Sunday, February 15, 2009

Volkswagen Soap Opera Continues: New Disclosure May Lead to Recoveries for Hedge Funds, Pain for Porsche

Luxury automaker Porsche, which in October briefly became the world's largest hedge fund after it disclosed stock and derivative holdings in fellow car maker Volkswagen, prompting a massive short squeeze, and propelling Volkswagen to the status of largest company in the world by market capitalization, may be in some deep trouble after brand new disclosures by Porsche CFO Holger Härter.

For those uninitiated in the hate fest that transpired on October 28, Financial Ninja has done a good analysis of the events on that day:

This morning Volkswagen (VOW) was worth more than Exxon Mobile (XOM) as common shares rocketed up as much as 93% on a short squeeze.

Porsche, in an attempt to take over the carmaker has engineered a shortage of common shares by gobbling up as much as 75% of the company via options. The counter parties to these options went long the actual stock to hedge their exposure, leaving the shorts scrambling for shares to buy back.

Volkswagen Overtakes Exxon as Most Valuable Company (Update1): “Volkswagen AG became the world's biggest company by market value after Porsche SE announced plans to raise its stake in the German carmaker to 75 percent, triggering demand from short-sellers.

Volkswagen rose as much as 485.01 euros, or 93 percent, to 1,005.01 euros and was up 55 percent as of 11:10 a.m. in Frankfurt trading. Wolfsburg, Germany-based Volkswagen has risen more than fivefold this year and at its intraday peak was valued at 296 billion euros ($370 billion), more than Exxon Mobil Corp.'s $343 billion market value at yesterday's closing price in New York, according to data compiled by Bloomberg.

Porsche, the maker of the 911 sports car, has accumulated Volkswagen shares since 2005 in an effort to protect ties to its largest supplier. Porsche said Oct. 26 that it aims to increase its holding from 42.6 percent. That prompted some short-sellers to buy from a shrinking pool of stock to end their bets. BaFin, Germany's financial-market regulator, said today that it's monitoring trading in Volkswagen shares following the gains.

“One of the biggest risks with the herd mentality approach to shorting is that a lot of money can be made on the outset,” said Ed Oliver, a senior business consultant at Spitalfields Advisors, a London-based firm specializing in securities lending. “But you can end up losing the whole of it when you try to close the position. There's no limit.”

Stock On Loan

Volkswagen's surge came as 23 of the 29 other stocks in the country's benchmark DAX Index fell on investor concern that a slowdown in the global economy is accelerating. About 12.9 percent of Volkswagen's common stock was on loan as of Oct. 23, mostly for short sales, the highest proportion of any company on the DAX, according to London-based Data Explorers.

Stuttgart, Germany-based Porsche added to an earlier 35 percent stake and said two days ago that it holds options for another 31.5 percent.

“Porsche heads for a domination agreement and triggers a short-squeeze,” Horst Schneider, an HSBC Holdings Plc analyst in Dusseldorf, Germany, wrote in a report yesterday, in which he upgraded Volkswagen's common shares to “neutral” from
“underweight.” The stock “will be more driven by covering of short positions rather than by fundamental valuations.”

Porsche's Intent

Until Oct. 26, Porsche had said it was aiming only for a stake exceeding 50 percent, and Chief Executive Officer Wendelin Wiedeking said at the Paris Motor Show early this month that a stake of as much as 75 percent would be “not realistic” because of market turmoil.

Short sales have largely been undertaken by investors betting on a decline in Volkswagen's common stock, which hold voting rights, or its underperformance relative to the preferred shares, which carry no votes, according to analysts.

The common shares, which outnumber the preferred equity almost three to one, are the only gainers this year on either the DAX or the nine-member Bloomberg Europe Autos Index. In contrast, Volkswagen's preferred stock has dropped 62 percent, including a 14 percent decline yesterday, to 37.89 euros.

Volkswagen has been one of the greatest shorts of hedge funds, and it's been an absolute, absolute disaster,” Emmanuel Roman, co-chief executive officer of GLG Partners Inc., said at a conference in London on Oct. 23. “It's been very painful.” GLG didn't participate in short-selling trading of the carmaker's common shares, he said.”

BaFin, which has long been criticized for doing nothing in reviewing allegations of Porsche's market manipulation, recently had the heat turned up on it, after billionaire Adolf Merckle committed suicide as a result of huge Volkswagen short-related losses, and may finally be forced to investigate what really happened in the days leading to October 28.

At first sight it is glaringly obvious that Porsche did not act in good faith during the sequence of events disclosing its stake accumulation especially considering the resultant profits to the company - in 2008 Porsche generated a €1 billion profit from car sales and €6.8 billion from Volkswagen option trades.

Porsche has long contended that its option trades in Volkswagen were driven by "industrial logic as it built a stake in Europe's largest carmaker." However at its January 31 shareholder meeting, CFO Holger Härter made a disclosure that can dramatically weaken this position and make the legal claims of complaining hedge funds strong enough to potentially lead to civil and criminal claims against the company. Härter said at the shareholder meeting that Porsche "has also arranged share options to generate liquidity. The underlying shares were referring to Dax companies and not Volkswagen." The company, acting as a full-blown hedge fund, made €400 million placing bets on several German blue-chip shares, in addition to the €6.8 billion from Volkswagen. It will be a very tough sell to BaFin that the company's finance division was speculating in one set of companies (i.e., the Dax) but innocently trading massive amounts of VOW options with no manipulative intentions.

If hedge funds are successful at proving manipulation, which this disclosure may have made significantly easier, Porsche could be on the hook for a full refund of the option proceeds, in addition to further civil disgorgement and/or criminal liabilities. While the luxury carmaker is currently in swimming financial health with a huge cash war chest thanks to the options trades, any regulatory escalation could result in a rapid and dramatic downfall of the company which has a €10 billion term loan maturity in March, as banks may run away from a debtor that may be liable for a €7 billion cash outflow. And if the dominos really collapse and Adolf Merckle's suicide is found to be a result of the alleged stock market manipulation, the life of Porsche CEO Wendelin Wiedeking may get really ugly fast.

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El Rider said...

I was shocked that hedge funds were so involved on the short side of this trade, on the one hand you had a money making company that had more than financial reasons to control VW along with the state of Lower Saxony and on the other hand you had hedge fund managers who appear to have not been fully aware of the historical ties between the Porsche/Piech families and the two companies.

The need for VW to supply the Cayanne (SUV) platform is real and historically the dramatic price change of such supply once cost Porsche dearly when VW dropped their end of the 914 project under a new chairman in the late '60s, making the 914 too costly for Porsche, especially the wonderful 914/6. VW had recently threatened to stop some engine production for the Cayenne, reminding all who chose to listen of that now 40 year old VW/Porsche spat. Additionally the Piech family has a lucrative VW distribution deal through (I believe) their Salzburg Porsche distributorship. Salzburg Porsche recorded the first Porsche Le Mans 24 Hour overall victory by beating none too happy Porsche customers Martini-Rossi and Gulf-Weyer.

The family ties are downright incestuous, former VW Chairman Ferdinand Piech was the designer of the Porsche 906, the head of the Porsche racing division during the late '60s and the son of Louise Porsche Piech. Louise, the daughter of Porsche founder Ferdinand and brother of long-time Chairman Ferdinand owned Salzburg Porsche and was critical in keeping the Porsche engineering firm together in the early post war years, as a woman she could bring supplies across the borders of the various Allied zones of occupation.

So you had a situation in which a majority of the shares were in the very, very strong hands of the Porsche/Piech families, the Porsche corporation and the state of Lower Saxony. Further those strong hands have likely been in close contact with each other over those shares for years, decades or generations. Further still, public protestations aside, it appeared that Porsche wanted to own VW. Until not so long ago Porsche even received 1 DM for every old Beetle built.

Current Chairman Wendelin Wiedeking has been very critical of hedge funds, as have many corporate cheiftans it's just that Wiedelking used the hedge fund managers to achieve his goals. Maybe if some of those European hedge fund managers had traded their cheesy Gallardos and F430 Spiders in for classic Speedsters or Carreras they wouldn't have found themselves up that river.

El Rider said...

I neglected to add, thanks for the post, it's very informative.