Market Entering In Volkswagen Through The Wrong Door

Summary

• Seems like the EV gap of TESLA to VW is closing, specially in Europe and China.
• More clear bet by VW in EVs has put the light of the market into the company.
• Clear flows into VW but through the wrong door. I explain here why.

Even those that have been following VW a bit closely during the last years, are surprised about the bold bet by the company into EVs. Last Monday and Tuesday have been intense in presentations and interviews that have pretended to change the perception of the company. Somehow it seems like they have achieved it.

The company finally realized that it needs to show the market that they are not a simple dumb-legacy company doing some old business but that they have the capability to play the game against TESLA and even more, that they will have better cards to play in what is a long game that only has started.

They might have been late and slow but in the auto industry scale and global presence is relevant as in any other mature, capital intensive busines.

VW normally sells 10 million cars among all its brands so the cost of R&D and capex that it can stand with its recurring cash flow is miles ahead of a company that sells less than a million cars, TESLA or any other company.

I will soon provide a valuation article for VW but today I didn’t want to go through that.

The market seems to have finally put the focus in VWs possibilities and while TESLA share is off its absurd valuation peak of $800bn, Volkswagen has done +51% YTD vs. -5% of TESLA.

Seems clear that there are a lot of new investors coming to VW and some might be doing it through the wrong door.

(please be aware all amounts and prices are in euros and this this is a blog-post and not a proper article).

Volkswagen capital structure

The company has two different kind of shares, common [VLKAF] and preferred shares [VLKPF].

Preferred shares have no voting right but are entitled to receive 6 extra cents of euro as dividend if common shares receive any dividend, as it is usually the case. For example, in 2020 the proposed dividend for common shares is 4.8€ and 4.86€ for preferred shares.

The company has 295.1M common and 206.2M preferred shares outstanding. What is more important to the newcomers is that the most traded and liquid shares are the preferred ones because common shares have a relatively small free float (only 10% of the shares are freely traded), as you can see on the table:

The common shares (with voting rights) are controlled by the Porsche family,  with 53,3%, the German-Saxony state, 20%, and Qatar Investment Authority with 16.99% of the common shares. Altogether they own 90.3% of the common shares while the rest can be considered free float, but that is only 10% of the total.

On the other hand, 100% of the 206.2M preferred shares can be considered free float. That is why the share price that is considered more reliable is the price of preferred shares which represent 84% of the total free float of the company.

Common and preferred price evolution

If their economic rights difference is marginal, as 6 cents of one euro make for a 1% differential in dividend per share, and voting rights value is marginally relevant to most investors, price of both shares should be similar.

In the last 10 years (Mar-11 to Jan-21), the average differential of common to preferred share price is marginally negative (-€0.26 to be precise), but it has traded around that average in a range that goes from -€18 to +€24.7.

A more more recent 5 years average is positively skewed with an average of €4.8 and a range of -5 to +23 euros per share.

Today VW share price closed at €230.8 but common shares closed at €308.8, that is €78 higher, equivalent to a 33.8% differential, and 3 times more than the maximum of the range of the last ten years.

What is going on then?

In my opinion there are two possible explanations for this huge differential for what is economically exactly the same underlying asset.

The complex, less credible explanation, is that somebody is pushing for control of VW and is therefore buying shares with voting rights no matter he/she ¡s paying a hefty premium for it.

This is hardly credible because the control of the company is clearly in the hands of the Porsche family through the, also publicly traded, holding company called Porsche Automobil Holding (OTCPK:POAHY), which trades at a significant discount to its NAV by the way.

It is hardly possible to get the control for VW because its control is on the hands of the Porsche family with majority of voting rights (53.3%) and even more so if they join forces with either with QIA or Saxony regional estate.

The other, more credible explanation is that a huge flow of investors has looked at VW’s recent investor and PR events and with little knowledge or due diligence about the company or its structure have decided to buy into the new EV potential star.

In front of the common-preferred choice it is logical that without previous knowledge the normal investor would go for the common share. Therefore it is plausible that a significant part of the new investors in the company have bought into common shares without realizing they are in fact overpaying and buying into less liquid asset than preferred shares.

The second explanation sounds like more appropriate of the times we are living in the market.

Finally, it could also be that part of the market is investing through ADRs in the US which are made of common shares, as far as I have been able to do and that creates a tradable spread against European common shares that pushes up prices on common shares regardless of preferred shares. I do not know the inner workings of ADRs in the US to have an opinion there but what is certain is that the effect is bringing common shares to absurd premium over preference shares.

Closer look at price performance YTD

The EV overhaul of the company has brought good vibes to the share price.

Since the beginning of the year, preferred shares have performed very well +55%, but common shares have increased its price 30 percentage points more, up to 85%.

In total, the market cap of the company has increased by 74% in a little less than three months which is only explainable by the widening focus of the market from TESLA into other, not so far behind, companies in the EV spectrum.

The widening of the gap between the two share prices really started on the 8^th of March 2021, that is beginning of last week. Until then, the spread had been around €20 for most of the year. But that day, marked the beginning of this short trend out from the normal range that pushed the spread to €48 by the 10^th of March.

After some relaxation in the coming days, down to €44 last Monday, it suddenly broke to €55 on Tuesday and to €78 today.

Conclusion

Clearly this premium to buy a less liquid asset with less economic rights makes no sense at all, unless you are deeply concerned about having voting rights. By the way, in front of shareholders that altogether control 90% of the votes.

It is advisable to avoid paying a €78-33% premium above regular share price, which is the one marked by preferred share price, to become a minority shareholder with voting rights.

It makes much more sense to buy the more liquid, 100% free float part of the market cap that counts with marginally higher dividends and trades at a €78 discount to the shares with voting rights.

I think that when the new investors that have been buying the VW new EV trend, maybe with little attention to what they were buying, and with the feeling that an 85% revaluation YTD starts to resemble past adventures, might realize that they have entered in the company through the wrong door.

Hopefully, this does not kill the trend to buy into a company that makes a lot of sense to own, if you want to be exposed to the auto industry with less price and industrial risk than TESLA and with prices that still today make some sense (obviously more sense if you buy the preferred shares).

The best but not obvious door to buy into VW is through Porsche Automobil Holding which offers a discount to buying directly in VW. The second-best door is preference shares of VW that closed today at €230. The wrong door is the ones that 10%-free-float-common-shares offer.