VOLVF - Nikola And Iveco Part Ways

2023-06-01 11:25:27 ET

Summary

• Nikola and Iveco have ended their joint venture, with Iveco taking full ownership of the European operations and both companies continuing as regional players.
• Iveco will record a $44 million loss for this.
• Iveco needs to strengthen its electrification know-how, while Nikola shifts focus to hydrogen fuel cell trucks, potentially pushing the time it takes to become profitable further out.
• The only reason to invest in Iveco would be betting on a potential M&A, but overall, there are healthier players in the industry in my opinion.

Introduction

Well, if it wasn't in the air, it was close. Unsurprisingly, a few weeks ago Nikola ( NKLA ) and Iveco ( IVCGF ) announced they were parting their ways, with Nikola loosening ties with the U.S. start-up and exiting the European joint-venture that develops in Germany BEV and PHEV trucks. In this article, we will see what this means for both companies and how this forecasted event can change the way to look at them. Seeking Alpha readers may already have read some of previous articles where I have always given a sell rating to Nikola and have always stayed away from Iveco, rating it between a sell and a more recent hold (which I used as "neutral" rather than suggesting it was worth holding on to this investment). In this article I would also like to suggest the only reason I see to be long Iveco in the current situation.

Summary of previous coverage

A few months ago, I shared an article assessing Nikola's partnership with Iveco. I tried to explain what happened during their partnership among the two, since it first started when Iveco was still part of CNH Industrial ( CNHI ).

At the beginning, CNH Industrial took a $250 million stake in Nikola. This stake is now held by Iveco Group, which was spun off from CNH Industrial at the beginning of last year.

This deal had a double goal. On one side, Iveco was a latecomer to electrification, with other industry leaders such as Volvo Group ( VOLAF ), Daimler Truck ( DTRUY ) and Paccar ( PCAR ) well ahead in this game . Therefore, Iveco needed a technological partner. On the other side, Nikola seemed to have the technological know-how on electrification while it was lacking experience on the manufacturing side.

We already went over the whole history of this partnership and it was already quite clear that it could not last much longer. Nikola is still figuring out a way to enhance truck production before it runs out of cash. At the moment, the company doesn't have the strength to focus on other markets besides North-America. On its own side, Iveco continues to be an important regional player, but it can't rely on Nikola to keep up with the speed of its competitors. Therefore, Iveco needs to run the new factory the joint venture built in Germany by itself. In addition, Iveco's stake in Nikola records quite a big loss, considering how depressed the price of Nikola shares is.

The end of the joint venture

The Iveco side

On May 9th, 2023, Iveco announced it would assume full ownership from Nikola of the joint venture in Europe. Here are the words released to the press release:

Iveco Group will assume full ownership of the joint venture in Ulm, Germany. Also, Iveco Group will be licensed to freely access and continue developing vehicle control software for the jointly developed BEV and FCEV. Nikola will be granted the IVECO S-Way technology license for North America and related component supply from Iveco Group, and will gain joint ownership of the intellectual property of Generation 1 eAxles, technology developed together with Iveco Group’s powertrain brand, FPT Industrial.

What is the impact of this transaction?

First of all, let's look at the starting point, that is, Iveco's stake in Nikola. In Iveco's 2022 Annual Report we read that:

Equity investments measured at fair value through other comprehensive income mainly include the €52 million fair value of the approximately 5.0% investment held by Iveco Group in Nikola Corporation ("Nikola"), made in the context of the strategic partnership with Nikola to industrialize fuel-cell and battery electric Heavy-Duty trucks. During 2022, Iveco Group recorded in Other comprehensive income a pre- and after-tax loss of €172 million (a pre-tax loss of €95 million and an after-tax loss of €94 million during 2021) from the remeasurement at fair value of the investment in Nikola.

Compared to the original $250 million stake, we see that last year generated a big loss in terms of this investment's fair value.

Now, in the press announcement, Iveco disclosed it will record a one-off €44 million negative impact in its income statement for Q1 2023. In any case, Iveco said it forecasts to absorb the negative cash impact through cash flow generation.

I actually was taken a little bit aback by this statement. In fact, when Iveco released its preliminary 2023 outlook, it didn't talk about free cash flow, but, rather, about its expected EBIT. These two financial metrics are not the same. In fact, EBIT measures a company's profitability, representing the earnings generated before interest and tax expenses are deducted. Free cash flow shows the real cash a company generates after capex deduction. It is the cash available to fund debt repayment, dividends, buybacks, further investments and so on. Now, after Iveco released its Q1 earnings , we found out that the company seems to be a year behind the industry. What do I mean? In the manufacturing industry, we often see a Q1 with negative free cash flow, due to inventory build-up. While many big manufacturers, such as Paccar were actually able to be free cash positive this quarter, Iveco reported a €-593 million in industrial free cash flow, worse than the €-427 million recorded in the same quarter of the previous year.

Iveco did update its guidance forecasting and adj. EBIT between €600 and €640 million (vs. the previous guidance set between €550- €590 million). I think this upwards revision is reasonable, given the order backlog all truck manufacturers have, Iveco included.

However, as of now it is not that clear how Iveco will generate these additional €44 million of free cash flow to absorb the loss. For sure, once Iveco releases its next quarterly reports, it will be something to consider when reading them.

So far, Iveco has lost quite a bit of money. As we have seen, with this transaction, Iveco will pay $35 million in cash and will return to Nikola around 20 million shares it owns. We know the exact amount of shares that were issued to Iveco: 25,661,448. This means Iveco should still have a little bit more than 5 million shares on its balance sheet.

Overall, I don't see this situation as truly positive for Iveco. In fact, I believe this joint venture was providing Iveco with the opportunity to enter the space of electrified trucks. Now, Iveco has to record a loss and seems to have found out its partner is weaker than expected.

The Nikola side

These are the words we read in Nikola's latest annual report

In 2019, the Company was granted a non-exclusive and non-transferable license to intellectual property used in the Iveco S-WAY Platform and Product, which is the cab over engine truck manufactured by Iveco S.p.A ("Iveco"). The material rights under the license agreement include the non-exclusive use of the S-WAY key technology to manufacture, distribute and service BEV and FCEV trucks and related components in the United States, and the ability to grant the use of the key technology to the Company's North American sub-suppliers. The license was placed in service in the second quarter of 2022 commensurate with the start of production of the BEV. The license will be amortized over a 7-year useful life, as it reflects the period over which the sales of BEV and FCEV trucks utilizing Iveco S-WAY platform are expected to contribute to the Company's cash flows. The Company recorded $5.4 million of amortization expense to cost of revenues on the consolidated statements of operations for the year ended December 31, 2022, related to the S-WAY license.

During the last earnings call , Nikola stressed more than once a point: the company will focus only on North-America to dedicate its resources only to this market. As Michael Lohscheller, Nikola's CEO, said during the call, Nikola is now pausing production of battery electric trucks for a month before it resumes building them at its facility in Coolidge, Arizona. This should improve capital allocation and working capital. What sounds new is that Nikola is aiming no more at being a BEV leader, but rather a hydrogen fuel cell zero emission truck manufacturer. Here are the CEO's words regarding this new direction Nikola is going in:

I am confident to say we have best in class products and no other company can do what we have set out to do. This direction is exciting for all of us. We are creating an ecosystem that will allow Nikola’s customers to own a hydrogen fuel cell zero emission truck, and with HYLA fuel that truck with readily available hydrogen. It has already started. The U.S. and Canada have put themselves on the forefront of hydrogen production, and the countries and states or provinces have created incentives to make it possible to dedicate all of our efforts to capture a sizable share of the commercial trucking market as well as a quickly growing hydrogen infrastructure business. The upside potential on both businesses is virtually unlimited, and we are well on our way to making it happen. Nikola fuel cell trucks are in heavy testing along with HYLA hydrogen mobile fuelers, all of which will be available to customers later this year.

I think Nikola will have a hard time convincing investors that this product shift with a larger focus on hydrogen rather than electric trucks will pay off. The company may or may not succeed, but, in any case, it is making a choice that probably pushes the time it will take to become profitable further out. In fact, while many other peers are ramping-up electric truck production, Nikola is now betting more on a technology that still needs a lot of investments, if not only to build a network of refueling stations. The question then becomes: will Nikola have enough cash to survive during the time it will need to become a profitable manufacturer?

In Q1 2023 , the company delivered 31 vehicles and reported a revenue of $11.12 million, a gross profit of -$32.9 million, a net loss of -$169 million, with EPS of -$0.26. In just one year, the outstanding shares increased by 32%, a huge dilution.

If we look at the balance sheet, we see a decrease in assets due to strong cash burn. While at the end of 2022, just a quarter ago, the company had $233 million in cash, at the end of Q1 the company reported $121 million, a 48% decrease.

Because of this situation, Nikola exited its JV with Iveco in Europe, to save from development spend in that region and to be able to use the 20 million shares Iveco is returning to Nikola for "additional capital raise activities", as Stasy Pasterick, Nikola's CFO, said.

Takeaway

What do I understand from this situation? First of all, it is clearer that both Nikola and Iveco can, at best, be two regional players that may become, for certain technologies, a supplier one for the other. Mr. Lohscheller stated it during the Q&A session of the earnings call:

... the partnership with Iveco will obviously continue. I mean, Iveco will stay shareholder of Nikola in a meaningful way. We, from the Nikola side, will continue to have a supply agreement with Iveco, so the cab and also the e-Axle. So, in a way the partnership continues, but in a more focused way. And why does this make so much sense for both partners? I mean, it’s much better that Iveco does the business in Europe and we focus here on North America.

I have nothing against regional players. But the truck manufacturing industry is tough and needs to have scale to be truly profitable. It is no coincidence Iveco is lagging behind its peers in terms of margins in my view.

Secondly, it seems like both companies are not fully prepared to control the whole manufacturing process of the new truck generation. Iveco needs to strengthen its know-how in electrification; Nikola needs to be supported in terms of manufacturing capacity when we consider cabs and chassis.

In case of an economic slowdown, both companies, though in different ways, have a balance sheet that will be stressed. Nikola is already unprofitable, Iveco is at risk of having negative margins if the market isn't be as strong as it has been in recent years.

I currently don't see any reason to invest in either of these two companies. There are simply more healthy players in the industry. But there is one caveat. Iveco could be a different kind of investment. I have said for a while that Iveco has many characteristics that could make it an appealing investment for one of its peers. Within a larger group, Iveco's strong foothold in Europe and in light and medium duty commercial vehicles could be alluring for other players such as Paccar or Volvo. Therefore, I do see one reason to be long Iveco: betting on an M&A. However, this is not my style of investing because understanding what could be bidding price of such an operation is quite difficult.

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