Thursday, 30 October 2008

Company Focus – Porsche Automobil SE – Trimming the Hedgies

This week's Dax 30 phenomena will be the talking point of hedge-funds and regulators alike. A market contortion created by the after-shock once it dawned on the investment community that Porsche SE had silently but contractually scooped up a second majority stake in VW AG through a massive batch of cash-settled options set against VW common shares. This represented 31.5% of the share-issue in addition to the previous 42.6%, equaling 74.1%.

With approximately 13% of the free-float on loan to hedge-funds for shorting purposes the Porsche announcement set fund managers scuttling back to buy back into VW stock. The problem was stock availability and elasticity, turning what is usually a very liquid instrument and asset into something decidedly frozen. It rapidly turned the remaining few stock sellers into price-fixers who recognised the level of buy-back panic and temporarily effected a lucrative auction.

Previous weeks has seen 2 similar events of contorted peaks, but prior to this 3rd enormous peak the markets thought the concerns had been contained and were over. Piech and Porsche knew better.

Much originates from the investment community's mistake to assume Porsche's stake build into VW would consist of Preference stock, but given its more limited availability and higher profile (esp to watchful VW management) why would such an assumption have been made? And the very fact that Piech's long-time plainly lauded ambition has been to envelope VW, has been acutely reflected by Porsche's actions as a self-perpetuating hedge fund in order to build its capital position. Yes, there were previous mutings that Porsche wanted only a limited stake to ensure opportunity for operational synergies but, given Piech's voracious business appetite and Porsche's limited organic growth capabilities, such a corporate position should have been seen as part of a bigger Porsche plan.

That plan, we believe, looks three-fold:

Firstly, to access VW envious at-hand and other liquid assets in the short term able to thus use VW as banker for Porsche Cars operations given the endemic credit freeze.
Secondly, to benefit from the expected major margin improvement and expected major sales growth of VW Golf series VI. Essentially the global, mainstream car that is well recognised as premium in its segment. (Strong management focus has been appointed to this critical project, spanning savings across materials, purchasing, productivity and enhancement in volume and FX currency off-setting)
Thirdly, to piggy-back VW/Audi technologies, platforms, dealer network and associated credit division to enable Porsche to broaden its product portfolio far more speedily than it could otherwise – we believe to possibly become the new BMW, mimicking BMW's impressive rise from the 1970s.

To undertake the latter and remain credible as truly Porsche, requires Porsche in the business and operational driving seat, and that is what Piech has ensured. He recognised that whilst the rest of the world looks to alliances that his company's experiences as an engineering and production partner on projects like Cayenne / Toureg / Q7 were less than satisfactory regards preserving brand quality. And that this would always be the case given the low volume take Porsche represented in such projects. Instead, leading with Porsche means that future Porsche-VW model programmes can have a far greater Porsche input, and with swelling global platform volumes, allow the higher Porsche related on-cost (of specific components etc) be absorbed into the expansive products programme.

That way Porsche stays Porsche. And as importantly, from the public's perspective, the VW line-up from Audi and down benefit from DNA origins and association.

At a time when German industry has been consolidating through an ever implicit 'semi-protectionist' political tone enabled with industrial family money, those in the Reichstag and the Deutsche Borse who are critical of Piech's methods may do well to recognise the bigger picture of the resultant effect. Yes there has been temporary, probably inadvertent market surprise and reaction, but Porsche's actions may well have greatly consolidated and strengthened a major pillar of Germany's economic value-creation machine.

Piech and the dual intelligences of his executive team and company solicitors and brokers have performed a near faultless 'fait accompli'.

As for that supposedly conservative arbitrage play undertaken by the now famished hedge-funds - shorting VW expecting it to return to sector norm and Dax 30 norm valuations - the truth is that they should have looked harder at the underlying realities of the situation that was indeed driving up the VW stock.

Fund managers of whatever persuasion, 'Beta' index-orientated or supposedly 'Alpha' smart, tend to be herd creatures, and generally right to be so given the safety of numbers and the market power of numbers. But that doesn't preclude them from their own proactive research, analysis and determination on each and every investment decision.

Unfortunately for the sprawling many who had simply rode the previous economic growth wave, it was the apparent absence of a broader comprehension of the situation - the importance of the qualitative became clear, beyond the easy-spot quantitative fundamentals that promised so much.

As for this historic Porsche-VW tie-up, it sits as an early player and beneficiary within what investment-auto-motives believes to be an increasingly probable eventuality of European automotive consolidation. Consolidation that will continue via both cash-rich enterprises picking over fallen peers openly or secretively for synergies and enhancement with divisional 'bolt-ons'; and governmentally sanctioned M&A to strengthen singular nation's and Europe's auto-sector standings.

The united voices of France's Nicolas Sarkozy and Italy's Silvio Berlusconi are essentially calling for the ECB to provide aid packages to Automotive similar to Washington's efforts, and that will generate an official enquiry that will consequently re-organise the industry to consolidate and climb the industrial value curve.

The real politik that surged through Germany's highly integrated communicational grapevine shows them ahead of the curve, even if it has had to try and be seen as balancing public national interest vs private empire building.

But even if Porsche has been crticised as “part hedge-fund, part automaker”, the formula has been astoundingly successful. The question is, now that it controls VW with its highly cash generative base, will it eventually re-play the same fiscal engineering strategy and tactics over the coming years to perhaps absorb yet another player in either the US, Europe, Japan, China or SE Asia?

The most obvious candidates are the Chinese alliances of FAW-VW and SAIC-VW but Chinese authorities would probably wish to IPO them first to gain maximum value extraction and so full take over would theoretically be at least a decade away. Conversely, VW has over the last year or so periodically mentioned wanting to be the European Toyota, but why mimic Toyota when Porsche-VW could latterly feasibly try similar takeover actions with part by part stake-builds.

As the US government looks hard at the SEC which in turn looks hard at the NYSE's regulatory framework the likelihood of buying slowly into Toyota secretively may be harder and harder, but the TSE's Nekkei , given Japan's never-ending economic anemia, may embue relaxed regulation to encourage transactional activity...and if so, who knows, even Toyota could be on Piech's, or at least Porsche-VW's, far horizon.