Could Ford's EV split decision lead to even bigger consequences in the future?

• According to some on Wall Street, Ford's move indicates that the EV business, despite its potential, is not yet ready for independence.
• The current strength of pickup truck sales remains the leader, and reporting within Ford may help shares overcome a market valuation discount.
• The booming vehicle sales market is benefiting car companies, but this may not last during the next recession, which is why some experts predict a future Ford EV IPO.

Last week, made a significant move by separating its electric-vehicle business from its traditional auto business. Unlike other companies, it did not spin off its EV business to pursue the high stock valuations of EV leaders like Tesla and fast followers like Rivian and Lucid Motors, whose stock prices have recently declined.

The company's restructuring plan, although not fully implemented, was met halfway by Wall Street, and analysts were unanimously positive on the decision.

Nick Colas, co-founder of DataTrek and a former Wall Street autos banker, has been stating that auto companies need to convince the market that spinoffs should be done sooner rather than later. He called Ford's move an "interesting reorganization."

"Such dramatic changes in reporting/org charts are rare among auto companies, and they always carry risks to productivity. However, they provide clearer management accountability, which is beneficial in the long run," he stated.

Ford management has announced that the EV business, despite strong sales of the Mustang Mach-E, is not yet ready for prime time. To keep its promising emerging business connected to the profitable parent company, Ford has opted to keep it tied to the mother ship for a longer period. This decision allows the EV unit, known as Ford Model e, and other tech initiatives to invest up to $50 billion, mostly from the cash flow of the existing Ford, called Ford Blue. Over the past two years, Ford Blue generated $40 billion in cash flow, meaning Model e won't need to rely on bond or stock markets for funding expansion.

Ford may be able to reduce the significant discount its shares trade at compared to EV pure plays by keeping its businesses aligned but reporting their results separately starting next year, allowing Wall Street to assess the EV business's growth and value it independently.

Ford’s spin

Will it work? For now, the answer is likely yes.

Garrett Nelson, a CFRA Research analyst, stated that they like the move and believe it was motivated by frustration. Ford's stock has a high single-digit price-to-earnings ratio, which is significantly lower than Tesla's, despite Ford becoming the number two seller of EVs and experiencing growth in the coming months with the release of the F-150 Lightning pickup.

Ford executives highlighted the benefits of keeping the companies united, including financial and operational advantages. Farley emphasized the financial benefits of the combined company's ability to finance its growth strategy without accessing capital markets. Aides explained in a press briefing the details of plans to share costs between the EV and gasoline-powered vehicle businesses, cut costs in the traditional unit, and get both sides of the business to work together to boost profitability faster than they likely could on their own.

"Spinning this out could jeopardize our leverage, which is crucial and we have the funds," Farley stated.

The primary objective of the plan is to reduce annual expenses by up to $3 billion by 2026. Key areas of focus include Ford's advertising budget, estimated at $1.8 billion in 2020 for U.S. spending alone, and the $4 billion annual cost of warranties, which Ford Blue President Kumar Galhotra stated would be addressed through improving the quality of Ford vehicles.

Nelson stated that the company may seek cost cuts overseas, particularly in Europe and certain Asian regions, due to money-losing operations in those areas.

The launch of new electric vehicles, particularly the F-150 Lightning, is expected to stimulate fresh growth, with Ford reporting 250,000 pre-orders and increasing production in anticipation of shipping this year. Despite only offering the electric version of its popular pickup truck in one body style, compared to various luxury cabs in traditional gasoline-powered F-150s, Ford has achieved its production target.

The company anticipates that electric vehicles will account for one-third of its automobile sales by 2026, which is approximately 2 million vehicles. In the U.S. last year, the company sold about 726,000 F-150s.

But there is still reason to suspect a true spinoff could occur sooner.

EV spinoff talk won’t go away

To successfully spin off its Ford E unit by about 2024, Ford must continue to expand sales of the electric Mustang Mach-E, which sold more than 27,000 units in 2021, and follow through on the early promise of the electric F-150 and the electric E-Transit commercial vehicle for small businesses. Additionally, the company should add other models as it grows.

Ives stated that in 12 to 18 months, if the F-150 is successful, investors will demand capital and want the company to double down. He added that once the company starts reporting unit sales, it will be able to value the EV business and take the first step towards a potential spinoff.

The challenges facing Ford management extend beyond the automotive industry. In the energy sector, traditional carbon-intensive companies are being threatened by renewable energy sources, and incumbents are under attack from activists to consider spinoffs. Shell has experienced an activist campaign, and its CEO argued that investors do not comprehend the significance of the current cash generation model to the renewable energy investments being made for the future. The past year has been a pivotal moment in the restructuring of iconic companies such as GE and Johnson & Johnson.

According to Emilie Feldman, a professor of management at The Wharton School, University of Pennsylvania, who specializes in corporate restructuring and divestitures, Ford and other car companies who may follow its approach are not likely to make the final decision on corporate structure, resulting in a full separation.

Although the EV technology may advance in the future, there is still worth in keeping Ford's traditional auto and EV businesses combined due to cash flow or operational interdependence.

Divestitures occurred when the value of separation surpassed the value of integration in the market's history.

According to Feldman, situations have occurred frequently across various industries and time periods, including companies with old and new technology, mature and nascent businesses, and commodity and end-product businesses. He predicts that the same will eventually occur for companies like Ford and GM in the automotive industry and Shell and other energy companies with green and brown energy businesses.

Adam Jonas, a Morgan Stanley analyst, stated that other automakers such as General Motors and Volkswagen will observe Ford's moves to enter the EV market. However, Jonas advised against investing in Ford stock, arguing that the company's reliance on the cash flow of its existing business is an expensive investment in a high-risk EV business.

Colas believes that comparisons between Ford and other automakers are limited.

The Ford family, with a focus on preserving the Ford 'blue' icon and maintaining thoughtful decisions for the future, aims to keep the company afloat for the next 100 years.

Ives stated that this is one of the good decisions Ford has made recently.

When a true Ford EV company makes more sense

A formal EV spinoff may not be determined by a fixed timeline, but rather by the occurrence of a recession.

Currently, Ford's funding for EVs is dependent on the hot market for trucks in the US. However, if a recession occurs, the company may struggle to meet its targets due to the cyclical nature of the auto industry and the decrease in cash flows. With a decrease in vehicle sales, Ford will need to find alternative sources of funding for its $5 billion annual EV investments.

Colas stated that his perspective on the automotive industry, formed during his time as a banker, is that car companies are more likely to act ethically when they face financial difficulties in a weak economy. However, in other stages of the economic cycle, they are hesitant to take action and prefer to maintain their market share.

Ford's EV spinoff may not receive a Tesla valuation, as the majority of profits over the next eight years are expected to come from traditional F150 sales. However, the current environment presents an opportunity for Ford to spin off its EV business when it needs capital, and to provide a safety net for its stock during the next recession. "You create optionality and you don't have to do anything," Colas said. "There will always be a market for a Ford EV IPO," he added.

Feldman's research on corporate strategy has confirmed the inertia that surrounds spinoffs and divestitures, as demonstrated by Ford's cash flow analysis and decision.

The mentality of Ford is that although they know they will eventually need to separate, the cash flow and interdependence are too useful and complicated to unwind right now, so they are hanging on to the business. This logic highlights how some companies might hold onto certain businesses for too long, even when divestitures might be necessary.