate is €13,784 billion:

Note that despite using conservative assumptions, TV still makes up 61% of the total NPV.
Cost of Capital
The final component of the valuation was the calculation of a weighted average cost of capital (WACC) for Ferrari.
This was, of course, challenging given that the company was just now moving from being privately held to being
publicly traded.

Debt. Estimates were needed for two costs of debt, both euro-denominated.9 The first was the baseline cost of
debt in the European Union and euro-denominated markets, the 10-year German government bond rate. This
was considered the risk-free rate of interest in the euro markets (kRF ), and was currently at 4.000%. The second
cost of debt needed was for Ferrari itself (kD ). Although the firm had incurred little debt of its own to date,
European banks were quoting the company a rate of 6.000% (therefore, a 2.000% credit spread over the risk-free
rate). With an effective tax rate of 33.5%, the after-tax cost of debt was 3.990%.

Equity. To estimate the cost of equity (ke ) using the capital asset pricing model (CAPM), assumptions need to be
made about the risk-free rate of interest (kRF ), the market risk premium (MRPm ), and Ferrari’s beta (β). The cost
of equity was then calculated as the risk-free rate plus a beta-adjusted market risk premium:
Cost of equity = ke = kRF + β x MRPm

The risk-free rate was 4.000%, and the market risk premium (MRPm), the average spread of expected
returns on equities in Europe over and above the risk-free rate, was currently assumed to be about 5.500%.

Estimating Ferrari’s beta (β) was in many ways guesswork with no real trading history. A company’s beta
was measured over time, statistically, as the covariance of the company’s return with that of the market, divided
by the variance of the market return. By definition, the beta of the market was 1.0. A firm with returns that
were relatively less volatile than the market might have a beta less than 1, typically between 0.6 and 1.0. A firm
demonstrating more volatile returns than the market may have a beta as high as 1.8 or more. With no history,
and no clear conclusion over whether Ferrari was an automaker or a luxury good in the eyes of the market (at
least yet), a conservative assumption was a beta of 0.9. The resulting cost of equity was 8.950%.

Cost of equity = ke = 4.000% + (0.90 x 5.500%) = 8.950%

As illustrated in Exhibit 6, current estimates of the market cost of debt and equity were used to calculate a
weighed average cost of capital (WACC). Ferrari’s capital structure was largely equity, with interest-bearing debt
outstanding of €510 million, representing only 5.3% of its capital structure. Note that this analysis calculates
Ferrari’s equity value on its market value, meaning equity value is the company’s market capitalization, the share
9
Interest rates are currency-specific. Given that the valuation of Ferrari was to be made in euros, interest rates for Ferrari’s
debt would have to be euro-denominated as well.
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price of €48 per share (market close on December 31, 2015) for the 189 million shares outstanding. The WACC
was calculated as 8.686%.
Exhibit 6. Ferrari’s Hypothetical Cost of Capital (in millions or percent)
Debt Value Equity Value Capital Structure Value Weight Cost Cost
Cost of debt 6.000%   Risk-free rate 4.000%   Debt value € 510 5.3% 3.990% 0.212%
Tax rate 33.500%   Beta 0.90   Equity value * € 9,072 94.7% 8.950% 8.474%
      Market risk premium 5.500%   Enterprise value € 9,582 100.0%    
Cost of debt after-tax 3.990%   Cost of equity 8.950%   Weighted average cost of capital (WACC) 8.686%

* Uses share price of €48 per share (closing price December 31, 2015) and 189 million shares outstanding.

Using the calculated WACC for Ferrari and its projected cash flows, the baseline DCF analysis in Exhibit
5 estimated a present value of net operating cash flows of €10.269 billion. The present value of all projected
operating cash flow accruing to equity was €9.759 billion after netting the €510 million in company debt. Given
189 million shares, this was a per share value of €51.64 ($56.80 at $1.10 per euro). Further sensitivity and scenario
analysis was obviously needed to provide more of a range and context for the DCF valuation.

Valuation with Comparables

What is the most expensive stock in the world? If you asked a trader, his answer until Tuesday would
have been, without hesitation: Hermes. The luxury house trades at 34 times 2015 forecast earnings.
But yesterday, when luxury sports car maker Ferrari debuted as a rocket on Wall Street, the answer
would have been different. At $60 per share, a level hit at the opening, Ferrari is the new queen of
luxury: 35 times 2015 forecast earnings.
– “Mission Accomplished: Ferrari Debuts at Hermes Multiples,” Italy24, October 22, 2015.

A second valuation methodology widely used by investors and analysts was comparable multiples. A comparable was
any business or firm that would be considered a close competitor. A comparable valuation multiple is any form of
comparison across companies using a ratio or multiple of other financial values. When valuing companies, this
typically involves combining a market-based value measure, like share price, with a financial statement value,
like earnings or cash flow.

One of the challenges in using multiples is always what to conclude from the numbers. A firm having a
higher value than the average of the market or its industry could be reflecting the market’s conclusion that the
firm is in some way superior to the average, reflecting a price premium that may persist. Alternatively, it might
be that the higher value reflects a short-term mispricing of the firm’s shares in the market, and if the market is
rational and logical in its movements over time, the firm’s share price should then return to near the average of
the market in the near future, the so-called reversion to the mean.

One of the most widely used multiples was the price-to-earnings ratio (PE), the ratio of an equity’s current
market price per share to the firm’s earnings per share. If the calculation used the company’s most recently reported
earnings, it was termed PE or trailing PE. Alternatively, if the PE was calculated using some estimate of the firm’s
future earnings, usually 12 months into the future, it was termed Forward PE.

Exhibit 7 provides a collection of price-based multiples for Ferrari in January 2016. These multiples would
seem to support Ferrari’s management argument that the company was, in the eyes of the marketplace, valued more
like a luxury good brand rather than a traditional automobile manufacturer. Although final financial results for
2015 were not yet available, earnings were thought to be €1.58 per share. Consensus estimates of 2016 earnings
for Ferrari (future earnings) were approximately €1.69 per share.

A second multiple widely used in industry was the Enterprise Value (EV) to EBITDA multiple. Enterprise
value is the sum of the current market value of the company’s debt and equity less cash. Many practitioners
prefer the EV/EBITDA multiple over PE ratios because of the belief that PE ratios are affected by company
capital structures (and all capital structures are different), whereas EV/EBITDA is not. The consensus forecast
for Ferrari’s 2016 EBITDA was €800 million.
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Exhibit 7. Ferrari’s Market Value in Multiples

Auto Industry Luxury Industry
21 January 2016 Ferrari Daimler BMW Auto Hermes LVMH Luxury
Multiple (RACE) (DDAIF) (BAMXY) Industry (HESAY) (LVUMY) Industry S&P500
Price to Earnings 31.7 9.1 9.3 11.7 33.0 12.6 20.2 19.0
Price to Earnings Forward 18.8 7.4 8.4 --- 24.9 15.5 --- 17.2
Price to Book Value 3.1 1.4 1.3 1.4 9.4 3.1 3.1 2.7
Price to Sales 2.9 0.5 0.6 0.5 6.8 2.2 1.7 1.8
Price to Cash Flow 12.5 0.0 35.3 0.1 29.1 20.9 12.7 11.5
Dividend Yield 0.0% 3.7% 3.8% 2.3% 1.0% 2.3% 2.4% 3.0%
 
Price per share (USD) $41.94 $71.49 $28.80 --- $32.98 $31.09 --- ---
USD to = 1 EUR 1.0814
Price per share (EUR) € 38.78 € 66.11 € 26.63 --- € 30.50 € 28.75 --- ---
Source: Data collected from Yahoo, Morningstar, JPMorgan, S&P, The Wall Street Journal.

If Ferrari was indeed more of a luxury good than an automaker, then its financial performance needs to
be evaluated in that comparable context. Exhibit 8 offers one such comparison. Here, Ferrari’s EV/EBITDA
multiple is compared to a multitude of European luxury goods sellers.

Exhibit 8. Ferrari’s EV/EBITDA vs. European Luxury Peers

Source: Ferrari NV: The Ferrari ‘Bond’, Initiate Overweight With $56 PT, Morgan Stanley Research, December 7, 2015, p.47.

Horse Trading
The expression horse trading has long meant that negotiating the price of anything—including a horse—was
complicated, as the determination of true value was very difficult. Ferrari had now been publicly traded for more
than 12 weeks, giving the market time to digest the IPO and form an opinion on the company. But, as illustrated
by Exhibit 9, Ferrari’s share price had largely slid since the IPO. Down nearly 30%, many analysts were coming
to the conclusion that Ferrari had indeed been a one-trick pony—and the market had seen the trick.

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Exhibit 9. Ferrari’s Share Price Since IPO (NYSE: RACE)

Source: Constructed by author from closing shares prices for RACE as quoted by Yahoo.com

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Appendix 1. New Business Netherlands N.V. Consolidated Income Statement

For the years ended December 31,
(€ thousand) 2014 2013 2012

Net revenues 2,762,360 2,335,270 2,225,207

Cost of sales 1,505,889 1,234,643 1,198,901
Selling, general and administrative costs 300,090 259,880 242,819
Research and development costs 540,833 479,294 431,456
Other expenses/(income), net 26,080 -2,096 16,534
EBIT 389,468 363,549 335,497

Net financial income/(expenses) 8,765 2,851 -898

Profit before taxes 398,233 366,400 334,599

Income tax expense 133,218 120,301 101,109

Net profit 265,015 246,099 233,490

Net profit attributable to:

Owners of the parent 261,371 240,774 225,403
Noncontrolling interests 3,644 5,325 8,087
Source: Form F-1 Registration Statement, New Business Netherlands N.V., p.373.

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Appendix 2. New Business Netherlands N.V. Consolidated Statement of Financial Position

  At December 31,
(€ thousand) 2014 2013
 
Assets
Goodwill 787,178 787,178
Intangible assets 265,262 242,167
Property, plant and equipment 585,185 567,814
Investments and other financial assets 47,431 37,911
Deferred tax assets 111,716 41,543
Total nooncurent assets 1,796,772 1,676,613
 
Inventories 296,005 237,496
Trade receivable 183,642 205,925
Receivables from financing activities 1,224,446 862,764
Current tax receivable 3,016 1,297
Other current assets 52,052 39,163
Current financial assets 8,747 74,759
Deposits in FCA Group cash management pools 942,469 683,672
Cash and cash equivalents 134,278 113,786
Total current assets 2,844,655 2,218,862
 
Total assets 4,641,427 3,895,475
 
Equity and liabilities
Equity attributaable to owners of the parent 2,469,618 2,289,506
Noncontrolling interests 8,695 26,776
Total equity 2,478,313 2,316,282
 
Employee benefits 76,814 65,479
Provisions 134,774 103,785
Deferred tax liabilities 21,612 27,958
Debt 510,220 317,304
Other liabilities 670,378 470,325
Other financial liabilities 104,093 4,485
Trade payables 535,707 485,948
Current tax payables 109,516 103,909
 
Total equity and liabilities 4,641,427 3,895,475

Source: Form F-1 Registration Statement, New Business Netherlands N.V., p. 377.

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Appendix 3. New Business Netherlands N.V. Consolidated Statement of Cash Flows

For the years ended December 31,
(€ thousand) 2014 2013 2012

Cash and cash equivalents at beginning of year 113,786 100,063 94,025

Cash flows from operating activities:

Profit before taxes 398,233 366,400 334,599
Amortization and depreciation 288,982 270,250 237,540
Provision accruals 66,274 24,095 41,932
Other non cash expense and income 53,348 31,818 37,007

Net gains on disposal of PP&E and intangible assets -742 -1259 -1166
Change in inventories -65,548 -19,549 -18,940
Change in trade receivables 824 -81386 8857
Change in trade payables 12,986 14,260 24,770
Change in receivables from financing activities -201,692 -56,531 -148,422
Change in other operating assets and liabilities 14,322 44,700 80,665
Income tax paid -140,920 -138,784 -134,322
Total 426,067 454,014 462,520

Cash flows used in investing activities:

Investments in property, plant and equipment -169,363 -161,653 -161,380
Investments in intangible assets -160,635 -109,250 -96,972
Cash acquired in change in scope of consolidation 38,751 0 0
Proceeds from the sale of PP&E 1,828 1,939 2,664
Change in investments and other financial assets -358 1,622 -1,960
Total -289,777 -267,342 -257,648

Cash flows used in financing activities:

Proceeds from bank borrowings 80,745 15,208 10,495
Repayment of bank borrowings -1,715 -10,010 -916
Net change in financial liabilities with the FCA Group 89,075 50,638 -292,588
Net change in other debt -27,638 8,189 22,877
Net change in deposits in FCA Group cash management pools -247,034 -227,495 72,887
Dividends paid to non-controlling interests -15,050 0 -7,148
Total -121,617 -163,470 -194,393

Translation exchange differences 5,819 -9,479 -4,441

Total change in cash and cash equivalents 20,492 13,723 6,038

Cash and cash equivalents at end of the year 134,278 113,786 100,063

Source: Form F-1 Registration Statement, New Business Netherlands N.V., p.379.

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Appendix 4. Unit Sales by Geographic Region

Number of cars For the 3 months ending March 31 For the 12 months ending Dec 31
2015 % 2014 % 2014 % 2013 % 2012 %
EMEA
UK 210 12.84% 168 9.70% 705 9.72% 686 9.80% 686 9.26%
Germany 92 5.63% 163 9.41% 616 8.49% 659 9.41% 755 10.20%
Switzerland 72 4.40% 88 5.08% 332 4.58% 350 5.00% 366 4.94%
France 58 3.55% 68 3.93% 253 3.49% 273 3.90% 330 4.46%
Italy 51 3.12% 64 3.70% 243 3.35% 206 2.94% 318 4.29%
Middle East (1) 138 8.44% 150 8.66% 521 7.18% 472 6.74% 423 5.71%
Rest of EMEA (2) 144 8.81% 162 9.35% 604 8.33% 663 9.47% 825 11.14%
Total EMEA 765 46.79% 863 49.83% 3,274 45.13% 3,309 47.27% 3,703 50.01%
 
Americas(3) 515 31.50% 552 31.87% 2,462 33.94% 2,382 34.03% 2,208 29.82%
Greater China (4) 134 8.20% 111 6.41% 675 9.30% 572 8.17% 789 10.65%
Rest of APAC (5) 221 13.52% 206 11.89% 844 11.63% 737 10.53% 705 9.52%
Total 1,635 100.00% 1,732 100.00% 7,255 100.00% 7,000 100.00% 7,405 100.00%
(1) Middle East includes the United Arab Emirates, Saudi Arabia, Bahrain, Lebanon, Qatar, Oman, and Kuwait.
(2) Rest of EMEA includes Africa and the other European markets not separately identified.
(3) Americas includes the United States of America, Canada, Mexico, the Caribbean, and Central and South America.
(4) Greater China includes China, Hong Kong, and Taiwan.
(5) Rest of APAC includes Japan, Australia, Singapore, Indonesia, and South Korea.

Source: Form F-1 Registration Statement, New Business Netherlands N.V., p.39.

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