Ford’s EV “Not-A-Spinoff”

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Ford’s EV “Not-A-Spinoff”

Nick here, with a discussion of Ford’s announcement today that it will restructure its global automotive business into two operations. It is not anything close to the electric vehicle operations spinoff we and many investors were hoping for. Still, in the conservative world of the Ford Motor Company and the auto industry generally, it still counts as a very important development.

Many of you know I covered the US auto industry at First Boston/Credit Suisse from 1991 – 1999 and did the same thing for Steve Cohen at the old SAC Capital for 3 years after that, so I have seen more than my share of automotive industry restructurings. That experience gives me a long historical perspective on the industry, its management, and how reorganizations tend to play out. Sometimes they work great: Chrysler in the early 1990s, for example. And sometimes they fail outright: Daimler’s acquisition of Chrysler in the late 1990s is the case study there.

Before we dig into the issues around the reorg, here is a summary of the plan:

  • Ford will create two distinct businesses to focus on electric vehicle development (called Ford Model e) and traditional internal combustion engine products (dubbed Ford Blue)
  • The company plans to have discrete P&Ls for each business by 2023.
  • The mandate for Ford Model e is to take a clean sheet approach to EV development and production by attracting and retaining tech talent and thinking creatively about how a 21st century car company should be structured.
  • Ford Blue is essentially a lifestyle brand built around the company’s hugely successful US truck, SUV, and sports car franchises. These products are generally very profitable, and Ford Blue’s cash flows will go to fund Ford Model e’s growth plans.
  • In addition to announcing these new groups, Ford also raised its operating profit target to 10 percent EBIT and stated a goal of selling 2 million EVs by 2026 (about a third of total annual production) and getting to a 50 percent EV sales mix by 2030.

Now, all this sounds pretty good. We are big believers in the old saying “what gets measured gets managed”, so setting up 2 operations should focus management attention on maximizing the long run growth and value of each operation. This is especially important for Ford Model e, which needs to show potential hires that they will be working in a division solely focused on electric vehicle design and development.

Still, there are some real issues with this plan. For example:

How do you handle access to common resources? Every new light vehicle or refresh of an existing product starts life in a design studio, which develops both the interior and exterior. Supplier management then steps in to work with third parties to produce parts. Production management designs the processes by which the vehicle comes together in a factory. As production starts, marketing, advertising and dealer relations help promote the vehicle and train dealership sales and service staff. Both “e” and “Blue” will need these resources, so prioritizing which asset has the first call will be a management challenge.

Ford is still a very global company, with wholly owned operations in Europe and partially owned assets in China. Every vehicle market around the world is different. Ford has traditionally let the regions develop vehicles on their own, but EV powertrains should be easier to adapt to local markets than internal combustion engines. How the rest of Ford’s new plan comes together at a global scale is a real question mark and we’ve seen the company fail at global design/product initiatives. That’s not casting stones; it is ferociously hard.

Ford Credit has been a reliable profit generator for decades, but how will it adapt to an all-EV marketplace and eventually perhaps even one dominated by autonomous vehicles? Last year, Ford Credit posted earnings before taxes of $4.7 billion, 26 percent of whole-company pretax profits. In 2019, it represented 35 percent of EBT. We assume Ford Credit can continue to be a strong free cash flow generator even as EVs gain ground because the purchase/lease process is the same as an ICE vehicle. Still, a significant part of auto credit profitability relies on stable resale values (especially for leases, but also for repossessions).

Even under Ford’s plan to be 50 percent EVs by 2030, the company’s profit mix will continue to be driven by Ford Blue’s traditional product offering for another 8 years. There are very few vehicles anywhere in the world that have the same manufacturer’s profit margin as a Ford F-150 pickup or fully optioned Bronco. EV profits will come, but for now and much of the decade Ford’s bottom line will likely remain tethered to the very high profit US light truck market.

Recessions happen. The single most common management error we’ve seen in covering auto companies for 30 years is management not adequately planning for an economic downturn. Ford’s plan to fund EV development with ICE cash flows will not work as effectively as envisioned in today’s presentation if there is a serious recession between now and 2030. Now, this problem is not unique to Ford – every global auto company faces the same issue.

Takeaway: the best thing we can say about Ford’s announcement is that it is a step in the right direction. It aligns management and the critical strategic goals that are important to investors. It gives Ford a better shot at hiring the right talent for EV development. It will give markets better visibility into EV growth and profitability. What it does not do – because nothing can – is fundamentally remake the company’s profit profile over the next 5-10 years.

Now, this will sound strange, but the best-case scenario for equity holders from here is, in our view, a recession that hits the traditional Ford Blue business. When times are good (like now), auto companies focus on evolutionary changes to maximize profits and shareholder value. Hard times force bigger, truly revolutionary change. With today’s developments Ford will be in a good spot to spin off the EV business when the next downturn hits in order to raise the capital needed to continue its investments in this key product offering. Today’s move doesn’t necessarily unlock any value, but at least the key is now in plain sight.