As many of you may know, on March 27, 2008, Ford (F) completed negotiations to sell its Jaguar and Land Rover divisions to Tata Motors (TTM), a division of the Indian conglomerate Tata Group.
The deal went for a reported $2.3 billion, despite Ford’s original cost of $5.2 billion for the duo ($2.5 billion for Jaguar in 1989 and $2.7 billion for Land Rover in 2000). However, after Ford pays $600 million into the pension funds of these companies, the deal will only net them $1.7 billion.
But with total losses exceeding $15 billion in just the past two years alone, Ford was clearly desperate. It had no choice. It needed cash, and fast.
After spending enormous amounts of money to clean up production inefficiencies of the UK-based Jaguar unit, Ford has completed most of the work needed to transition Jaguar to a wider market. But sales for Jaguar have been on the decline ever since hitting the 2004 high of 130,000. Although management felt they could achieve 300,000 units by 2007, only about 60,000 were sold. With economic conditions accelerating downward, 2008 numbers are likely to be even lower.
Any Jaguar mechanic will tell you Ford delivered numerous improvements to the auto line, perhaps most notably within the electrical system. As well, the assembly line was streamlined to make it more efficient.
And with the release of the new models in 2004, the all-aluminum body has reduced the total body weight substantially, accounting for the much improved fuel efficiency, now at 28 mpg (highway) for the XJ8 – quite impressive for a car of that size and power.
What Went Wrong
Ford made a big mistake in brand strategy with Jaguar. In an attempt to seize some of the very hot $30,000 luxury market, Ford introduced the X-type in 2001, thinking it could compete with BMW’s 3-series. The release of the poor performing X not only angered current XJ and S-type owners, but made many prospective buyers view the model as a Ford clone in disguise, with poor styling and performance.
While the XJ remains as one of the best luxury sedans for the money, the X-type is perhaps the worst. This blunder aside, with most of the work already done restructuring Jaguar, Tata Motors stands to win big from the deal.
The story with Land Rover was much different. Ford used the right combination of product style and mix to turn a lingering brand (formerly owned by BMW) into a profitable unit. Ford did what BMW was unable to do – turn a profit on the Land Rover. Land Rover was becoming a very profitable unit and showed a lot of promise.
In 2006, sales increased 18% to 226,000. So why would Ford sell off this investment? The answer may well indicate the extent of Ford’s problems. After having sold Aston Martin a year earlier for $925 million, Ford is running out of liquid assets. And soon it will have very few choices available as it attempts to emerge from a very deep hole.
The Value of Jaguar and Land Rover
Let’s take a closer look at the value of these two luxury brands. Although valuation of intangible assets is highly subjective (especially for brand assets), in my opinion the Jaguar and Land Rover brands alone are worth a combined $2 billion.
First you should understand that brand recognition has multiple sources of potential revenue streams. The Jaguar brand name can be licensed out to sell retail goods and even be partnered with services. And of course, each brand can be licensed for distribution rights in specific geographic markets such as those in Europe and Asia. The same is true with Land Rover. Dealers pay a flat fee plus a percentage of revenues in exchange for the rights to sell and service these autos, similar to other franchising arrangements.
But if the autos aren’t selling there won’t be a demand for dealerships and revenues will fall. Next, consider how brands are built. It takes many years of customer satisfaction and hundreds of millions of dollars for R&D, marketing and promotional activities to build a reliable brand. So when looking at the revenue potential as well as the capital invested, these two brands have significant value.
Now let’s look at other intellectual property such as design and technology patents and manufacturing and operational trade secrets. Without going into the details, I would roughly estimate this intellectual property to be worth $2 billion, at minimum.
But the ability to generate revenues from these assets on a short-term basis is limited. The real potential rests upon the ability to sale the vehicles. Thus, the synergy of these intellectual assets is what really matters. And that depends on how well management executes all of the operations to produce sales. In other words, sales ultimately determine the income potential and therefore the valuation. However, the value of these assets may also be determined by considering the cost to develop similar assets (that is creating a strong luxury brand name, R&D manufacturing and design patents and manufacturing trade secrets) by starting with nothing or by leveraging current assets. Most likely, when Tata analyzed the deal, management calculated both the value of these assets, as well as the estimated costs to create similar assets.
Finally, while I have no numbers on the tangible assets such as facilities and equipment or how much if any debt or lease payments were attributable to these assets, I would say a reasonable estimate would place this figure around $700 million.
Combining the intangible and tangible assets and assuming reasonable execution, I would value the deal roughly at around $8 billion for synergy effects. Without reasonable execution, the deal would be worth about $4.7 billion (i.e. for the “bare bones” valuation of the intellectual property, equipment, plants and facilities).
Thus, either way, Ford handed Tata Motors a great deal. At the very worst of all scenarios, Tata paid $2.3 billion for facilities and equipment, access to (and ownership of) state-of-the-art automotive R&D, manufacturing and design secrets and other valuable know-how, which would otherwise take many years and billions of dollars to match.
But the closing of this deal wasn’t valued based on what Tata stands to gain but rather how desperate Ford was for cash. Ford’s desperation, along with what appears to be a fairly uncompetitive bidding process enabled Tata to walk away with a sweet deal. In exchange, it bought Ford another year or two before having to take even more drastic measures.
Why No One Showed Up to Bid
With so many LBO and private equity deals being made, one might ask why, apparently very few stepped in to bid for Jaguar and Land Rover. Official reports have not disclosed all bidders. But even if a financial firm was interested, it is likely they would have targeted Asia for the sale.
As we have seen, private equity and LBO deals have dried up due to the credit crisis. Ironically, private equity firms would rather invest in troubled US financial firms like Citigroup (C), Bank of America (BAC), E-Trade (ETFC), Wachovia (WB), Washington Mutual (WM) and others because they know the financial system is supported by the Fed Reserve.
Why would any US investment house bother to buy a manufacturing firm when America can no longer compete with the Asian and Latin American workforce? It’s not that Asians and Latinos do better work or work harder. It’s that their labor is much less expensive. So instead of spending money on a dying industry, why not invest in some troubled banks, knowing the Fed has opened up the printing presses when needed?
Playing Its Last Hand
Although Ford bought Volvo in 1999 for $6.4 billion, it has been the company’s best seller of the premier brands. But as a part of its only remaining way to raise cash, Ford has been looking for potential buyers for Volvo for over a year.
While talks were in place with BMW in 2007, nothing came out of this. Perhaps this prompted the decision to sell Jaguar and Land Rover. If the company sells Volvo, it could bring in potentially $9 billion, assuming there are any buyers who are willing to pay fair value during current economic conditions. However, based upon the continued problems, Ford may soon have no choice but to sell Volvo to the highest bidder.
Selling Volvo would certainly help Ford in the short-term, but would severely hinder its longer-term business prospects because it will no longer have any premium brands other than the struggling Lincoln. Given the desperate need for cash as well as the global economic outlook, it is quite possible that Ford will be forced to sell Volvo for much less than it’s worth.
Implications for India
Tata’s recent release of the Nano further highlights a management team that truly “gets it.” Amazing fuel efficiency aside, Tata Motors is addressing its own consumer demands, as more of its 1.1 billion citizens will soon be on the road at a sticker price of $2500.
The continued mobilization of Indian consumers will enhance the nation’s economic revolution. Tata Motors will help transition India’s dominant outsourcing services economy into one with more balance, marked by increased consumer spending and business commerce. That said, I would not be buying Indian funds here, nor would I be buying Tata Motors. I would wait for more of the effects of the global recession to kick in.
But you should certainly be on the lookout for opportunities to enter this promising economy. Investors who believe in the long-term economic prospects of India should consider a diversified play, such as the India fund (IFN), a closed-end fund managed by a division of the Blackstone Group (BX). I will be looking to pick this fund up down the road, after it shows some signs of bottoming.
Implications for America
We have already seen how Asian and European auto makers have taken leadership of what was once the pride of American manufacturing. One need only look at Detroit’s socioeconomic demise over the past two decades to see the effects of free trade. Detroit represents but one of many casualties of free trade. On a larger scale we see similar effects in Ohio, Illinois, Pennsylvania and many other states.
In exchange for more affordable automobiles, America has traded good jobs. In exchange for cheap trinkets from China, America has mortgaged off its future with ballooning debt. In exchange for the hope of oil deals in Iraq, America has traded thousands of lives and up to $3 trillion before it’s over. While money is spent in Iraq to rebuild hospitals, schools, roads and bridges – all destroyed due to the US presence - taxpayers are stuck with the bill to rebuild this demolition.
Meanwhile, America’s own infrastructure continues to erode, while US workers struggle with several years of muted wage growth and soaring costs for basic necessities - all while the Federal Reserve opens its printing press to bail out the banking system, causing the further devaluation of the dollar and higher oil prices.
Going forward, it is very likely we will see a bailout for US auto makers and airlines, shifting even more strain on taxpayers. In the end, there will be very little funds for Medicare or Medicaid, while the buying power of Social Security continues its slide. If fiscal and monetary responsibility does not soon become the top priority in Washington, these benefits will face devastating cuts while taxes soar. And this will only guarantee the continued decline of American living standards for decades to come.
Over the next decade and beyond, it is highly likely that Washington will shift more of its responsibilities to the private sector – more private security services to replace the National Guard, the Coast Guard and other government agencies, more private-run prisons, and the privatization of the Department of Transportation.
You can imagine what is going to happen when profit seekers become involved in government services. The situation will resemble the US healthcare system, whereby quality takes a backseat to profits, while fraud and exploitation go relatively unchecked.
I’ll let you use your imagination, but here is a start – most interstate roads will be tolled by private companies who will be awarded transportation contracts by state and local governments. This process will begin by putting tolls on Hov (High-occupancy vehicle) lanes. You can imagine what will happen to the prison system.
When one compares the downward momentum of Ford, General Motors and Chrysler (not to mention their increasingly high chances of a bailout to avoid bankruptcy) to the soaring growth of Tata Motors (the fastest growing division of the Tata Group giant) this further emphasizes the longstanding trend of manufacturing and innovation transfer from American soil to developing nations.
Ultimately, the sale of these two auto divisions is but one of thousands of transactions that have served to transfer wealth from America to developing nations. This trend has been in place for well over a decade. In conclusion, Ford’s recent Jaguar-Land Rover “fire sale” represents just another signal to the end of America’s consumption orgy fueled by delusional gains and dependent on foreign credit.
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