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Teutonic Turnabout: VW to Acquire Porsche

The histories of German automakers Volkswagen ( (VOWG.DE)) and Porsche ( (PSHG_p.DE)) have been intertwined since the 1930s, when Porsche founder Ferdinand Porsche designed for the German government the car that would become the Volkswagen Beetle and launch the company we know today. But this week, the two iconic car companies are expected to announce a deal that will finally unite them under the same ownership. German media reports, confirmed by executives who have knowledge of the negotiations, point to an agreement that will likely be approved by both companies as early as Thursday, July 23. It is expected to result in Volkswagen buying an initial 49.9% stake in Porsche, with a provision to acquire the rest of the company later for a total price of $11.28 billion. The markets reacted negatively Monday to the prospect of a deal, in part because of emerging reports from Germany that debt held by Porsche's holding company is close to $20 billion. That is considerably more than the $12 billion to $14 billion that was believed to be on the balance sheet as a result of a complex derivatives scheme the company was pursuing to acquire a controlling ownership of VW last year. There are also unresolved issues that might require a combined VW-Porsche to pay billions in new taxes, a complication that could delay closure of a deal until September and possibly change the financial terms of the deal. VW shares closed down €13.49, or 5.4%, to 236.50 in Frankfurt trading, while shares of Porsche fell by 6.1%, to 48.76, its steepest slide since May 13. The deal between the two automakers, which is expected to be approved by both boards, would result in the Porsche and Piëch families owning 50% of Volkswagen, with Porsche as a new division in the company, say the same executives. The German state of Lower Saxony will own the same 20% of the company it has since the 1940s, and the Persian Gulf emirate of Qatar and its sovereign wealth fund will own as much as 20%. Wiedeking "Must Shoulder the Blame" The combination of the companies is also expected to result in the retirement of Porsche Chief Executive Officer , who has been the highest-paid CEO in Europe, with an annual salary topping $100 million. Wiedeking, who has been CEO since 1993, is expected to leave with a "golden parachute" of about $140 million, say industry sources, despite being the architect of the scheme to acquire VW that has piled so much debt on the companies. Despite holding all that debt, Porsche owns about 51% of the company, which is not enough to control its management. Wiedeking was seeking to acquire 75% of VW. "Wiedeking, along with the company's chief financial officer, , have been largely responsible for the VW takeover strategy and must ultimately shoulder the blame for its failure and Porsche's current debt level," says Tim Urquhart, an auto industry analyst at . Before the global credit markets crashed last fall, Wiedeking's scheme was considered innovative by many media outlets and industry analysts. As late in the meltdown as last January, he was hailed on the cover of Fortune as "The Man Who Outfoxed the Market." Fortune wrote: "Thanks to an astute mixture of long-term strategic foresight and short-term financial wizardry, Wiedeking has Porsche headed into this downturn in an extraordinarily strong position. The company is sitting on a $20 billion mountain of capital—more money than the U.S. government is injecting into GM, Ford, and Chrysler combined." Last year the scheme looked more creative than anything a hedge fund could have cooked up. Porsche's profits before taxes in its fiscal year ended July 2008 were $11.6 billion, higher than its total revenues from selling automobiles. Just 12% of Porsche's profits last year came from making cars; the rest came from the hedging strategy designed by CFO Härter before Porsche started buying into VW, a move that panicked short-sellers, drove up the price of VW shares, and enriched Porsche, at least on paper. One-Two Punch: Credit Collapse, Sales Plunge Porsche had been accumulating shares in VW since 2005, with an eye to locking up the 75% stake. As Porsche bought shares, hedge funds sold a lot of VW shares short, figuring the automaker's share price would fall as soon as Porsche gained control and stopped buying. When Porsche announced last fall it had options to acquire 31.5% on top of the 42.6% it had already acquired, there was a squeeze on the short-sellers, because there would be so few shares for anyone else to buy after factoring in Lower Saxony's 20% holding. Briefly, VW shares skyrocketed to more than €1,000 a share. What stymied Porsche's plan in the end was the collapse of the credit markets and global auto sales. The automaker could not raise the financing it had counted on to pay for the VW shares on which it held options. And the fall in auto sales has hurt the company's cash flow, which is needed to service the debt it had already accumulated. Porsche's sales in the U.S. fell by 36% in the first half of this year. It has seen similar sales declines in other markets. The collapse of the scheme to acquire the much larger VW is not the note on which Wiedeking had expected to close his tenure at Porsche. Credited with saving Porsche in the mid-1990s by bringing Toyota-style production and manufacturing methods into a recalcitrant German culture and developing the popular Boxster sports car, he is a larger-than-life character in Germany and Western Europe. The CEO, who is often seen in Stuttgart driving his tractor down the road to or from his potato fields, has been lauded for building up Porsche's brand with well-heeled baby boomers. He kept more of Porsche's manufacturing in Germany than industry analysts believed was wise. And he earned public relations kudos by rejecting, on principle, grants from the German government that his rivals have taken. In a May 2006 survey, Porsche was awarded the title of most prestigious automobile brand by the Luxury Institute in New York. The group questioned more than 500 households with a gross annual income of at least $200,000 and a net worth of at least $720,000. Concern Over Porsche's Prestige So why try to acquire VW? Wiedeking has said he was driven by two concerns. First, he knew that courts were set to review the so-called "Volkswagen Law" that includes a provision to allow the federal state of Lower Saxony to keep a blocking minority vote in VW. That stake, which gives the state enormous power on the VW supervisory board, has been a de facto poison pill, preventing other automakers and investors from thinking about taking over VW even when its shares were relatively cheap. Wiedeking and others, including VW Supervisory Board Chairman , had bet that courts would overturn the law, making VW an attractive target for private equity funds and possibly another automaker. Wiedeking often said that a VW in unfriendly hands would threaten the stability and fortunes of Porsche. Additionally, Wiedeking believed that it was critical in a Porsche-VW tieup that Porsche be the acquirer in order to maintain its prestige and brand value, so as not to be seen as just another brand inside VW along with Audi, Bentley, and Lamborghini. "Without acquiring a holding in Volkswagen, our own survival would have been at risk," wrote Wiedeking in his 2007 book, Don't Follow the Crowd. VW and Porsche have extensive co-dependent relationships, such as the joint development and manufacture of Porsche's Cayenne SUV. VW sells a version of that SUV as the Touareg. As recently as this past weekend, Wiedeking was still putting on a face for a fight. At a 100-year anniversary for Audi in Ingolstadt, he told reporters, "I have a concept that can stabilize the company." He added that he was "not wounded, but robust and battle-tried." The irony of Wiedeking's undoing by a hedging scheme gone bad and the capital markets is rich. He has long decried quarterly financial reporting, and backed out of listing Porsche on the New York Stock Exchange ( (NYX)) after the Sarbanes-Oxley legislation passed in the U.S., making for the kind of more restrictive and onerous financial reporting that he often decries. Wiedeking wrote in his book: "Our tasks are to design and build engines, press sheet metal into shape and paint it, assemble components into vehicles of high quality, and look for as many people as possible, day after day, who are prepared to buy our products at the prices they command, without calling for discounts. If we continue to perform these tasks successfully, we need have no fear that the capital markets will turn against us." He had the upper hand, especially in Germany, by sticking to a strategy that had not involved merging with or acquiring another automaker. While Daimler's ( (DAI)) acquisition of turned out disastrously, costing the company nearly $40 billion and distracting it from its more profitable and successful Mercedes-Benz business, and BMW ( (BMWG.DE)) struggled with its burdensome acquisition of MG Rover, Porsche stuck to its knitting and achieved the best operating profit margins in the auto industry. Personal Rivalry Comes to a Head In trying to take over VW, Wiedeking waged a risky battle with Piëch, who is also a major shareholder in Porsche. Piëch and Porsche Supervisory Board Chairman are both grandsons of Ferdinand Porsche. The rival families control 100% of the voting shares at Porsche. While the acquisition of VW by Porsche was backed by Wolfgang Porsche, Piëch, say industry sources, was not sold on it. Piëch turned away from it altogether when the courts upheld the Volkswagen law. Piëch has gone so far as to publicly rebuke Wiedeking. "This was a contest of two alpha males like I have never seen before," said one VW executive. "And nobody has ever won such a battle against Dr. Piëch," said the same executive. Porsche's absorption by VW, and Wiedeking's likely exit, comes as the sportscar maker is preparing to begin selling the Panamera, its first four-door sedan, later this year. Wiedeking took Porsche into the sport-utility vehicle market with the Cayenne, which came under much criticism by reporters and industry analysts who believed Porsche should stick to its sportscar and engineering-services businesses. Wiedeking believed Porsche needed a sedan to expand its customer base and remain independent—a strategy that now seems especially redundant, considering the upmarket sedans VW offers through its VW and Audi divisions. The design of the Panamera has been criticized by many for ungainly proportions in its rear half. Indeed, Wiedeking, who is over 6 feet tall, insisted that the rear seat be large and spacious enough for him to ride comfortably in as a passenger. Not that the CEO was ever interested in taking a back seat to anyone, but now it appears that if he wants a Panamera, he'll have to buy one from a dealer like everyone else.
David Kiley is a freelance writer based in Ann Arbor, Mich.

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