Porsche's Gambit to Acquire and Now Merge With VW Could Unravel

Posted by: David Kiley on May 14, 2009

Based on a new report issued by investment banking firm Sanford Bernstein on Thursday, a lot of Volkswagen investors still hanging on may want to unload their shares. Moreover, if the firm is correct, Porsche’s current 51% stake in VW could be worth a whole lot less in a few months.

VW’s share price, which closed Thursday at 222.55 euros, down 1.33, could hit as low as 65 euros in the next six months if Porsche AG’s plans to merge with Volkswagen AG don’t get a boost somehow from VW or the markets—scenarios that seem increasingly unlikely.

Porsche has been accumulating shares in VW with the intention of going all the way to 70% or 75% of the automaker. The advantage of that plan, though, got derailed when German courts upheld the 20% ownership of VW by the State of Lower Saxony earlier this year. That ownership dates back to post World War II when VW was emerging from the rubble of the German defeat by the Allied forces.

Bernstein said that Porsche is facing three scenarios, and none of them are good. Under the first one, Porsche admits it can’t afford to take up the options it holds to increase its holding in Volkswagen to 70% and walks away. Under the second scenario, Porsche has an obligation, rather than an option, to buy the additional shares but can’t afford to and defaults. Under the third scenario, Porsche is forced to sell some of its existing stake to finance the obligatory purchase of the options.

Part of the problem is that Porsche has been coy about disclosing whether these are options it holds or obligations. In the U.S. you would have to disclose such things. In Germany, you don’t. But lots of rumors are swirling. And investment researchers don’t much like the opaque nature of what Porsche has been up to. Keep in mind that Porsche AG a few years ago had plans to list its shares on the New York Stock Exchange. But along came Sarbanes-Oxley legislation and new financial reporting rules, and Porsche CEO Wendelin Weideking said he was no longer interested.

Among the signs of trouble cited by Bernstein were rampant rumors in the banking community that Porsche struggled to refinance its debt in March (they did so in the end), news that the two companies will try and merge rather than Porsche swallowing Volkswagen, and comments from Porsche and VW management spelling out that Volkswagen will not help it repair its balance sheet.

Porsche could soon see liquidity problems. It had net debt of 9 billion euros ($12.2 billion) at the end of it’s most recent six-month reporting period. That was much more than Bernstein analysts anticipated.

The broker said it believes that the “investment subsidiaries” figure of 6.3 billion euros in Porsche’s reported cash flow statement at the end of the first half of its reporting year is actually the cost of the purchase of Volkswagen shares. The figure implies Porsche paid more than 110 euros a share.

The current market valuation of VW is more than 40 times the average earnings of the past ten years. That valuation seems more a function of Porsche having locked up all the free floating shares via its own stake building and options, according to the Bernstein report.

As a consequence, if for any reason Porsche cannot deliver on its plans to buy the shares, their bank counterparties will sell Volkswagen shares back into the market. At the most, Bernstein estimated the market might be willing to pay 75 euros a share.

Even that would be far below Porsche’s cost.