Porsche: The Hedge Fund that Also Made Cars

I usually only write book reviews because I feel books have enough content in them that a book review is a handy way to organize one’s thoughts from the book. However, I’ve recently read a 6000-word article on a website that I felt had so many learning points that I just had to write a review on it. The article is Porsche: The Hedge Fund that Also Made Cars by Priceonomics Blog. The article is basically a case study on how Porsche tried to takeover Volkswagen but ended up being taken over by Volkswagen instead.

Firstly, Wendelin Wiedeking was clearly a capable businessman. He managed to turn Porsche, which had been on the verge of bankruptcy when he became CEO in 1993, into a company that made $166 million in profit in 1998. He did so by improving quality, reducing inventory, increasing efficiency, and reducing headcount. He hired a team of experts from Toyota to revamp the production line.

Secondly, while Wiedeking’s work at Porsche showed he was a more than capable CEO, he would really be remembered for also having a keen eye for investment. Over time, Porsche had become increasingly reliant on Volkswagen. For example, the Porsche Cayenne and Porsche Panamera were both built using VW chasis. There was a threat that another company could buy over Volkswagen and sever this partnership because Volkswagen had a very depressed stock price. VW had annual profits of only $2.2 billion from $123 billion in annual sales or a net profit margin of  1.7% and so was very poorly rated by the financial community. Interestingly, Porsche decided to buy a stake in VW. In 2005, it acquired a 20% stake in VW which acted as a deterent against a hostile takeover of its partner. Wiedeking had not only made a strategic investment by buying a stake in a partner company that allowed his own company to keep a high profit margin, he had done so at a very undervalued price. I like that Wiedeking was not only a good CEO, he was also a savvy value investor.

Thirdly, Wiedeking made a mistake by becoming the market for VW shares. While things started well for Wiedeking, it seems like he got overly ambitious. He started to buy more shares in VW and tried to turn VW around. By 2008, Porsche owned 50% of VW and VW shares had tripled in prices from Porsche’s first buy price. The market noticed Porsche’s interest in VW and VW’s share price continued to trend upwards even though the company performed poorly because investors believed Porsche would continue to buy up shares. This attracted many short sellers who believed that VW shares would plummet once Porsche stopped buying VW shares. Porsche had essentially become the market in the sense that it’s holdings of VW shares were only valuable on paper. If Porsche tried to sell any of its VW shares, the value would likely drop since the market would no longer expect Porsche to continue buying VW shares. This was a very dangerous moment for Porsche.

Fourhly, Wiedeking was bold enough to pull of an amazing stunt. As the Great Financial Crisis hit, short sellers piled on VW and 12.8% of the shares were sold short. Porsche pulled off a clever move where it announced that it raised its stake in VW to 42.6%, and also purchased cash-settled options to purchase another 31.5% of VW shares, taking it’s stake in VW to 74.1%. The company also announced it’s intention to acquire VW, which would allow it to use the cash on VW’s balance sheet to finance the acquisition. This created a short squeeze and VW’s share price went from $200/share to $500/share to $1000/share. Porsche didn’t have to disclose its growing position because it used cash settled options which technically wasn’t considered buying shares in the comapny. Moreover, it did so by buying the options through six different banks so no individual person knew the extent of Porsche’s move. Porsche was on the verge of completing an audacious takeover move and I am very impressed by how it has done so.

While Wiedeking had so far played his cards very well, he had made a few mistakes. Firstly, he was too optimistic that the German government would repeal the “Volkswagen Rule”. The local German government of Lower Saxony owned 20% of Volkswagen and could prevent anyone from acquiring the company without their permission or anyone from having more votes than them over shareholder matters. It was argued that this law was incompatible with EU laws and so would be soon repealed. Once the law was repealed, Porsche would be the frontrunner to acquire Volswagen since it had a large stake. I feel that Wiedeking should have waited for the law to be revoked before increasing Porsche’s stake in VW above 20%. The 20% stake already made Porsche the most likely to acquire VW. By increasing the stake, he was making it more expensive to acquire more shares, even though the VW rule was in place and preventing him from taking over the company.

Secondly, Porsche financed these share purchases by accumulating debt and it needed more capital to buy off the rest of VW. Precisely when Porsche needed banks the most, banks stoppped lending money. Banks were no longer interested in lending more money due to the GFC. As Porsche CFO Holger Harter said, “We learnt the hard way that banks are there for you when you don’t need them, and when you do need them, they’re no where to be seen.” Porsche neede money to repay some loans that couldn’t be renewed. I feel that using debt to finance these share purchases was foolhardy since Porsche was not in the position to complete the takeover anytime soon since the VW rule had to be repealed. In my opinion, using debt means that your end goal has to be reached before the debt comes due.

The Great Financial Crisis was transforming Porsche’s move from brilliant to stupid. By March 2009, Porsche owed $13 billion to 15 different banks, each of which could bankrupt Porsche if so it wished. Porsche needed a bailout. If you read the article, you’ll learn that Ferdinand Piesch, the Chariman of VW, was also on the board of Porsche. In fact, Piesch was the grandson of Porsche’s founder and was the second largest shareholder in Porsche due to his lineage.He used to work at Porsche but family squabbles made the family decide that no family member could work in the company. Piesch went to work for Audi, rising to CEO in 1988 and became CEO and Chairman of Volkswagen by 1993.

While the story of Wiedeking and how he made Porsche make millions from its stake in VW was fascinating, I reserve most admiration for Piesch. While Porsche was building its stake in VW, Piesch remained silent on the issue. He sat on the board of both companies so he was very aware of what Porsche was doing. Observers speculated that he may be selling Volkswagen to Porsche so he could profit from the move, since he was one of the largest shareholders in Porsche. In 2006, Piesch even announced that he would step down from the VW board  in two years time. While Piesch sat around and let events unfold, he was in fact biding his time for Porsche to make a hiccup.

This hiccup came during the Great Financial Crisis when Porsche was in need of a bailout to repay its bank debt. Piech used VW to provide an emergency loan of $1 billion to Porsche. By doing so, Porsche went from predator to prey. As the $1billion loan approached maturity, Piesch started commenting about his waning confidence in the Porsche management team. Since Porsche was unable to repay the loan, VW mandated that Porsche would have to sell itself to VW. By biding his time and striking when the iron was hot, Piesch transformed his stake in Porsche to a stake in both VW and Porsche.

I feel that this case study was very illustrative and would serve as good reading to all.

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