LGA White Paper © All Rights Reserved

Date – May-08 what’s it worth?

Les Glassock of Les Glassock & Associates takes a detailed look at the Ford Financials and estimates what shares in the com- pany may really be worth in a few years from now.

Every investor dreams about An investors view... investing in a company and • Kirk Kerkorian wants to raise his stake in Ford to 5.6%. Is making millions. Microsoft, this ego or a serious business Google, Berkshire Hatha- investment? way. • Long term investors have seen the share price drop 70%. So, does billionaire Kirk Ker- Should they hang in there or korian’s offer to buy an ex- Kirk Kerkorian, 2008 get out now? tra 20 million shares in Ford can – and is open to offers on the rest - under- lines the seriousness of its financial predica- • The Ford family always vote as signal that a dream is in the ment. a bloc. So far, they’ve retained making? If you were a long- control but lost $2 BN. Is now Ford Fundamentals the time to go? suffering investor – who’d

• Should Ford dispose of all of seen their shares tumble Ford is two very different businesses rolled into one: a $150 Billion+ turnover global auto- the Jaq Nasser legacy—even from almost $30 down to $7 motive business, losing money since 1999; and Volvo? – would you be a buyer or a an $18 Billion financial services company that • If the Ford turn-around fails, seller? does the opposite. what are the options To put the automotive business in perspective: While Mr Kerkorian can afford to take big risks, most investors have to take a more balanced It accumulated operating losses between Contents view. They invest in shares for a five to ten FY1999 to FY2007 amounting to almost year period and, while it would be great if the $29 Billion or roughly $560 for every unit share price were to rocket in value in just a few they built in that period. Balance Sheet Funds Flow 2 months, most of them don’t expect it. Instead they pick shares carefully and expect them to These losses would have been $2.6 Billion Operating Cash Flow 3 mature slowly, but positively in the long run. more if the gains from sell-offs were ex- Ford Family Holding For many years Ford Motor Company was one cluded. Since 2005, Ford Motor Company of those. However, since 1998 shareholders sold off Hertz ($1.5 Billion), Kwik-Fit ($152 What the Shares might be 4 have seen billons wiped off the balance sheet – Million), and ($958 Million). worth much of it their money. On 1st January 1999, Ford opened at $32 Does this deliver shareholder 5 Of course Ford investors are not alone. Share- a share; by 27th May 2008 they closed at value? holders in Daimler (formerly DaimlerChrysler) $6.80 a share – a fall in value of 79%! In and GM have also lost money as strategies The End of Jaq Nasser’s dream 6 fact, in FY 1999 shareholders equity on the have unravelled. Some observers have sug- balance sheet stood at $27.6 Billion. By FY gested that the Ford global brand strategy, 2007, this had shrunk to $5.6 Billion, an- What is the Turn Around Plan 7 bringing Jaguar, Aston-Martin, and Range other drop of 80%! Rover alongside Ford and , was cor- rect and better shareholder value would have Financial Services to the rescue! About Us 8 delivered by keeping the group together. The fact that Ford has disposed of every asset it Perhaps the most important reason why Ford Page 2 Ford Motor Company—what’s it worth?

did not go bust is that is that it has a profit- on Ford’s balance sheets in their published able Financial Services business. (See Table annual reports or SEC filings. Automotive and 1). Financial Services are consolidated and all fig- ures are in $ Millions. Income from Ford Credit (FC) in the period 1999 to 2007 added up to $22.5 Billion, The firm survived bankruptcy because it gen- which covered three-quarters of the losses erated cash from three sources: it received made on automotive. More importantly, it has almost $30 Billion of extra long terms loans; it been FC’s ability to raise corporate bonds and sold off over $9 Billion is assets; and it man- – since 2006 – to act as the conduit to sell off aged to slow payments to suppliers that gave it Ford’s asset backed securities that has en- access to another $9 Billion or thereabouts. In abled the automotive division to keep invest- total, balance sheet changes gave it access to ing cash in the next generation of products. $47.7 Billion. Ford Share Price: May 1998— May 2008 The stakes couldn’t be higher for Ford. In How did it use this cash? Roughly, $26.5 Bil- December 2006, the company raised its bor- lion went to finance stocks and cash, while the rowing capacity to about $25 billion, placing rest, $21.2 Billion, was used to fill the hole all its corporate assets as collateral to secure made by losses in equity. Keep in mind, the the line of credit. It has literally “bet the $2.61 Billion generated from selling assets, “How did the farm” on its turn-around strategy. which also was also swallowed up. business survive Keep in mind that the turnover of profitable Was all of this helpful to shareholders? Ford Credit has shrunk by 40% since 2001 – such a difficult while the loss-making automotive business Yes, in the sense that a forced sell-off might period in its 105 keeps growing by 3% a year. Fortunately, have destroyed even more shareholder value. the profitability of the financial services busi- However, shareholders certainly lost heavily in year history? ness stayed positive, although volatile. The this period. In 1999, shareholders equity was Surely, most firms unanswered question is whether Ford auto- valued at $28.3 Billion on the balance sheet. motive could ever rely on such a “cash cow” But, in terms of the ‘market capitalization’ would have gone in the future. The Ford Credit operation has (Number of issued shares x share price), the bust or been taken had a difficult time accessing capital at eco- equity was worth $37.5 Billion. Today’s market nomical rates because of the company's Ford Motor Company Sources and Uses over?” downgrading to ‘junk bond’ status and re- 1999 vs 2007 mains weakened so long as its parent is 40000 29,791 weak. 30000 Sources 20000 Balance Sheet Funds Flow: Uses 8,940 9,033 1999 to 2007 10000 0 Current Assets Current Liabilities Fixed & Financial Long Term Debt Total Equity Assets While it’s traditional for financial analysts to -10000

focus on ratios, the survival of Ford has been -20000 based on managing its cash position from one -21,230 -30000 -26,534 period to another rather than achieving a quick breakthrough in profitability. capitalization is $15.04 Billion, so shareholders Table 2 and the graph opposite summarise have really lost almost $22.5 Billion since 1999 the changes at Ford between 1999 and 2007. – and that omits the dividend payments fore- It’s a simplified funds flow statement based gone.

Table 1: Net Income 1999 2001 2002 2003 2004 2005 2006 2007 Before Taxes ($Millions) Automotive 7,275 -8,857 -1,153 -1,908 -155 -3,899 -17,040 -4,970 Financial 2,579 1,438 2,104 3,247 5,008 4,953 1,966 1,224 Services Consolidated 9,854 -7,419 951 1,339 4,853 1,054 -15,074 -3,746

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Operating Cash Flow 2001 - 2007 Table 3 All sums in $ 2001 2001 – 2007 2001 -2007 2007 Millions Opening Sources Uses Closing So, moving funds around the balance sheet, Cash Cash helped Ford to stave off bankruptcy, but where Opening Cash 4,776 is the money coming from to finance the turn- Cash from 129,199 around? Operations

Invested in the 63, 806 The Ford family don’t have enough and the Business rest of the shareholders have lost a packet. Cash 38,734 Anyway, who would finance it with the Ford (Used)/Provided from Financing family still in control? Cash from 3,447 Hedging, The Operating Cash Flows show how Ford Discontinued Ops, etc solved this problem as well. Table 3 gives a simplified Operating Cash flow based on Ford’s Closing Cash 34,882

Annual Reports for the period 2001 - 2007.

The business itself generated $129. 2 Billion, primarily from Financial Services, creditors, voting rights. asset sales and so on during this period. Back in 1999, the family shares were worth Of this, $63.8 Billion was re-invested, the bulk around $3.86 Billion. Since then it has shrunk – almost $50 Billion going into Capital Expendi- to $584 million – just as much pain as a stan- “ The Ford Family ture, mostly for new factories and new prod- dard shareholder, but the losses are significant ucts. Another $38.7 Billion was used to pay in another way. Much more importantly, the own 3.3% of Ford back short-term debt. What was left over – “B” shareholders benefited from around $130 by value, but have plus another $3.5 Billion of FX profits and cash million a year in dividends, discontinued since from discontinued operations – was all added 2007. So, not only have the family lost a lot of 40% of the voting to the cash reserves. their wealth, their income has also fallen. rights.

Why not repay some of the huge debt bur- Clearly, the question of whether the Ford The value of their family will retain control is significant. One as- den? Ford needs the cash to implement the shares fell by 85%, turn-around plan without constantly going back sessment of the move by Kerkorian is that he to its banks for extra funds. believes that the firm needs restructuring – from $3.86BN to basically along lines that he tried to get GM to $584 MN since Q1 Ford Family Control adopt when he bought a similar stake in them. In the case of Ford it would be sell-off Volvo, 1999. A casual observer might think that the share- leverage the control of to get more holders experience benefits and pain equally. Ford-badged cars and tie-up with Renault- However, the shares in Ford Motor Company Nissan or someone else. The obstacle is that are split into two classes – “A” and “B”. The no tie-up is possible unless the family relin- Ford family own the 70.9 million class “B” quish their super-voting rights. shares, worth about 3.3% of the total equity, but with ‘super-voting rights’ equal to 40% of If the company does turn-around – and start the entire issued shares at any time. These paying dividends again – the Ford family will shares come with strings: if they are sold to a probably be around for a long time yet. If not, non-family member, the shares lose their super their stake may be put up for sale at a signifi- cant premium.

Table 2 1999 2007 Sources Uses Current Assets 158,203 184,737 26,534 Current Liabilities 43,155 52,095 8,940

Fixed & Financial 112,046 103,013 9,033 Assets

Long Term Debt 198,815 228,606 29,791

Total Equity 28,279 7,049 21,230

Total 47764 47,764 Ford Family Fortune

Page 4 Ford Motor Company—what’s it worth?

What the Shares Might be Worth around being delayed or stopped by US eco- nomic factors There are many sophisticated methods of valuing companies, but none are precise or In contrast, the High Growth Scenario esti- faultless. Among those most accepted – keep mates that growth will be 3% to 5% higher in mind the cartoon alongside – are discounted than average, over the same period as the cash flow valuation models. Main Scenario and EBITDA will decline slowly, ending at the industry average, reflecting im- Which one you use depends on your estimate proved profitability. This scenario is based on a of the future pattern of growth of the firm. But short US recession ending by 2008 or 2009 “One hundred thousand the basic idea is to see how much cash the firm lemmings can’t be wrong!” is likely to generate in future and value that as The Turn Around Scenario is based on a 6- an investment, if you were a shareholder. year turnaround period, with Ford growing 1% to 4% faster than the industry average and Setting aside the immediate difficulties facing EBITDA falling from its 2007 level of 21% rap- Ford, it is reasonable to make certain key as- idly declining to the industry average of 13%. “Ford shares are sumptions: It assumes that the company can sustain the under $7 today. Ford will experience a period of higher improvement posted in Quarter 1 2008, even In my forecast, A than average growth – an implicit assump- against the difficulties posed by a higher oil tion of its turnaround plan - before growth price, material prices, and switching production modest slows to the industry average. to smaller cars, by reducing headcount and turnaround reducing volume. In broad terms it assumes Its high gearing reflects a stable, mature that the company’s revised turn-around plan should bring them business whose stable earnings can sup- will be successful. (See Final page for details of up to $14; strong port the debt burden. Its debt ratio is the Turn Around Scenario input). unlikely to fall much in the future. growth could see Forecast Outcomes Aswath Damadoran’s ‘Troubled Firm’ valua- them reach $50. tion model was used under three scenarios: Using Damadoran’s valuation model suggests If they fail, the Main Scenario, Low Growth and High Growth. that – if the turn-around is successful— the All used a 10 year horizon with variations in the shares would be worth $14 each. So, an early shares will drop to pattern/rate of growth and expected EBITDA move by Kerkorian might simply be backing his less than $2”. as a % of revenue. The three scenarios are hunch that the Ford management will be suc- compared in Table 4 below. cessful and he could benefit by $6 a share. With his target ownership of 30 million shares The Low Growth Scenario anticipates that the that would generate $180 million dollars. growth will be only 1% to 3% faster than the average, and will only last 5 years and Earn- What are the chances? ings will decline faster, down to 10% while Let’s begin with the downside: If the Ford Working Capital will rise from 3% to 4% of management do not succeed in this turn- revenue. This scenario is based on the turn around in the next product cycle, the likely outcome is that the family Table 4 Low Growth Turn-Around High Growth stake will be sold and the Growth Period 4 years 6 years 6 years company will move into Debt % 94% 94% 94% the hands of a new owner. Cost of Capital 7.3% 7.3% 7.3% However, at that point the Stock Beta 2.28 2.28 2.28 shares will rise to reflect Risk Free Rate 4.58 4.58 4.58 the premium people would Risk Premium 7% 7% 7% Cost of Debt 10% 10% 10% pay for control, so Ker- Growth Rate 6 – 7% 6 – 9% 8 – 10% korian should still be able Years 1 - 5 to exit with at least his Growth Rate 5% 5% 5% stake money. Years 5 – 10 While the Ford results EBITDA 14 – 12% 15 – 17% 21 – 18% Years 1 – 4 are currently improving EBITDA 11 -10% 16 -13% 17 -13% Years 7 - 10

Page 5 Ford Motor Company—what’s it worth?

each quarter, the structural problems affecting Hindsight is a wonderful thing. With the dra- “Ford commercial the U.S in general, and Ford in particular, are matic changes facing Ford, ‘mothballing’ plants, formidable: A significant proportion of its pro- paper currently rather than selling them could have been a duction is in higher margin, larger cars, trucks better choice. They might now be resurrected has junk bond and large SUV’s – all victims of the rise in US to build US versions of models pump prices. At the same time hot-rolled steel status. It is at low reinvestment cost. As I said, hindsight is prices rose from $830 per metric ton to $1,035 a wonderful thing. paying between per metric ton between January and May 2008, 9.45% - 10.6% this also hurts. These factors added to the US Sadly, Ford of Europe (FOE) is unlikely to credit crunch have decimated demand for large come to the rescue either, for two reasons: interest and it’s vehicles across all brands. As Ford switches firstly, the adverse exchange rate of the $ to pleased to get towards smaller, more fuel-efficient and mar- both the Euro and Sterling mean that imports ketable products, it needs to reduce labour into the US are more expensive than US con- takers!” costs, as well as material costs, to reach profit- sumers are used to; secondly, while FOE ability. posted strong profits in Quarter 1 2008, the potential for a European recession may wipe Building Intrinsic Value out that contribution by the year-end. In the last 20 years, FOE has either broken-even or Increase the Increase the growth lost money by the year-end. Cash Flows from rate of cash flows by Existing assets by investing more or There are only four ways to change intrinsic raising earnings or improving return on reducing needs for new capital invested value. The question is which of these – or what reinvestment combination – is the turn-around based on? Option 1 is to raise cash flow by reducing Extend the ‘high Reduce the cost of investment or boosting the cash flow from ex- growth’ period for the capital by lowering firm risk, gearing or isting investments. Ford’s capital spending is sources of money less than 4% of turnover compared to an in- dustry average of over 9%. So while there is potential to increase cash flow, much of it may be sucked up with increased investment. Is this the right plan to deliver shareholder value? Option 2 is to grow faster by investing more and wisely. Once again this is possible – the The original plan was to slash $5 Billion from current 5 year Growth Rate is 1.23% - but the operating costs in 2008 and return to profitabil- industry average is 4.87%. In other words, if ity in 2009. It has two main tactics: switch to Ford quadrupled its sales growth rate it would lighter, smaller cars and ‘cross-over’ SUV’s and only match the industry average. build more in Mexico, Africa, Thailand and Option 3, reduce the cost of capital, also has other low cost centres. At the same time, slash some potential. Ford has $228 Billion of debt plants and expensive people in the US. on which it pays between 5 – 10% interest, But this plan was conceived in a different set depending on the maturity date. of circumstances: US pump prices were not $4 More importantly, any new debt is at the a gallon; the credit crunch had not decimated higher ‘junk bond’ rate. An improved perform- consumer confidence; falling home values had ance would recover its ‘investment grade’ not undermined personal equity and steel status and probably drop interest down to 5 – prices hadn’t jumped 20%!

Table 5 Low Growth Turn-Around High Growth Value of Firm $181,361 BN $205,452 BN $271,858 BN +Cash & Securities $50,817 BN $50,817 BN $50,817 BN - Value of Debt $288,606 BN $288,606 BN $288,606 BN = Value of Equity $3,572 BN $27,663 BN $94,069 BN Equity per Share $1.81 $13.99 $47.56

Page 6 Ford Motor Company—what’s it worth?

7%. However, its flexibility is limited by the of maybe $1BN a year – while Land-Rover fact that it already has 98% debt in its balance makes a small net contribution after CAPEX. sheet. There is little scope to raise it more and More importantly, if had been re- switch from expensive equity to cheaper debt. tained, it was worst placed to weather an eco- nomic downturn based on high oil prices. Option 4, extend the ‘high’ growth period, is probably the option on which Ford has the The financial results, however, were the con- least traction. The larger a firm is, the more its sequence, not the cause of the problem : lim- growth rate tends towards that of the economy ited market acceptance. as a whole. Jaguar failed to gain sales traction with its X- type while Land-Rover needed constant re- ex CEO Ford, investment to rejuvenate its product line. Brad Trent Gallery The End of Jaq Nasser’s dream Along the way Ford never managed to Why did Jaq Nasser’s vision for Ford not suc- achieve the ultimate goal of a common range ceed? sold world-wide. There is no doubt that Jaq Nasser’s vision of One reason why the PAG strategy failed may Ford in the New Millennium is now dead. His lie within the Ford organization itself. Senior 34 month reign, which ended in October 2001, teams in Europe and in the US that felt they saw the acquisitions of the PAG brands and the “Ford shares are needed different cars for ‘their’ markets. Al- emergence of the ‘portfolio’ strategy. It has though they tried to cross models from Europe been all but labelled a failure by Ford’s current under $7 today. In to the US — Mondeo, for example - the at- Chief Executive. my forecast, A tention to detail was lacking, so the cars never modest turnaround Few employees mourn his passing and it may developed a fan base. be that the his abrasive style and the losses No one at the top with total commitment to a that were mounting before he left were early should bring them single line-up of cars that could be sold every- indicators that the plan was flawed from the up to $14; strong where. outset. growth could see Too many competing brands in the portfolio, To be fair, one brand out of the four Euro- each with its own fiercely loyal team. them reach $50. If pean brands in the PAG stable – Volvo – has they fail, the shares been a successful investment. Ford has man- And...perhaps.. no one who wanted Nasser’s aged to share components and maintain sales legacy to succeed in any case. for separately badged, common platforms such will drop to less than $2”. as S40/Focus and S80/Mondeo. Estimates sug- gest that annual profit contribution from Volvo What is the Turn Around plan? to PAG has averaged $600 MN - $1200 MN a Get back to the core business: volume cars! year. That is in addition to the incremental sales of Ford products for Ford of Europe. There is no escape from the fact that Ford CEO Alan Mullaly has publicly announced (22nd However, in the case of the other two main August 2007) that “Having a global luxury brands – Jaguar and Land Rover, the results brand is not important”. His turn-around is have been less favourable. Most estimates sug- centred on the core Ford business and the view gest that Jaguar consumes money – at the rate that all other brands and activities are ‘non- core’. He sees the way for- ward in global, common- Table 6 platform products, lightly Volvo Land Rover JAGUAR PAG differentiated for local mar- Price Paid ($6.45) BN 1999 ($1.7) BN ($2.5) BN kets. 2000 1989 His strategy has been spelt Est. CAPEX Break-Even ($10.0) BN out: 2005 $800MN - $1.2 NK ($238) MN 2006 BN ($715 ) MN ($327) MN Total global vehicle 2007 $559 MN ($550) MN ($238) MN

Page 7 Ford Motor Company—what’s it worth?

The Jaguar X-Type platforms will be reduced from the current ment, dependent as it is on Ford for most of its levels by 40% by 2012, leaving the com- platforms going forward. pany with just 10 core platforms. Roughly The idea that Ford does not need a global 70% of the company's products will be luxury brand is a stunning reinvention of the based on those 10 platforms. company's international positioning. Potentially, Some vehicles will become global "world it heralds a new future Ford Motor Company cars", with platforms shared between re- that is much smaller but better focused -on gions. The upcoming B-segment vehicle is mass-market core products in an attempt to re- The Jaguar X-type one, as will be the next Focus (C-segment) establish itself at home and abroad. built at Halewood, and Fusion (D-segment). In the same way that there are only BMW’s, arguably the most Ford will reduce complexity by dropping wherever you buy them in the world; in future efficient Ford plant in the number of six-cylinder engines from there will only be Ford’s. eight to two by 2012, the number of four- the world, as an ‘entry- Is the truth that Ford is simply putting the cylinder engines from 10 to three, and the luxury model’ to best gloss on a three-option future? number of seat structure types from 20 to compete with BMW 3 two. Turn-around the business and end up with a Series, Audi A4 and smaller, but profitable independent; almost Mulally says that having a global luxury turn it around but end up in an alliance with Daimler’s C-Class, brand is not important. the CEO will focus someone else – but the Ford family strangle- simply failed to deliver the company's efforts on its mainstream hold has to be sacrificed; or fail to turn it Ford-brand product portfolio globally, and the volumes. around and go bust! Launched in 2001 make that the central effort to reverse the company's fortunes and grow the business with the objective of worldwide. selling 100,000 units by

2005/6 to a whole new generation of Jaguar Lessons and Conclusions owners, it never sold Was Mullaly’s plan a surprise to anyone? I more than 73,656 doubt it. (2001) and by 2006 Taken as a whole, the Premier Automotive sold 32,519. Group has been an undoubted drain on re- sources – see Table 6. That is not to say that Alan Mullaly, CEO Ford 2007- In 2007 it entered selling Volvo – the jewel in the PAG ‘crown’ Time Magazine’s list of wouldn’t generate cash. Merrill Lynch estimates ACKNOWLEDGEMENTS: the “50 worst cars of all it to be worth between $6BN to $8 BN. FORD SHARE PRICES AND GRAPHS: time”. Unsurprisingly, it The poorest performer has been Jaguar, REUTERS.COM slumped to sales of sucking in millions but not producing a sales winner with its hoped-for flagship, the X-Type. VALUATION MODEL: ASWATH DAMADORAN 4,000 units in the US in http://pages.stern.nyu.edu/~adamodar/ 2007 and was pulled Land Rover is believed to be making money, (Ford doesn’t break out the individual financial VOLVO VALUATION: MERRILL LYNCH from the market in performance of its PAG ) but not FORD STRATEGY SUMMARY: GLOBAL INSIGHT 2008. enough to fund the required prodigious invest- 24/8/07 US—and many ment in new models. And it makes heavy, un- PHOTO—CARLOS GHOSN: Brad Trent Gallery European— customers fashionable, gas-guzzling 4x4s which don’t perform well in quality tests. never saw it as the up- OTHER PHOTOS: Newspress.com Mullaly's statement that a global luxury brand market car it promised. is not important to Ford going forward might They saw it as a well be signalling the fate of Volvo: observers Mondeo in ‘drag’. expect that will be next on the auction block, which could put that brand in quite a predica- L. Glassock & Associates Ford Motor Company – what’s it worth?

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Motor Trade Economics Chapter 1: Introduction and Price Elasticity Chapter 2: The Economics of the Box Chapter 3: Gross Domestic Product Chapter 4: Interest Rates Chapter 5: Inflation Chapter 6: Shotover Edge, Exchange Rates Shotover Hill, Old Road, Headington, The Credit Crunch The Credit Crunch Oxford, OX3 8TA, Ford Motor Company - What’s it T: 0044 (0) 1865 76 16 27 worth? F: 0044 (0) 1865 76 16 27 Ford Motor Company - What’s it worth? M: 077 68 93 28 71

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