There has been a proliferation of theories explaining the ‘real reasons’ why Porsche decided late last year to buy a stake in Volkswagen. But the analysts at the investment banks have dismissed the more fanciful explanations and concluded that fears over the robustness of the Porsche business model in the future have actually driven the move. Neil Winton reports.
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When exotic sports car maker Porsche shocked the automotive world with its decision to buy a piece of run-of-the mill Volkswagen with its €3 billion cash pile, conspiracy theories abounded.
Some said because of the link between VW board chairman Ferdinand Piech and the Porsche family, it was a plot to protect VW from a hostile takeover. (In the next couple of years the European Union will finally force Germany to lift its rules which allow minority shareholders, like the state of Lower Saxony which owns just under 20 per cent of VW, to outvote majority shareholders).
No, it wasn’t a corrupt German stitch-up, said Porsche. There were sound business reasons for a money-making machine like Porsche which makes sleek, powerful, sporting machines, investing in tired, overweight, chronically inefficient shareholder-value shredder VW.
It turns out that none of the above were true, even if you had thought for one moment that VW was likely to fall prey to a hostile takeover (who would be mad enough?) or that Porsche’s investment experts saw value in VW.
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By GlobalDataPorsche bought its near 20 per cent stake in VW because it had peered into its crystal ball, and reeled back in horror at what it had seen.
Fear of the future
Investment bankers have now had time to delve more deeply into the ramifications of the deal, and J.P. Morgan believes Porsche feared its future was in jeopardy. Crucial projects – the new Panamera 4-seater, and ongoing production of its Cayenne SUV and Boxster roadster – were threatened. A cosy linkup with VW might be the answer.
Porsche developed the Cayenne jointly with VW and it is produced on the same production line as the VW Touareg, and new Audi Q7. J.P. Morgan believed VW was taking more than its share of the costs of Cayenne production. Porsche was unable to agree a Cayenne-type deal for the upcoming Panamera, and wanted VW input to help pay for the €1 billion euro development budget. J.P. Morgan also thinks that production of the Boxster, made by Finnish firm Valmet for Porsche, could be taken over by VW if the current arrangement failed.
Cracks in the business model
In a report on Porsche and its deal with VW, J.P. Morgan reckons that the motivation behind the deal is distinctly defensive and based on the notion that there are “cracks in the (Porsche’s) business model”.
J.P. Morgan said the motivation for Porsche was defensive because of its failure to find an agreement to build its new Panamera along the lines of the Cayenne SUV, where development costs were shared with VW, which also produced the vehicle.
“The first visible crack in the Porsche business model came with the delayed announcement of the Panamera. It is clear to us that the company has been unable to secure an alliance to share development costs of this model; it has admitted that the €1 billion development budget did not include required investment in some of the physical assets needed to produce the vehicle, such as a paint shop,” J.P. Morgan said.
“We believe Porsche is at risk from potential instability at Metso, the shareholder of Valmet, as Metso has come under pressure from investors seeking disposal of loss-making assets. It is unclear whether Boxster was ever a profitable business for Valmet, and its diversification potential is limited by the Porsche agreement.”
Disproportionate share
“We also believe, particularly after visiting the manufacturing facility run by VW in Slovakia, that the contribution of Cayenne to Porsche’s profits may be supported by VW absorbing a disproportionate share of the costs of the venture, particularly in terms of quality. If we assume the (profit) margin on Cayenne is 17 per cent, in line with the group average of 2005, the EBIT (net earnings) contribution exceeds €300 million. Any reallocation of costs between the partners could have a material impact on Porsche’s profit,” J.P. Morgan said.
J.P. Morgan said acquiring influence at VW could stabilise the Cayenne partnership, ensure the use of VW’s production assets for the Panamera and provide a home for the Boxster if there were problems with Valmet.
40 per cent more
So the €3 billion investment does have a healthy base? Well not really. According to J.P. Morgan, Porsche actually spent 40 per cent more on buying the VW stake, than it would have cost to physically buy the assets required.
“We estimate at €1.25 billion the cost of acquiring the physical production assets needed to manufacture all vehicles in-house. If we add to this Porsche’s own estimate of the investment cost required to develop electronic architectures for its vehicles (€1 billion), we reach a total of €2.25 billion, versus an estimated €3.1 billion spent to date on acquiring 18.5 per cent of Volkswagen (excluding the cost of the optional 3.5 per cent),” J.P. Morgan said.
J.P. Morgan said the relationship between VW and Porsche is potentially unstable, with the prospect of a battle for control with shareholders possibly leading to Porsche feeling it had to take control of VW. There were also worries about conflict of interest which may contravene German corporate governance guidelines.
And VW has serious problems of its own.
VW profit plan has no chance
Under its ForMotion programme, VW plans to increase pre-tax income to €5.1 billion in 2008 as part of its restructuring plan of cutting the workforce and manufacturing costs. VW’s pre-tax income in 2004 was €1.1 billion.
According to Morgan Stanley, this plan is unlikely to come close to succeeding. In Europe, VW has been making more money than Toyota while Ford Europe and GM Europe have been loss making. The trouble is, because of an ageing model line-up and increasing competition, sales growth will end and profits in Europe will come under pressure. Unfortunately for VW, other parts of its global empire aren’t likely to fill the gap.
Morgan Stanley said VW lost €907 million in North America in 2004, and will lose a bit more in 2005, as the Passat, Jetta and Touareg fail to excite U.S. buyers. In 2006 red ink will still be about €760 million. In Latin America, Brazil’s car market is under pressure, and an appreciation of the currency – the real – has sabotaged the economics of the little VW Fox city-car which was being shipped to Europe from Brazil.
SEAT losses
China has been a license to print money for VW but Morgan Stanley expects a €100 million loss in 2005, doubling in 2006. SEAT, the Spanish based VW brand, is expected to lose €100 million in 2005, twice as much in 2006, and €500 million by 2008.
There’s the much publicised scandal that VW funds were used to pay for prostitutes to entertain union members. German authorities are investigating.
The company is also reeling because of a power struggle in the boardroom where the chairman of the supervisory board, Ferdinand Piech, has used the German system of power sharing with unions to fill a crucial salary and conditions negotiating executive with a candidate who was opposed by CEO Bernd Pischetsrieder.
Piech stands accused of conflict of interest because he effectively controls Porsche with other members of the Porsche family.
J.P. Morgan, having pointed out some home truths about Porsche’s business model, doesn’t hold much hope for success.
At odds with current trends
“The need to buy an influential stake in a partner is at odds with current trends in the industry where partnerships and topical joint ventures flourish, but given its size, we would agree that as either a partner or a customer, Porsche has virtually no leverage to influence or share the growing costs of both electronics and of meeting emissions and safety regulations.”
“Porsche management highlighted it expected annual synergies of approximately €400 million, which would provide a double-digit return on the VW investment, but in Porsche’s previous business model such synergies were expected without Porsche having to commit its own capital,” J.P. Morgan said.
Neil Winton
