Thursday, 23 April 2009

Company Focus – Porsche & VW – Sparring Partners

'Parry' and 'Counter-Parry'...the sparring between Porsche and VW has rarely stopped throughout the 62 years that two companies have been formally associated.

2008 witnessed the revelation that Wiedeking had been (allegedly) secretly buying-up options trades through 3rd parties on the derivatives markets, allowing a Q109 stake in VW of 50.8%. At a reported cost/debt of Euro 9bn, some commentators think that the stake-holding was build-up at a heavy price, especially so given a debt-servicing level of Euro 500m per annum.

Of course, three and half years ago when the Porsche CEO set out on the quest for VW, capital markets were strong and lenders were convinced of the massive commercial potential of a more formalised commercial integration. Although the current financial terrain and its associated sentiment has shifted massively, and thereby raised the loan-criterion bar visibly, there are few M&A deals in stable, matured industries that hold the kind of RoI potential that a melded Porsche-VW or indeed VW-Porsche offers – especially so in the Auto-Sector and the credentials of the 2 participants.

And that is why, at this prescient moment, that Piech has decided to subtly employ the press as communicators of his renowned strategic acumen. VW will have 'run the numbers' on Porsche Holdings and recognised that changed funding conditions could be a possible cause of fragility allied to its apparent reliance on its VW share dividends. Seeing the 'opening', he seems to have attempted to simultaneously divert analysts' attention away from VW's near-term contraction and toward the better commercial prospect of the medium-long term.

The crucial truth is that the combined forces of VW & Porsche make for a very attractive commercial proposition.

With its recent 'position of power' Porsche has been able to deploy VW platforms and production-lines to its advantage through the probable use of highly advantageous 'transfer-pricing' terms for Cayenne and Panamera. At the heart of the Stuttgart company's business model is the avoidance of 'bounding itself up' with capital intensive plant and infrastructure beyond its production of the iconic 911 – hence Boxster & Caymen built by Valmet in Sweden (with overspill at Stuttgart) and Cayenne built in VW's Bratislava facility (NB previous 924/8 build at Audi's Neckersulm plant).

Importantly, the VW joint venture partnership remains the key for Porsche to access non-traditional, mainstream segments; as the successful Cayenne project has demonstrated, and the Panamera project seeks to replicate. Thus Porsche understandably wishes to leverage VW capability but done so at arms length to reduce CapEx, management responsibility and importantly remain remote from the political expectations and incumbencies that larger car production entails in Germany. Why change a winning formula is the ethos in Stuttgart, and to maintain the stability of that formula meant increasing its power in the relationship; and by doing so defending VW itself from aggressive external attack.

VW Group also well recognises the potential advantages of greater integration, and understandably wishes to control the 'special relationship'. Although investment-auto-motives is not privvy to exact transfer-pricing details between the 2 parties, we suspect that they are heavily in favour of Porsche at present – especially vis a vis Valmet - and that will surely be a rub for Piech and the senior management team who are now under pressure to increase build-cost vs ex-factory margins on all cars produced – its own and contracted. But more importantly Porsche plays a different potential role.

The accompanying graphic illustrates VW Group's brand stable, depicted as a triangle to highlight the general volume and pricing relationship. It appears that as VW built its portfolio, it intentionally maintained a 'white space' or 'vacuum' for Porsche between its Audi and Lamborghini & Bentley divisions. It serves as a crucial 'Missing Link' to a completed brand portfolio, which if/when filled by Porsche would provide substantial Group leverage for volume/capacity, R&D strategies (inc Group trickle-down), robust platform strategy formulation, procurement / production / logistics economies of scale and of course consolidation of general administration and associated reduced overhead costs. Such a marriage would provide substantial fixed and variable cost advantages.

But critically of course for VW Group it would allow it to once again 're-run' its highly effective 'adjusted-common-platform' modus operandi that reduces costs and promotes margin at model, division and group levels. It could underpin a massive growth ambition for Porsche, providing for a 'Baby Cayenne' derived from Audi Q5 (already in the product pipeline) and importantly Audi-based front-engined sedans, coupes and coupe-cabriolets that would allow Porsche to compete on-par (relative to fundamental product technical architecture) against BMW, Mercedes, Maserati, Jaguar and Lexus. Panamera is viewed as a landmark product; only the start of something potentially massive for Porsche.

Both parties recognise that Porsche, through VW capabilities, could follow in the 'growth model' footsteps of BMW Cars, but able to do so without the operating baggage of a traditional 'self-assembly' car company. And that is the value of Porsche.

Indeed investment-auto-motives conjects that the Porsche operating model itself is an ambition of Piech, and could in time be replicated by the rest of the Group as VW itself seeks to outsource production to JV (VW-controlled) Tier 0.5 companies.

Thus, on the day that Martin Winterkorn gave his Q109 update to investors, the struggle by VW to regain self-determination begins. Because it knows that although Porsche Automobile Holdings SE would be unlikely to blatantly draw upon VW liquidity (if able to obtain 75% hold) to prop-up its own Balance Sheet use, it could create a battle over 'at hand' and 'provisioned' cash as it seeks to re-direct VW cash toward a bias of its own shared-platform projects, their engineering provider/integrator (via Porsche Engineering) and so could portionally re-direct liquidity.

Both Wiedeking & Piech recognise the importance of VW's current assets and the pivotal role they will play in paving the way to a successful future.