Why Ford's big EV split decision may get even bigger in the future

In the biggest deal it has done in a long time, Ford Motor Co. decided to split its electric-vehicle business from its traditional auto business last week – but notably, not spin off the EV business in pursuit of the white-hot stock valuations that have followed EV leader Tesla and, intermittently, fast followers like Rivian and Lucid Group, whose stock prices have suffered recently.

The company met Wall Street halfway in its restructuring plan, which is still significant, and analysts were roundly positive on the decision.

DataTrek co-founder Nick Colas, a former Wall Street autos banker who has been saying for a while that the auto companies will need to convince the street that these spinoffs shouldn't be done sooner rather than later, called Ford's move "an interesting reorganization."

"Auto companies don't often shuffle their reporting/org charts in such a dramatic manner and such moves are always risky in terms of productivity. Still, it does allow for clearer management accountability and that's always good in the long run," he said.

The message from Ford management is that the EV business, despite solid sales of the well-received Mustang Mach-E, isn't ready for prime time. Ford chose the safer course of keeping its promising emerging business tied to the profitable mother ship for longer. That lets the EV unit, to be dubbed Ford Model e, and other tech efforts, invest up to $50 billion mostly out of the cash flow from the existing Ford, to be called Ford Blue. That cash flow was $40 billion over the last two years, meaning Model e won't have to turn to bond or stock markets to fund expansion.

At the same time, Ford may be able to undo part of the significant discount its shares trade at compared to the EV pure plays. The compromise Ford chose was to keep its businesses aligned, but report their results separately beginning next year so Wall Street can begin to assess the EV business' growth and value it independently.

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

"We like the move, and think it was driven by frustration," CFRA Research analyst Garrett Nelson said. "Ford's [price-to-earnings ratio] stock trades in the high single digits, a fraction of Tesla's, [dropping this year] even though they became the number two seller of EVs and will grow much faster when the F-150 Lightning pickup ships in a few months."

Ford executives emphasized both operational and financial advantages that keeping the companies joined may give. Farley dwelled on the combined company's ability to finance its growth strategy without accessing capital markets, while 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.

"If we spin this out, we really risk that leverage," Farley said. "It doesn't make sense. The leverage is the key point, and we have the capital." 

The centerpiece of the plan is to cut up to $3 billion in annual costs by 2026, with major targets including Ford's advertising budget – estimated at $1.8 billion in 2020 by Statista for just U.S. spending – and $4 billion a year cost of warranties, which Ford Blue President Kumar Galhotra said will be addressed by improving the quality of Ford vehicles.

Nelson said the company is likely to look outside the U.S. for many of the cost cuts too, pointing to money-losing operations in Europe and parts of Asia.

Fresh growth is likely to be spurred by the arrival of new EVs, especially the F-150 Lightning, for which Ford has reported 250,000 pre-orders and is working to increase production in advance of shipping this year. Ford has hit that target while still only offering the electric version of its market-leading pickup truck in one body style, compared to different cabs with different levels of luxury in traditional gasoline-powered F-150s. 

The company said it expects to get a third of its auto sales from EVs by 2026 – about 2 million vehicles. It sold about 726,000 F-150s in the U.S. last year.

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

All of this may still lead up to, in fact better position Ford to, do the rest of the deal and completely spin off its Ford E unit by about 2024, said Wedbush analyst Dan Ives. The keys will be continuing to expand sales of the electric Mustang Mach-E, which sold more than 27,000 units in 2021, about half the number of gasoline-powered Mustangs, and following through on the early promise of the electric F-150 and the electric E-Transit commercial vehicle for small businesses, adding other models as the company grows.

"In 12 to 18 months, given the success of the F-150, investors will want to see them raise capital and double down," Ives said. "When they start to report unit sales, so you can see demand in the EV business, we'll be able to value it. It's the first step to an eventual spinoff of the EV business," Ives added.

The underlying issues Ford management is facing go beyond the auto sector. In the energy business, where tradition carbon-intensive businesses are being threatened by renewable energy sources, incumbents are under attack from activists to consider spinoffs. Shell has faced an activist campaign, and its CEO countered that the investors fail to understand the importance of the current cash generation model to the renewable energy investments being made for the future. And the past year has shown it to be a peak moment in corporate restructuring of iconic companies, including GE and Johnson & Johnson.

Emilie Feldman, professor of management at The Wharton School, University of Pennsylvania, who specializes in corporate restructuring and divestitures, says Ford and other car companies who may follow its approach aren't issuing what is likely to be the final say on corporate structure, culminating in a full separation.

"Today, there is still value in Ford's traditional auto and EV businesses remaining integrated, whether because of cash flow or other operational interdependence. At some point in the future, though (perhaps once the EV technology develops further), the calculus will change."

The history of the market is replete with examples of where the value of separation eventually came to exceed the value of integration and then divestitures happened.

"Situations have played out many times across industries and time periods, whether it is companies with old plus new tech businesses, companies with mature plus more nascent businesses, or companies with commodity plus end-product businesses," Feldman said. "I suspect the same will eventually happen for companies like Ford and GM in autos and Shell and other energy companies that have green vs. brown energy businesses."

Other automakers like General Motors and Volkswagen will be watching to see if they can make similar moves, Morgan Stanley analyst Adam Jonas said. But Jonas, who doesn't recommend Ford stock, argued that relying on the cash flow of the existing business is expensively priced capital invested in a high-risk EV business.

And the comparisons between Ford and other automakers only goes so far, according to Colas.

The Ford family, looking over the board's shoulder and focused on maintaining the Ford 'blue' icon through all eventualities — he noted it was the only of its peers to never go bankrupt — has a history of what he described as more "thoughtful decisions about the next leg. They want it to survive for the next 100 years," he said.

"Ford has made a lot of good decisions recently, and this is one of them," Ives said.

When might a formal EV spinoff be in the cards? It may be less dictated by a predetermined timeline than the economic cycle and when a recession occurs.

Funding EVs right now relies on a hot vehicle market for trucks in the U.S., and Ford may continue to have those conditions for a few years to come, with the cash being generated from the traditional autos allowing Ford to meet all of its targets. But if a recession hits, "they can't get anywhere close to it," Colas said. "Autos have a cyclical profit profile and those cash flows go away, and you still have $5 billion a year in EV investments you need to make. Where will you get it when you are selling four million less vehicles?"

His view of the auto sector based on his time as a banker: car companies tend to do the right thing when their backs are against the wall financially, in a weak economy. "In every other part of the cycle, they are reluctant. They want to retain critical mass," Colas said.

A Ford EV spinoff won't necessarily get a Tesla valuation with the majority of profits over the next eight years still residing in traditional F150 sales. But the current environment sets Ford up even better to spin EVs off when it needs the capital, and provide a floor under the stock's shares when the next recession hits. "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.

The cash flow analysis at Ford and its decision demonstrate a powerful force that Feldman says her research on corporate strategy has confirmed: the inertia that surrounds spinoffs and divestitures.

"The mentality is something like the following: 'We know that eventually we'll need to separate, but the cash flow is too useful for the time being/interdependence is too complicated to unwind right now/[insert other explanation here], so let's hang on to the business.' This logic is probably correct right now for Ford," she said. "But this mentality does illustrate how and why some companies might hang on to certain businesses too long when divestitures might instead be warranted."