I bring news for Fiat Chrysler owners (Ticker FCAU), after what feels like years of searching, and let’s face it, a couple of heartbreaks, Fiat Chrysler has finally found the right suitor... In fact, this deal may bring you, the shareholder $5.88 right back into your waiting pockets.
Ok, enough of that… If you haven’t already heard, Fiat Chrysler has agreed to merge with the French Car Manufacturer PSA Group to become a bigger, better automobile company. This new company will be created through a 50/50 ownership between the current FCAU shareholders and the PSA Group Shareholders, and will create the world's 4th-largest automaker.
If you don’t know who PSA group is, then like me, you’re probably from North America. The PSA Group owns several iconic european brands such as; Peugeot, Citroen, DS Automobiles, & Opel.
FCAU and PSA Group Merger Benefits
The combination would create the 4th largest global OEM in terms of annual unit sales (8.7m vehicles).
At its inception, the combined company would realize among the highest margins in the markets where it would operate, based on FCA’s strength in North America and Latin America and Groupe PSA’s in Europe.
The combination would unite the groups’ respective brand strengths across Luxury, Premium, Mainstream Passenger Car, SUV and Trucks & Light Commercial – making them stronger together.
The merged entity would bring together the companies’ extensive and growing capabilities in the technologies shaping the new era of sustainable mobility, including electrified powertrain, autonomous driving and digital connectivity.
Approximately €3.7 billion estimated annual run-rate synergies without any plant closures resulting from the transaction.
Highly respected combined management team recognised for exceptional value creation and with proven success in previous OEM combinations.
Dutch parent company Board would have balanced representation and a majority of independent Directors. John Elkann as Chairman and Carlos Tavares as CEO and a member of the Board.
That all sound like pretty excellent news for the two companies merging together, but what about us as shareholders?
FCAU Current Share Price Gain
This is where things get really interesting…
Before this merger was announced FCAU’s stock price was hovering just below $13. The day of the announcement, the stock price shot up $1.23 to $14.22. This represents a 9.46% move in one day. Since then it has moved up to $15.59 a share, or roughly 20% since the news of the merger was released. Ok so there’s 20% gain Number 1.
Next, it was announced that the terms of the merger include a ₤5.5 Billion (Euro’s) special dividend be paid to FCAU shareholders. If you do a quick conversion this works out to $6.14 Billions USD.
Here’s what’s important for you to know so that you can understand what this $6.14 Billion means for you. There are 1.57 Billion Shares on the public market that will be splitting that special dividend. In other words, for each share of FCAU that you own, you’ll get $3.91. Yowza.
If you’re lucky like me, and followed Mohnish Pabrai into this investment, your purchase price is probably a lot closer to $10 a share. If this is your basis then this special dividend represents a one time payout of 39%.
What if I buy FCAU today?
If you were to buy the stock at today's average price of $15.59 you’d still be doing quite alright for yourself. You can look at this special dividend in one of two ways.
You could consider this lowering your basis, or Return Of your Capital, or taking money off the table. This would lower your Risk of Loss by $3.91 making your basis in the stock $11.68. Not bad.
You can consider it a Return On your Capital. If you’re in this school of thought it means that at the purchase price of $15.59 you will be getting paid a one time dividend of 25%. Double nice.
If you think the way I do, and you purchased at today's price because of this merger, and if it goes through, you would be almost immediately be taking 25% of your money off the table. In other words, your would be reducing your risk of loss in this investment by ¼. Sweet.
But wait, there’s more…
Selling Comau for FCAU Shareholders
Included in the deal for us as Fiat Chrysler shareholders is the sale of a company FCAU owns called Comau. Comau is an Industrial automation and robotics company, and is a subsidiary of Fiat Chrysler with over 9000 employees, located in Turin, Italy.
The sale price of this business is very difficult to judge and will likely depend on market conditions at the time of sale. With that in mind, they apparently have roughly $1.6 Billion in yearly sales. Let’s say they sell for even $2 billion, that puts another $1.27 in your pocket for each share you own of FCAU, or another 8%. Sweet.
This brings our payout total up to of $8.14 Billion, or $5.88 per share. Again, if you bought at today's average price of $15.59, you’d be lowering your cost basis or Risk Price to $9.71.
Said another way you’d be taking more than 37% of your money off the table if/when this deal goes through. Very nice.
It’s important to remember that this deal isn’t guaranteed. Just because the two companies have agreed to the merger doesn’t mean it will get approved. There are still hoops to jump through and hurdles to get over. Although I think It’s highly likely, it’s still not certain. I also don’t know how long it will take for this deal to go through, so the time risk could be high.
One Last thing for FCAU Shareholder:
What will the new shares be worth?
Our next source for potential gain comes in the form of valuing the two combined businesses as a single business. As I stated earlier, the shareholders will each own 50% of the new business. In other words, we’ll be going into this as equal partners with the PSA group shareholders. Keep in mind that this is not a valuation of the businesses. This is a one for one valuation of what they should be worth using Today’s price.
The easiest way for me to value the new combined business is to look at the earnings of the two companies combined, and then give that new business a conservative multiple on those earnings. In other words, I’m going to use the most common valuation method that’s out there to put a simple value on this new business: The PE ratio.
For simplicity sake, I'm going to assume that the number of Shares Outstanding remains relatively the same for the new company (1.57 Billion) In other words, I’m keeping this super simple and making a few assumptions. This will be a Roughly Right VS a precisely Wrong kind of calculation.
In other words, you should probably get your grain of salt ready for this one.
If you’re feeling a little frisky, you could find both earnings of the two companies, combine them, then find the shares outstanding of both businesses, combine and average them, and then calculate your new EPS based on the total earnings divided by your calculated shares outstanding (1.255 Billion?). This would likely get you a little closer to how this all plays out…
Fiat Chrysler currently has a trailing twelve month Earning Per Share (EPS) of $2.32. They expect to have roughly $3.00 EPS in 2019, and a little more than that in 2020. They also expect to generate $1.68 billion in industrial free cash flow (FCF) in 2019 and $2.24 billion in FCF in 2020.
PSA group on the other hand has managed to generate $2.18 in earnings for the first half of 2019, and will therefore likely make close to $4.00 in earnings for full year 2019. We’ll also assume they don’t grow at all and do the same for 2020.
However, Since the share count of the two companies is undoubtedly different, in order to normalize these EPS numbers we need to go to their Net Income, and here we find that they made roughly $1.9 Billion for the first half of 2019, I’m just going to double that for full year to keep it simple ($3.8 Billion). Next we just divide that by the FCAU share count and find our new EPS number of $2.42
I also found that PSA group generated Free Cash Flows of $3.92 Billion in 2018, and will likely see more than $4.00 Billion in 2019 and 2020.
Remember that these companies are combining their earning, Free Cash flow, and all that other good stuff. What we can do is simply add these numbers together, use a conservative multiple on that number and find a future share price for the business.
Combined Simple Valuation of PSA Group and FCAU Merger
Total EPS for 2020 for the new company will likely be $5.42 ($3.00 from FCAU and $2.42 from PSA Group). Today FCAU trades at a conservative PE of 6.79, so we’ll stick with that. Next we simply multiply our earnings by, you guessed it, our earnings multiple, which is 6.79.
This gives us a new, combined fair value stock price of $36.80. That sounds pretty sweet right? I honestly have no idea how they are actually going to combine the shares.
Keep in mind that they said it would be a 50/50 deal. FCAU has roughly 1.57 billion shares out there while PSA Group has about 940 million.
Because of this I’m going to assume that for every two shares I own, I’ll get one share of the new company. In other words, I assume we only get half the value of the new total share price (or you could just cut your number of shares in half and calculate that against my share price of $36.80, but you’d get the same result…).
That gives us a valuation price of $18.40 for our shares today (half the total). That’s still an appreciation of a little more than 18% or another $2.81 from the current price of the FCAU. You may want to hold your excitement though because this is not a conservative estimate.
More Conservative Valuation
The other way we could perform a simple valuation of the new business is by simply combining the Market Cap of each. This gives us a future value of roughly $54 Billion. We can then figure out a stock price if we knew how many shares there would be in the new company. If we simply keep the number of shares currently in FCAU: 1.57 billion, we can find a share price by dividing the two.
This means that the new company could be worth around $34.4 a share. If we get a two for one deal in the merger this would leave us with a share value of $17.20 for each share we own today.
This is a much more conservative, and therefore more likely the measure we should use to value the future company.
In other words, we can see an appreciation in our shares by roughly 10% at this valuation.
The new company will also likely generate more than $6.00 Billion in Free Cash Flow each year. This means that even at my valuation of $18.4, and a $54 billion market cap, that gives us a FCF yield of 11% or 9 years of cash to pay off the entire business. Decent.
Is the Stock Market Efficient?
The Market is supposed to be efficient, right? Arguably, I’d say that most of the time, it is. With this in mind, the market should consider all the items mentioned above, and adjust the price of FCAU accordingly before the merger goes through.
In other words, the dividend payout and the sale of Comau should be added to the future value of the merged stock price. Why? Because the stock market is always future looking. It prices in the future, and discounts that price against risk, at least that’s how it’s supposed to work. In this case, I’d say the risk is that the deal doesn’t go through and the owners are left with FCAU as is.
The risk of this happening is low, but it’s still there. But what if the Merger was 100% certain? What should the stock price be in that case? I’d argue that my conservative merger valuation is a good place to start at $17.20.
Next add in the $3.91 from the special dividend onto the price because that’s what the shareholders will be given in the future. That brings the price back up to $21.11. Next we can’t forget about the sale of Comau which adds another $1.27 onto the stock price, bringing us to a grand total fair valuation for FCAU to $22.37.
This price appreciation of the stock could essentially become an arbitrage play. We could see short term traders could come in just to take advantage of this dividend payout, and then leave.
In other words, once FCAU pays out the special dividend and the sale of Comau, you could expect the stock to drop back down to $17.20.
Total Return to FCAU Shareholders
In summary. We (as FCAU shareholders) have participated in a little over 20% increase in share price since the deal was announced ($15.59), and can expect the shares to settle around $17.20 if all my (numerous) assumptions are correct maybe going as high as $22.37( if the market prices in the payout.)
We also get to benefit from the one time special dividend of $6.14 Billion and the sale of Comau for $2 Billion giving us as shareholders a total payout of $5.88 per share or roughly a 37% return on a purchase price of $15.59. With the share appreciation added in, that takes you to a 43.5% gain on your investment.
If you followed me into this one (if you’re signed up to my mailing list), then you’re basis is likely around $10, increasing your return on risk to a grand total of almost 124% ($10 to $22.37) and lowering your new risk basis to $4.12 in the process. Super sweet.
Next Level Investing Brag...
Now it’s time for me to get a little braggy about my personal style of investing...
I bought into this company for an average price of $10.03. Since that time I’ve managed to lower my basis to $7.87 (not including yearly dividends).
This means that if this merger goes through than my new Risk Basis in FCAU will be $1.99. That’s a lot of room to play with, right?!
This also means that the $5.88 return of Capital to me will represent a payout of 74.7%. Almost ¾ of my total risk capital in the business in one lump sum. Cool right?!
If the stock does move up to 22.37, that represents a 184% increase from my basis.
In other words, in the next two years, my original investment in FCAU will be completely paid back to me, and I will essentially have an Investment Risk of Zero in this business. Sweet
The other fun part… Even if this deal doesn’t go through, my basis will continue to be lowered by Next Level Dividends, and through the payout of FCAU’s yearly dividend of $0.73.
At my current basis in the company, just the dividend alone represents a 9.2% return for me. Pretty sweet. After the merger, and with my new basis, a $0.73 dividend will represent a yield on basis of 36.7%.
Disclaimer: This is for entertainment and educational purposes only. This is not to be taken as investment advice. I am not an investment advisor, nor have I considered your personal situation as your fiduciary. In other words, any investment you make (or don't make) is completely your responsibility.
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