Dr Ferdinand Piëch's reign at Volkswagen has been - all things considered - rather a mixed bag. The much-lauded policy of platform sharing across a multitude of brands has failed to assuage concerns over Volkswagen's structural problems and poor financial performance. Now, speculation is increasing that Volkswagen AG is considering a range of moves to protect its independence, including spinning off Audi. Moves by the European Commission to address Germany's protective 'Volkswagen Law' and a perception that VW's share price is low have increased rumours of interest. David Leggett considers the issues.

Could Volkswagen really be a takeover target? It would certainly be ironic were that to be so. Under Dr Piëch, Volkswagen has been a voracious buyer of automotive brands. The Volkswagen group stable includes the mainstream Seat and Skoda and the premium Audi brand, as well as the more exotic Bentley, Rolls Royce (until 2003 when it transfers to BMW) and Bugatti. And last year, VW took a 16% stake in Swedish heavy truck maker Scania. Signs of over-reaching ambition? Some would say that greater concentration on problems closer to home would be desirable.

Dr Ferdinand Piëch has recently signalled a change in Volkswagen's industrial strategy

Volkswagen the 'poor performer'

Hand-in-hand with the expansion of the Volkswagen brand portfolio, Dr Piëch developed a platform sharing industrial policy that was designed to yield big savings to manufacturing costs. When he took over in 1993, Volkswagen was building cars on 16 platforms - today that has been whittled down to 4. But the proliferation of models on each platform has generated additional costs, particularly in marketing, and the anticipated cost savings through the strategy have largely failed to materialise. Cannibalisation of volume between brands is also a worry, especially as each brand has tended to have its own product on each generic platform as a matter of course. The percentage of profit on revenues has stubbornly lagged behind Volkswagen's main competitors. According to Goldman Sachs, VW's 'Return on Capital Employed' is just over 3%. That compares with 8-9% for Renault and PSA, 10% for Ford, almost 10% for BMW and around 15% for Porsche.

Brand modules not common platforms please

Dr Piëch has recently signalled a change in Volkswagen's industrial strategy away from common components sets and platforms underpinning models across the group's brands and towards brand-specific modules. It is a quite radical departure and seems almost a belated recognition that common platforms were not the best way to drive industrial policy.

And lately concerns have increased that in some areas the company is failing to make steady progress and that structural problems persist. In particular, there are worries that Volkswagen has been slow to shift production out of its high cost base in Lower Saxony. Around half of Volkswagen's 300,000 workforce is located in Germany. And with the state of Lower Saxony's status as the largest shareholder (at just under 20%) there is a strong suspicion that seriously getting to grips with the cost-base is simply not on the agenda. Indeed, the state has been a largely passive investor and has seemed more concerned with preserving jobs than with traditional shareholder concerns like profits.

Lower Saxony 'shield' under threat?

Moves by the European Commission to address Germany's protective 'Volkswagen Law' and a perception that VW's share price is low for a company of its size, have increased rumours of possible acquisition interest. Germany's so-called 'Volkswagen Law', enacted especially for the company, has limited any investor from holding more than 20% of VW's voting rights. This has prevented the company from being a takeover target in the past. The rule gives an effective right of veto over any takeover bid to the Lower Saxony state government. Analysts say abolition of the statutes would rekindle the merger speculation which surfaces periodically around VW and is regularly dashed by Lower Saxony's insistence that it would block any hostile move.

To ensure future independence, VW may spin-off Audi - this may boost the group's 'sum-of-the parts'valuation

But the law has come under threat from EU competition officials who oppose legal provisions that hinder takeovers. The European Commission, the executive body of the European Union, said earlier this month that it is studying whether to obligate Germany to rescind the measure protecting Volkswagen. The law is being examined on the grounds that it could be said to interfere with the free movement of capital under European Union rules, although the EC has not yet launched a formal investigation.

VW, which has a market capitalisation of about 24 billion euros, is dwarfed by its Stuttgart rival DaimlerChrysler, with a market value of almost 58 billion euros, making it potentially vulnerable to a bid if the 'Lower Saxony shield' were removed. Even luxury car maker BMW has a bigger market capitalisation, with about 27 billion euros, despite having only a fraction of VW's sales volumes.

Protective measures being considered by Volkswagen

Volkswagen is now said to be considering a range of measures to help ensure it remains independent, including the possible spin-off of its premium Audi brand. A spin-off could be an effective defence strategy as it may boost the group's 'sum-of-the parts'valuation. Also, spinning off Audi would bring a cash windfall. The Audi shares that VW retained would be valued much higher on the open market than they are currently as part of the group. It is understood that VW would be interested in retaining a controlling stake of Audi in the event of a spinoff.

But Audi, which accounts for nearly a quarter of VW's revenue and operating profit, would be a key asset for anyone interested in the VW group as a whole, as well as an attractive asset in its own right. An Audi spinoff is something that could be used as a poison pill in the event of an attack. The threat of it could act as deterrent.

The premium Audi brand made more than 650,000 of VW's 5.2 million cars last year. While VW's other brands fight in the highly competitive market for high-volume cars, Audi has been able to enjoy higher profit margins.

Separate listings for VW Group units could be coming, in spite of official company denials. It could be in the interests of those seeking to see a higher valuation on the group as a whole.

Another protective option for VW might be a cooperation alliance with a friendly company that could involve a share swap.

The company is also involved in a shares 'buy-back'. VW said in March it would ask shareholders this June to authorise the board to buy 10 percent of its shares. The company already bought back around 10 percent of its shares last autumn. The move to buy back more shares was seen by analysts as a sign that VW is either gearing up to make an acquisition, possibly in the truck sector, or else seeking to boost shareholder value. It could do this by cancelling the shares and thereby raising earnings per share - a defensive move against a takeover bid.

Ford may be interested in a tie-up with VW

"Before I leave, I see this as my task to see to it that with or without the statutes, no one can swallow our group without choking on it," Piech was recently quoted by WirtschaftsWoche.

Ford in the frame for VW?

Some industry observers say Ford Motor Co might be interested in a tie-up with Volkswagen. Ford has a market value in excess of 50 billion euros, compared to Volkswagen's 24 billion euros. A takeover of VW would be a major boost to Ford's presence in the European market, where the US giant has struggled in recent years. The big question would have to be: how would Ford management add value and make VW more profitable? One obvious area would be cutting costs in Germany, but that could be filled with practical difficulties. The last thing a new owner would want would be a labour relations nightmare.

One thing's for sure. The talk of Volkswagen's defensive strategy and its 'under-valuation' will be helping to firm up the share price. That has been happening. Dr Piëch, who is scheduled to retire in spring 2002, has made improving his company's share price a high priority. The company's relatively poor financial performance and low valuation point to long-term structural weaknesses that he has presided over. In spite of the group's undoubted progress since 1993, the lack of progress in these areas will rankle with some shareholders. But the last thing that Dr Piëch would want would be to be held responsible or remembered for creating the conditions for a hostile takeover.


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