Porsche and Volkswagen - The Automotive Version of AOL-Time Warner

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January 6, 2009

Porsche Automobil Holding announced yesterday (Press Release) it had purchased a majority stake in the Volkswagen Group, Europe’s largest auto manufacturer as it raised its stake in the company from 42.6% to 50.76%. However Porsche needs at least an 80% stake in the company before gaining full control over management and cash flows because the German state of Lower Saxony can veto Porsche's plans with its 20% blocking minority that has protected government influence at Europe's largest carmaker for decades.

The Volkswagen Law currently grants Lower Saxony this special privilege, however the law is under pressure from the Europe Commission to be rescinded. The European Union's highest court last year struck down a 48-year old German law that shields Volkswagen from takeover. Although a revised German law still grants Lower Saxony its 20% blocking rights, the law is being challenged by the EU and a resolution is not expected until after 2010.

The market capitalization for VW currently stands at approximately € 84.5 billion. In recent months, the company's stock price has benefits from wide speculation. For a brief moment in time, VW was the most valuable company in the world.

The automotive division has had strong sales and revenue growth. VW Group earned €4.9 billion operating profit and had about € 15 billion in cash as of September 30, 2008 (Financial Report). At the end of November, the company’s global sales were up 1% to 5.73 million vehicles.

The growth has been lead by emerging markets. According to a December 12, 2008 press release:

There has also been a sharp decline in momentum on what have to date been growth markets. Nevertheless, development in Volkswagen Group deliveries during the first eleven months of the year was positive. In Brazil, the Group delivered 591,800 vehicles from January to November, an increase of 11.9 percent. In China, too, the Group reported good growth of 10.1 percent during this period, with deliveries totaling 931,100 units. There was significant growth in Russia, where deliveries rose 61.6 percent to 118,300 units and India, where deliveries increased by 59.7 percent to 17,700 vehicles.

VW Group has also delayed groundbreaking until March on what will be its first US assembly plant since it closed a facility over 20 years ago. The plant will have a capacity for over 200,000 vehicles once completed and is part of its goal to increase sales in the US from about 300,000 to 800,000 per year by 2018. This expansion is part of a larger plan to sell 10 million vehicles globally by 2018.

Porsche also has also posted excellent growth in recent years and is the most profitable automotive company by margin in the world. As of July 2008, the company reported a €6.83 profit for the business year 2007/2008. Much of the gains were on options trading of VW shares. This continued into the last half of the calendar year when Porsche profited when speculators drove the shares of VW to historic levels. In November VW had a market capitalization of over €1,000. Neither VW or Porsche has released recent financial information that begins to reflect the global downturn in the economy.

In the coming month, the logic of a Porsche takeover of VW may begin to look uncertain amidst the unwinding of the global automotive industry as the world economy teeters on what may be the worst recession since the Great Depression in the 1930s.

Porsche’s motives are simple as an alliance with VW will help reduce production and purchasing cost as well as the research and development burden. The latter is important as the company will need advanced powertrains to meet European and US fuel economy and CO2 emissions requirements. Porsche even as profitable as it has been is a very small company and susceptible to severe swings in the economy. Historically this has been the case and I would not expect otherwise going forward. In today’s climate, without the assistance of VW’s deep resources, the company would likely experience a sharp drop in profits putting its future into question. If the takeover goes as planned, in the end I expect the Porsche organization to be absorbed into the larger VW Group with the Porsche cars just a brand within a larger empire. Keep in mind that Porsche only sells 100,000 vehicles around the world and its product are not recession proof.

I do also believe VW’s sales will drop sharply in the coming months. It has relied heavily on emerging markets for growth and I expect those markets to be challenging. A 30% drop, similar to what has already happened in the US and Europe may be in the cards. There is no question world demand for automobiles is collapsing and I do not expect VW to be immune from the fallout. The Chinese market certainly will not see double digit growth in the near future but I am uncertain at this time if a substantial collapse is on the horizan. About the only market VW has not been a serious player is in the US. However it has seen reduced revenues in the US ( €1 billion) and is highly susceptible to the dollar-euro echange rate.

I also will raise serious concerns about its goal of selling 10 million vehicles by 2018 which was announced last years. In light of the current conditions, VW will likely have to rethink it growth strategy and reduce expansion and possibly capacity. The first indication may be the delaying of the US plant even if by a couple months, as that may change. It must be remembered at the time the plant was announced, global growth was still strong and because of the strong euro, US production made economic sense.  

In summary I am bearish on Porsche and VW’s near term future performance and believe the first half of 2009 will challenging for the companies. Historically Porsche and VW show great growth and than a great fall and I expect that trend to continue. Much like the developing problems at Toyota, VW might be another example of overextending.

Further Reading:

Europeans Raise Pressure on Detroit, Wall St. Journal, January 5, 2009

Timeline of Porsche-Volkswagen Merger, Automotive News Europe, October 2008

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