Ferrari: Magic from Maranello - [Business Breakdowns, EP.140]

28:02I suppose you can put in two British brands in there, Aston Martin and McLaren. Aston Martin is an interesting one we know well and actually run by Ferrari's ex -CEO. Under the Lawrence Stroll's leadership for the past few years, they have made progress and they have behaved more like a luxury brand. It does have a degree of heritage, but the breadth and depth of the client base and the product portfolio would take a long time to build up. I think you'd say that McLaren also faced some of the similar challenges. Just electrification is a wild card. Perhaps it's something that we can come on to later.

28:41Yeah, we will definitely get there. It feels very much like you're joining a club when you buy a Ferrari rather than necessarily buying a car. And the club just happens to be one of the most exclusive clubs on the planet. We've gotten probably half an hour into this discussion. We haven't really talked about the financials, which I'm sure will agitate a few people. So let's go there now. Everything that we've talked about, how does that translate into dollars and cents if you talk us through the high -level numbers and then we can dig into them? Sure. So the revenues this year is expected to be close to 6 billion euros.

29:11Nearly 90 % of that would be related to selling cars or spare parts. The remainder are coming from racing and sponsorship, but they also have a lifestyle segment. So they moved into a high -end fashion in a more serious manner past year or so. They make mid to high 20s EBIT margin, which is incredible for a car company. That's why we don't think it is one. Business is hugely cash generative. It paid down much of the debt that it inherited from the Viet Chrysler spin -off back in 2015. And so it returns a good chunk off its free cash flow to shareholders through buybacks and dividends. If we were just to make some comparisons, particularly around the margin profile of the business, both to more traditional car companies and then other luxury goods companies, where would this business fit?

29:59Labels is an interesting thing. We talked a bit internally. We talked a lot about whether this is a car company or a luxury company. So car companies, if you're talking about single -digit operating margins, if you're lucky, maybe low double digits, low teens. For example, Porsche would be high teens. That's very good for a car company. Luxury goods is more in line with Ferrari, 20 % plus 30 % plus operating margin. So Ferrari is very much in that club. You said something provocative when we talked ahead of this discussion that this is almost a SaaS -based model in terms of the way that they earn revenue.

30:38Can you explain that thinking and why you might compare it to what we generally think of as a technology business model? I made that comment, partly trying to understand the revenue drive for this business. We talked about the top collectors earlier. And to become a top collector, you do need to build up a profile. And the SaaS comparison is very much a reference to, hey, you need a regular record of buying multiple Ferraris to be considered a top collector. It's not quite a subscription stream, but there's an element of a regularity that goes beyond a single discrete big purchase. That point around VIPs, to me, is fascinating.

31:18We talked about the SP3 Daytona earlier. It's limited to $599, $2 million plus. Think of Ferrari's revenue of $5 .9 billion this year. On its own, it is quite significant. And that's without considering the purchase record it takes to get there. One way to think about the financial is not just to think, okay, 13 ,000 cars multiplied by the average price per unit. How can we flex those numbers? What I'm trying to do is try to understand the underlying driver. What is the unit economics? So approach it almost from an angle of, okay, the lifetime value of a collector looks something like this. How is Ferrari building that business, that hierarchy of clients who've got this pyramid?

32:11Are they expanding the base of the pyramid or are they stretching the pyramid to ever higher and higher heights? And so I think these are different mental models for us to think about Ferrari in different ways to try to take into account many fascinating dynamics we touched on earlier. I would love for you to answer that question for me about whether they're expanding the base or stretching the pyramid. I'm presuming they're doing both, but maybe we can just unline exactly how and what that means. Ferrari does disclose some statistics on the size of the client base. So over the past five years, they have expanded their client base meaningfully.

32:48I would say that a positive signal for me in the past couple of years is the launch of the 296 GTB and GTS, which is a hybrid model with a V6 engine. This is the start of a new product lineage. Effectively replaces the V8 mid -engine supercars. my understanding is that the 296 really brought in a lot of interest from a lot of new Ferrari clients. So thinking through that lifetime value, it's the beginning of a lot of new cohorts. You may not be able to get one just now, but it is a model that signals the start of something new. From what I can tell, the 296 appeals to existing Ferrari clients as well, as well as building, attracting the next generation of Ferraris, if you will.

33:41That's expanding the base of the pyramid. And there are stats like, I think, 40 % of the new clients would be under 40. So there are various snippets that suggest that Ferraris aren't just bought by 60 and 70 -year -old petrolheads. They are bringing in a new generation of Ferrari fans. And for me, that's a very positive signal. Thinking through that pyramid is they are expanding the base. the collectors are the number of ferraris in the collectors garage are going up and so they are coming up with new pathways for ferrari fans who are just starting the journey to move up so these are all the dynamics that we traditionally think of where we analyze sas business models or subscription -based business models and what are the cross -sell opportunities or are they how you would improve the ASP, how do you improve client retention?

34:34And I'm just really borrowing frameworks from analyzing different businesses to try to understand what's going on here. Yeah, it makes a lot of sense to me. The one thing that they have working against them, as do most luxury businesses, is that they can't just keep growing volumes because at some point that will reduce their exclusivity and start tarnishing the brand. There are other levers that they can pull in order to make the business more profitable in terms of a margin profile, how do they operate this scarcity versus increasing profitability? First of all, I'd say that I would be somewhat concerned if unit volume accelerates.

35:11So that 13 ,000 going up slightly every year, that's perfectly fine. But the opportunity here is very much increasing the lifetime value of collectors, bringing new collectors. How you square that with a volume growth that's more pedestrian would be, first of all, customization. A typical Ferrari, the options would be, I don't know, $50 ,000 or $60 ,000 or $70 ,000 US dollars, I'm just guessing here. But for me, it's quite interesting that the top level of customization called tailor -made was only launched, I think, just over 10 years ago. There are huge opportunities for Ferrari to push that further.

35:52Ferrari is coming with new ways to engage the community all the time. So that part of it I'm quite optimistic about and this one is shouldn't be. I think I remember seeing in the summer that they had to revise their profit guidance up earlier this year based on the number of personalizations that they were doing. And obviously they're very beneficial to the bottom line of this business. The one I think that stands out a little bit is they have this fashion segment, which is a very small piece of the business at the moment, but they look like they're really trying to push it and grow it. What is this and why are they doing it?

36:25I don't really have a huge amount of insights on the spot of the business myself. I would say that over the past few years, they have taken the non -car parts much more seriously. Their license agreements where a partner can come in and license a Ferrari brand and put it on products where that hasn't gone through Ferrari's own internal processes. that have really taken that control in -house much more in the past few years. And fashion is an area that they are taking very seriously. Now, I can't say how I've gauged the probability of success, but the fact that they are experimenting is great. And they seem to be doing it in a thoughtful way and very much leveraging the existing brand equity.

37:10So we'll see what happens there. Is it just another way of expanding the bottom of that pyramid? A 25 -year -old might be able to buy a jacket from Ferrari and they've been a Ferrari fan for their whole life, but they won't be able to buy a Ferrari until they're probably early 40s, for example. And so just another way to get people into the brand early. And then hopefully if they strike gold, they're then able to join the club in a more traditional sense. That's right. I think related to that, I talked about 296 earlier, bringing in new clients. It's the same with the Perisangue. Potentially, it's the same with Roma.

37:45they talk about offering different Ferraris for different Ferrarisities. I think it's the same concept. They need to be very clear about what Ferrari stands for. But within those confines, they are pushing full trust in the company on how they manage exclusivity in the brand. That's a very important part of the investment case. The other piece of the numbers is the cost profile. Is there anything interesting in there? Maybe it's that they spend more on R &D than other businesses or they spend less on marketing. Is there anything that stands out that says that's part of the Ferrari DNA? Optimizing manufacturing efficiency isn't really a priority here.

38:23If you look at the line between gross margin and operating margin, gross margin is at mid -40s percent. More than half of that would be on R &D. Now, Ferrari doesn't have a big parent where they can leverage research. In some ways, that's to be expected. there are bigger car makers like mercedes that do make high -end cars that do make a race cars obviously they can draw on the technology stats so the investments that mercedes make across a much bigger bigger base off units so direct comparisons on the cost base would be difficult yeah mercedes is a really good example i think because they obviously have a formula one business they make the high -end cars plus more mid -range cars as well their formula one business is very separate to the rest of the company, both in location and I think in ideology.

39:15The Formula One business we've touched on a bit, how meaningful is the team to the financial profile of the company? The investment case for Ferrari is very much, for me, based on the car business. Formula One is, I think as I said earlier, the non -car business is about 10%. I don't really expect that to be much bigger. Obviously, they would love to have more success on track in Formula 1. There are useful R &D value in running motorsports, especially on the powertrain and when it comes to having people move sometimes between the racing operation and the car design. It's useful to know how to share sometimes.

40:01That's the most important part of that is to get the Ferrari brand out there. That's the true value of motorsports in my mind. I say motorsport rather than Formula One because they have re -entered Le Mans in the past year. And won it. Yeah, they won it. So creating new stories rather than always talk about 60s and 70s and so on. It is a very important part of the company's brand building and DNA. When you talk to Ferrari employees, racing is always top of the mind, and that's completely authentic. And I would also say that Ferrari is the national team, obviously, when it comes to motorsports.

40:41You just have to go to the Italian Grand Prix and realize the passion of the fan base. So it's almost a parallel. Ferrari is in the middle of this cluster of motorsports companies and high -end car companies. The racing DNA is, of course, heavily contributed by Ferrari, but it's that region that it does have that racing heritage that goes beyond just Ferrari. We talked a lot about selling new Ferraris. One interesting piece that kind of extends across the luxury landscape is the secondary market. How closely do they watch that and or care about it? I can't really speak for themselves, but it's very clear that the pre -owned markets for Ferraris is in a much stronger position than many of the other high -end sports car companies in terms of value retention.

41:32It's an interesting stat. Last time I checked, the top 30 most expensive cars ever sold in auction, Ferrari truly dominates. I think you're talking about 20 out of the top 30 with some Jaguars and Aston Martins and Mercedes making up with the rest. And the reason that's the case would be when you buy a Ferrari, there's an implicit commitment from the company to support the maintenance of these cars. So when a car gets to 20 years, it's officially a vintage. You can certify it again. You get into the official Ferrari program. They would say that Ferrari is for life. You do not scrap a Ferrari. So thinking about most cars, they depreciate for 7, 8, 9, 10 years.

42:19And if it's scrapped Ferrari, that's not the case. So value retention, of course, they depreciate in the first few years of their life, but it hits a certain point and is stabilized. And for the limited editions, quite often they appreciate. I'm sure this is something that Ferrari themselves monitor, but I don't have the insight to tell you exactly what they do with it, other than to say that pre -owned Ferrari, Ferraris tend to retain their value much better than those obvious peers. I guess if you really look after who's buying these cars and you know their history with the business and you're not afraid that they're going to flip the car in a week's time, once you bought it, then that will surely help supply in the secondary market or limiting it anyway.

43:02One of the biggest threats, it seems like from the outside to a business like this, is the electrification of the car industry and general climate concerns about internal combustion engines and the car industry itself. I want to start with a very broad question of how do you view electrification with regards to Ferrari's future? We've held the Ferrari directly and indirectly for over a decade, the stocking of portfolio. The implication of electrification is the most wholly debated topic. We are big believers in EVs. We believe the future is electric and we have crossed that tipping point. It's clear that we need to decarbonize transportation.

43:46Ferraris are not about transportation. They would say to themselves, and then we completely agree, that Ferrari should not be considered a mode of transportation. And the implication is that turning Ferraris completely electric wouldn't make sense from an environmental standpoint. Think about an EV. An EV takes more energy to make upfront, but you get that payback over years through the use phase. For Ferraris, they get driven 2 ,000 miles a year. So you can make a full battery Ferrari and you may not get that payback. So for us, it makes sense for Ferraris to focus on hybrid in the short term.

44:27And interestingly, in the last quarter, looking at the outputs, hybrids, i .e. the 296, is over 50 % off shipment. In the future, they are already committed to launch a battery Ferrari in 2025. Now, social license is very important and they're working very hard in general to reduce the emissions of scope one and scope two in making the car itself. So they are leaving it up to the clients to say, hey, if you want a V12 engine, we do that. We've got a hybrid Ferrari that offers amazing performance, and they are doing electrification for performance reasons. They have always been very clear on that.

45:13And they're also investing in battery technology and developing a battery Ferrari that's in keeping with the character. We have every confidence that Ferrari can keep that obsessiveness and develop true Ferraris regardless of powertrain. But of course, it is a moving part. I would say one more thing. In thinking through the megatrends of the automotive industry, electrification is one part of it, but also autonomous driving is another, and who knows where ownership of automotive will go. And the trend is that cars are becoming more about utility, and Ferrari is about the opposite. Those two directions point in different ways.

45:58On the one side, we might worry about disruption. Is Ferrari going to be less relevant in the future? But the other scenario would be that when you have a product category that becomes more and more about utility, it opens up the space for creativity. It opens up the space for ever more high -end products. And we've seen that with watches in that they have gone through multiple disruptions. Think about the quartz crisis in the 70s. The watch industry has been making intricate mechanical movements for hundreds of years. And then Seiko came along and said, hey, here's a battery -powered movement, and that's much better than the mechanical one in terms of precision, just objectively speaking.

46:46It's much cheaper. You can tell the time much better. At the time, the watch industry would go through a crisis. You were saying earlier, you were listening to a podcast on a luxury brand. And guess what? All the top luxury brands in watches make mechanical movements. They make mood faces. They make tubions. They make minute repeaters. All of these are completely useless. But that's in some ways what luxury is about. They go over the top. And the value is in the complexity itself rather than the function. And I think this is the direction that the car industry could be going. And that's, I think, where Ferrari's prospect can be very bright in that you almost completely get rid of the constraint of making something that's practical and everyday.

47:38You can really let loose on human creativity. You talked about Porsche a bit earlier. It's often called the everyday supercar. Ferrari's not an everyday. They don't want to be. I think that's quite an interesting parallel. That's a fascinating idea that actually, as the car industry moves to electrification, maybe Ferrari stands out even more than they have done to this point. The analogy to the quartz crisis is going to be a really interesting one to watch because those businesses got sucked into making quartz watches. And then they ended up saying, no, what we're about is these mechanical ones.

48:12That's what people want to buy us for, despite them not being able to tell the time as precisely as these battery operated watches. Do you see that as a short term risk here with Ferraris? they've said they're going to build an electric car. They're already building hybrid cars. Is that potentially a risk in the short term that they get pulled along by the mega trend and then in 10 years time they say, oh, we've lost what made us Ferrari in the first place? They're producing hybrid Ferraris and they are developing pure electric Ferrari for the right reasons. It is about performance and enjoyment.

48:44They've been very clear on that. So take the hybrid because you've got this electric motor It makes acceleration even better. Even with the EV version of a Ferrari in 2025, one common concern would be that, hey, you're losing that C12 sound or C8 sound. That's been such an important part of supercars. But they've also been very clear that, look, battery electric Ferrari will still have a sound signature and they're infesting a lot in that. We've only got so many sensors to work with. they will not give up on sound as part of the experience. Driving pleasure is not just about sound. It's not just about straight line acceleration.

49:28It's about braking. It's about balance. It's about lateral acceleration. And all of those things are expertise that Ferrari has developed over many decades. And I must say, when Tesla first came along and you see all these YouTube videos of Tesla's going faster than all your traditional supercars, the question is, hey, where does this leave the traditional supercar companies? Ultimately, for a company like Ferrari, because they don't need to make practical cars, they would end up making design choices that are very different to EVs that are designed with everyday use in mind. So there's scope for them to differentiate.

50:12And this is something that I'm probably now a bit more comfortable with than, let's say, five years ago, when it's clear that's the EV tipping point that's coming our way. And if we think about the management team, clearly they have an interesting balance to strike here with this business based on everything that we've talked about. Is there a story there that we should know in terms of who runs the business now? Obviously, Enzo was part of it for a really long time. Who now oversees the operation? What does the board look like? walk from the management team is interesting. So the CEO is Benedetto Vigna.

50:44He has been in the post since 2021. He was a physicist by training. He was a prolific inventor with, I think, hundreds of patents under his name, as well as an accomplished executive at STMicro, which is a leading semiconductor company, before joining Ferrari. This may seem like a surprising background for a Ferrari CEO, but there's, of course, strong automotive and luxury expertise amongst the top team to complement the CEO's tech background. The board is fantastically diverse. You'd never guess the company makes cars just by looking at the board. So lots of luxury experience, caring, LVMH, and so on.

51:28There's an Apple executive, which perhaps ties in with the importance of tech and client relationships and services and so on. There is a lead shareholder here in Ferrari, Exor, which is the holding company of the Agnelli family. So Gianni Agnelli's grandson, John Elkan, is the chairman of the board. He's someone that we have interacted with, and we have a lot of respect for. The second biggest shareholder would be Piero Ferrari, who's Enzo Ferrari's son. I think like many luxury businesses, the long -term perspective offered by these anchor shareholders really matters. If we think about the future in terms of your most bullish picture that you could paint us, what does that look like?

52:12Because it doesn't seem like there's going to be a huge inflection point here. The process of managing a luxury brand like Ferrari is steady, constant improvement. You're growing volumes marginally, if at all, but you're trying to get margin improvements over time. What would the most bullish picture you paint us be? It is very much about the longevity of the opportunity. With all luxury companies, if they grow too fast and make us nervous, I would use that pyramid that we've talked about earlier as the framework for understanding the long -term bullish scenario, adding a new generation of ferrariety at the base, they might take time to get through.

52:49But we know some very promising signs there. And at the top, we suspect there's plenty of room for that to grow, for that pyramid to get ever taller. That would be the direction that I would investigate. It's interesting that for almost all of us, 300 ,000, 400 ,000 sounds like a lot for a car when your mass market car is more like 30 ,000. But you're thinking through the fast wealth of those right at the top, your classic Ferrari customers. The ratio of their wealth versus someone average would be much more than 10 or 20 times. Going back to the watch analogy, Patek Philippe starts at five figures but can go easily up to six figures.

53:35What's the ratio of that relative to an average watch? It's way more than 10 times. So I think at the top, there's plenty of room to stretch further. And as long as the company manages that brand and carefully with the long -term in mind. It is always very hard to evaluate companies with that longevity. We talked very similarly about Hermes when my colleague Mark Kirkett came on the show, and it's a similar sort of dynamic. For us, it's all about the culture and how carefully they manage that brand and cultivate the very small group of collectors. It is about the lifetime value, if you will. I don't know what the value of the top 1 ,000 clients is, but I suspect that's a very big number.

54:19So it's got plenty of zeros. One of the things that I should have asked earlier in the discussion was just the markets in which they sell into. Often we talk about brands like this, and Asia has become an important place where they sell into. One way of maintaining scarcity is by selling into a market where there traditionally hasn't been many of your products. So when you go out on the streets, you don't see as many Ferraris, but they are actually selling more Ferraris. They just happen to be in a different place in the world. Is that dynamic similar here? Yes, it is a very global distribution ready.

54:50It's interesting you brought up that point. For years, they limited themselves to 7 ,000 cars under Luca Montezemolo. They very much said 7 ,000 cars is the limit. We want to be exclusive. It is somewhat arbitrary number, but part of the rationale for increasing that and still be able to have that exclusivity is because the new sources of wealth around the world. And it's not like you see multiple Ferraris on your average city, with certain exceptions. I think part of managing that exclusivity also comes from collectors, the best collectors having more Ferraris. So you're not seeing a flood of Ferraris on the road because your best collectors can only drive one at a time.

55:36And most of the time, actually, they're driving some of the cars for their transportation or purposes. That's an interesting dynamic. and it's something that I would watch as the Ferrari portfolio becomes more electrified. It's very important to keep that sense of vacation. When you see or drive a Ferrari, the electric Ferrari experience should be no different in that regard. And that's something that they'll have to manage. It's going to be amazing to see what that electric Ferrari looks like, sounds like, feels like, will be an interested observer. Brian, this has been a really, really interesting discussion about one of the most interesting brands in the world, I would argue.

56:12We always finish these discussions with the same question. And that's, what have you learned from your time with and studying Ferrari that you could share for fellow investors as well as operators? First of all, I think that's a phenomenal question. And actually, incorporating that into our investment framework when it comes to reviewing companies. I would point to two things. We've talked a lot during this podcast about whether as a car company and a luxury company. So for me, the broad point there would be that as human beings, we like to categorize things, put things into boxes. And in the context of the financial industry, that makes sense.

56:50We talked about mental models and mental shortcuts. So I guess the first lesson I learned is if you have to categorize things, make sure you get it right. I think better still for investment research, we should really discard these labels and really think from first principles instead. This lesson really applies very broadly. I'm very used to artificial binary divides and markets are emerging markets or developed markets. Growth or value are companies, small capital or large capital. These are all boxes that we'll put things into. When it comes to critical investment thinking, we should go beyond that.

57:27And Ferrari is a particularly good example to remind us, don't be lazy and rely on labels for our investment inside. The second lesson would be thinking through Ferrari's edge. Well, it's a company with one of the strongest competitors for edge that I know. But if you ask me to articulate it, and I think I have struggled in this episode to truly articulate it well. I can't point to something that Ferrari does that no one else can. It's not like an ASML where they are the only company that can make an EUV machine. It's not like an AI company or leading internet businesses where they clearly benefit from network effects, two -sided or three -sided.

58:12Here, the edge is more combinatorial. It's a bunch of little things that they do extremely well and are completely obsessed about that in combination makes them unique. I think that's an important lesson. And sometimes, certainly when I do investment research, we sometimes try to figure out investment competitive edge in isolation. What is it that they can do that no one else can? But quite often, the answers can be more nuanced. And I think that combinatorial points is one that we can apply quite broadly. Super set of lessons. It's very difficult to attack a moat that you can't put your finger on, which is probably a good thing to have as well.

58:52It's very easy to chug a one ball, but when it comes to three or four or five, it gets exponentially harder. And we've certainly observed with other luxury companies that can do one or two but struggle with three. It's exactly the same dynamic. And I think that's what makes Ferrari special, having that ability and discipline to act like a luxury company, maintain that obsession, and have a clear set of DNA that backs up the brand. and even harder to do it for decades and decades. This business is past 75 years old now, which is extraordinary. Thank you so much for breaking Ferrari down with us.

59:29Thank you so much. This has been fun. To find more episodes of Breakdowns ranging from Costco to Visa to Moderna or to sign up for our weekly summary, check out joincolossus .com. That's J -O -I -N -C -O -L -O -S -S -U -S .com.