Ducati’s Diesel Drama

This month’s big transportation story is Dieselgate, the scandal surrounding Volkswagen and the discovery that they deliberately cheated government tests for exhaust emissions. The brand’s famous TDI diesel engines were manipulated to win generous carbon and tax credits by governments, thus defrauding taxpayers. Industry analysts agree that this maelstrom will cost the VW Group dearly and force a breakup.  Here’s why I believe VW will shed Ducati, and send the venerated motorcycle brand to auction for the fifth time in twenty years.

Motorcyclists the world over swoon for Ducati products, and for good reason. The famed Italian manufacturer likes to wrap itself in the national identity of its home country, and promotes itself as the Ferrari of the two wheeled universe. They are beautiful looking, often fearsome sounding machines that have, for the better part of three decades, been synonymous with exotic motorcycling. Celebrities and the regular folks alike aspire to the brand’s sultry latin appeal.

But as a business, Ducati has not always been a strong performer. The company has exchanged hands often in recent times, with some previous owners losing a lot of money. The Texas Pacific Group (TPG) is the organization famous for making Ducati a household name, when they took over in 1995 and transformed an obscure niche manufacturer of obsolete sport bikes into a lifestyle brand. TPG invested millions into advertising, marketing and eventually floated the company on the New York stock exchange in a much hyped IPO, but a market slump and mounting losses bled the coffers dry, and the stock crashed.

TPG sold the business to Investindustrial in 2005 for less than a third of what it paid, and Ducati was re-privatized. The new owners did the unthinkable, and actually spent money on developing new products, expanding global distribution and modernizing operations, all of which made Ducati prosper like it never had before. Investindustrial divested its majority stake in Ducati three years later to a consortium that included the unfortunately named BS Investimenti, and our very own Ontario Pension Plan, with a clear intension of selling the firm outright once the turn around was complete.

This caught the attention of one Ferdinand Piech, former CEO of VW Group and one time chief race development engineer at Porsche, who was hankering for a two wheeled addition to his growing automotive empire. Piech, a passionate motorcyclist and Italophile, had spent lavish amounts to acquire other Italian exotica like Lamborghini and resurrecting bespoke car makers Bugatti and Bentley. When he got wind that Ducati was available, Piech moved swiftly.

The acquisition of Ducati by VW’s AUDI division grabbed a lot of headlines. VW had, in the megalomaniacal way that only German organizations can, announced their goal of total world domination (of all things motorized). The plan was to become not only the world’s largest automaker, but also the most profitable and the one with the highest quality on earth. Piech and his cronies were well on their way to winning this titanic struggle after GM went bankrupt and Toyota got stained by quality woes. But that was not enough…

BMW, a much smaller player in the automotive volume contest, had annoyingly been making great strides with it’s pesky motorrad motorcycle division. From almost giving up on bikes in the mid eighties to breaking through the 100,000 units per year mark a scant fifteen years later, motorrad was on fire. The GS was every middle-aged man’s darling, and now BMW had the audacity to make a world-beating superbike in the S1000RR. On top of that, Mercedes-Benz signed a co-branding deal between Ducati and AMG, Mercedes’ performance division, in 2011. Out-flanked by German auto rivals on the two-wheeled front, the situation had clearly become too much for Piech.

In 2012, the Volkswagen Auto Group bought Ducati and quickly made lots of noise. They fired the CEO and brought in a new man, Gabrielle del Torchio, hand picked by AUDI’s board. Ties to AMG were cut, and everyone (myself included) assumed that a new era of financial and managerial stability was dawning at Ducati. The newly invigorated brand had excellent new models in the marketplace such as the much admired second generation Multistrada and Panigale, while last year’s arrival of the Scrambler line exploded the Twitter accounts of hipsters the world over.

But there was trouble in paradise. Ducati still had quality problems, and sales between 2013 and 2014 were essentially flat, despite overall industry growth. According to financial information released by VW in July, Ducati did post strong results in the first half of this year with sales increasing 22%, but the margin of profit was only reported to be 4%. Other high-end, luxury motorcycle brands like Harley-Davidson and BMW regularly post margins of 20% or more.

Meanwhile, VW Group is facing armageddon. Analysts in the financial industry are placing the total cost of Dieselgate around the $35 billion mark. Already VW has announced that “every model and every brand are up for review”, with strong rumors floating around that Bugatti and Lamborghini will be sold off to stem the bleeding. VW only last year bought Scania, SAAB’s old commercial trucking division, another expensive decision that is being scrutinized. Everything is on the table, and the auction is about to begin.

The company paid $1 billion for Ducati in 2012, at a valuation that has surely increased in the intervening three years. That billion-plus is money that is desperately needed now to keep the mother company alive. More to the point, Piech, the man principally responsible for bringing the exotic motorcycle brand to VW and it’s main champion, is gone, having been ousted from the VW Group in a boardroom coup. The drama of that event, plus the rapidly deteriorating fiscal situation makes it pretty clear that there will be no room for distractions.

It is my belief that Ducati will be spun off and sold, either in whole or in part, over the coming year. The interesting question is, who would buy it? Looking at the past five to ten years of exotic motorcycle brand history, we see that the suitors tend to be private equity firms and large industrial concerns with an eye to get into the upmarket lifestyle brand market. The former tend to be short term thinkers, looking to flip a failing company after a few years after turning it around, as Investindustrial did.

But this seems unlikely in this case. Today’s Ducati is not the wreck that it was when TPG unloaded it in 2005. Ducati is solid, with serious potential even if the profit margins need work. Assuming the same $1 billion sales price of 2012 sticks (I expect it would be significantly higher, unless there is a dark underbelly of debt that is invisible to the public), there are not many firms in the business that could raise that kind of capital, and have enough left over to build on it.

Canada’s own Bombardier Recreational Products (BRP), makers of Spyder and Skidoo, were once very keen to acquire a motorcycle brand. The company reportedly went after Aprilia before Piaggio scooped them up, and with expanded offerings on-road and well established European engine operations out of Rotax in Austria, an argument could be made for rational acquisition. BRP’s market capitalization (total value) is sufficient for a take-over, and with the long term decline of snow and off-road markets, it could make a lot of sense.  Could this happen? Given the history of the Bombardier family of businesses for making bold acquisitions (Learjet, Canadair, Rotax, Johnson/Evinrude, etc.) it is certainly within the realm of possibility.

European brands or other established luxury motorcycle OEMs are unlikely to show interest, because the overlap in products and the uncomfortable question of seniority. Each time two motorcycle brands of approximately equal status merge and sell bikes to the same market demographic, one must surely die. With a cult brand like Ducati in your stable, a BMW or Harley-Davidson or Triumph can expect cannibalized sales and long term internal conflict. It happened when Triumph and BSA went to bed together, Cagiva with Ducati, and later when Aprilia, Vespa, Gilera, Derbi and Piaggio all sold scooters side by side under the same, incestuous corporate umbrella. Only one prospers.

It is my belief that Ducati will end up in the capable hands of an Indian or Chinese brand, one that has large scale business and industrial manufacturing acumen, but is looking for a point of entry into the highly profitable luxury segment. Like Bajaj buying into KTM, or Quianjiang taking over Benelli, a strong Asian buyer could leverage low cost and scale to increase efficiency at Ducati, while adding overnight a prestigious and potentially lucrative business to their bottom line.

It will spark fury and scandalous headlines in the Italian press, just as it did in 1995 when TPG took over. Gli Americani, the Americans, were invading, read the front page of Il Piaggista, the in-house newspaper of the Piaggio Group. I was an intern there at the time and was amazed by the vitriol and anger roused in people because foreigners had taken over Ducati. That the Castiglioni’s had run it into the ground seemed to have no effect on conversation. It was, simply, an unthinkable affront to Italy.

Just how unthinkable it would be if an Asian company scoops it up is difficult to imagine. But these are different times than twenty years ago, and Italians are nothing if not pragmatic. In Bologna, the workers and professionals at Ducati are going through the same uncertainties and feelings of angst as before, but this time, probably, with a lot more confidence optimism. Ducati is in a healthier place than it has ever been, and unlike those dark takeovers of before, the brand will be looking for a partner instead of a savior.  One with a two-wheeler focus, management competence and complementary goals.

I am extremely confident that it will find one.