Volkswagen (OTCQX:VLKAY) has gone through some interesting corporate times in the past decade or so. From a staple of low-middle class offerings in subcompact vehicles, to charging the luxury sedan market with Audi, pushing ultra-luxury offerings in boom times like Bugatti's and Bentley, to a reinvigoration of its fuel efficient TDI technology. Volkswagen's most interesting piece in recent automotive history is the tug-of-war between Porsche (OTCPK:POAHF) and Volkswagen.
What at first seemed to be a brazen move by Ferdinand Piech to take over a larger company, which owns 10% of Porsche and a substantial amount of voting rights - Porsche began to acquire levered options on Volkwagen Shares. Though Porsche had already owned a substantial amount of Volkswagen shares it increased that ownership to over 50%, drawing a huge run up in Volkswagen shares as shorts clamored to cover positions and Porsche claimed that ability to buy up to 75% of Volkswagen.
At one time Volkswagen was the largest company in the world even as it sat at #3 on the list of largest car manufacturers. However, it turned out that the true reason Piech needed a stake in Volkswagen was to ensure no outsider came in at Volkswagen and impeded on the relationship between Porsche and Volkswagen. The relationship between Porsche/Audi/Volkswagen is one that really goes back to their beginnings and a Volkswagen takeover would have likely been devastating - more so to Porsche as the smaller fry. In other words, Piech basically wanted to protect his fortune in Porsche. At the same time Piech was still on the board of Volkswagen. Don't worry, it may get more confusing yet.
Regardless, there were a couple of things going on and I will list them as follows:
- The namesake Porsche family members were not happy with the leverage employed and aggressive maneuvering of Piech at Porsche
- Porsche had also taken some rather large capital investment projects to build out new models (Cayenne, Panamera)
- Result of leverage and value of options, led to a huge tax bill for Porsche, which it could not afford
- Porsche then sought out investment from outsiders and agreed to merge with Volkswagen to subside all fears
- Piech wins!
So today we have a Porsche that owned 32% of Volkswagen as an unconsolidated subsidiary, as a result of dilution from Volkswagen. And we have Volkswagen, which now owns about 50% of Porsche as a result of the merger agreement. For some reason Volkwagen elected to not buy back its shares. I'm assuming that was done to defer the tax bill that Porsche faces. But at some point in 2011 the cross holdings of shares between the two companies will somehow be sorted out.
Now the question becomes, how to make some money out of all of this? Well, the disorientation of the markets in Europe in general and the confusion around these two companies has clearly kept investors at bay. There are legal wranglings, tax issues and questions surrounding whether the merger will go on as planned. Despite all that, if you own any automotive company shares, whether Daimler (OTCPK:DDAIF), BMW (OTCPK:BAMXY), General Motors (NYSE:GM), Toyota (NYSE:TM), Honda (NYSE:HMC), Nissan (OTCPK:NSANY), or Mazda (OTCPK:MZDAF) - ask yourself if they have the prestige or the type of assets that Volkswagen owns. Out of that list you really end up only with Volkswagen's German counterparts in Daimler and BMW, both of which are considerably smaller and do not capitalize well on lower market brands.
For more evidence we can look at some valuation ratios. Namely, I'm going to look at Enterprise Value to Free Cash Flow ratios (I tend to ignore changes in working capital and I also take out estimated growth capital expenditures). Volkswagen comes in at just over 10x. BMW comes in at over 10x. Daimler at about 11x. Porsche is 10x. How interesting that all my ratios come in about even (there are some assumptions about capex here, which I can share if you email me). Of course there are some differences in capital efficiency that make some worth more than others, but at the end this is just to show that the valuations are reasonable.
The really interesting part is that Porsche owns over 30% of Volkswagen's 55 billion euro market cap. I decided to discount that by another 40% for any takes and end up with a net added value of 10 billion euro to Porsche's coffers. Against a 11 billion euro market cap for Porsche, that's almost a double!
And that is how you can get 1 free Volkswagen by buying 1 Porsche! What auto manufacturer can give that type of deal?? Hidden amenities abound in Volkswagen's global footprint across all car model classes.
Disclosure: I am long POAHF.PK.
Additional disclosure: I bought Porsche shares on the German market. I do not own the pink sheets.