Automotive Management: Navigating the next decade of auto industry transformation 9783486709964

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International Finance

Deutsches Institut für Corporate Finance

Automotive Management Navigating the next decade of auto industry transformation

by

Jens Diehlmann and

Prof. Dr. Dr. Joachim Hacker

Oldenbourg Verlag München

We would like to thank Daimler AG for supporting the pictures on page XVII as well as page 198.

Bibliografische Information der Deutschen Nationalbibliothek Die Deutsche Nationalbibliothek verzeichnet diese Publikation in der Deutschen Nationalbibliografie; detaillierte bibliografische Daten sind im Internet über abrufbar.

© 2011 Oldenbourg Wissenschaftsverlag GmbH Rosenheimer Straße 145, D-81671 München Telefon: (089) 45051-0 oldenbourg.de Das Werk einschließlich aller Abbildungen ist urheberrechtlich geschützt. Jede Verwertung außerhalb der Grenzen des Urheberrechtsgesetzes ist ohne Zustimmung des Verlages unzulässig und strafbar. Das gilt insbesondere fur Vervielfältigungen, Übersetzungen, Mikroverfilmungen und die Einspeicherung und Bearbeitung in elektronischen Systemen. Lektorat: Dr. Jürgen Schechler Herstellung: Anna Grosser Coverentwurf: Kochan & Partner, München Umschlagfoto: Jens Diehlmann Gedruckt auf säure- und chlorfreiem Papier Gesamtherstellung: Druckhaus „Thomas Müntzer" GmbH, Bad Langensalza ISBN 978-3-486-59780-6

Foreword

The ongoing global economic crisis has resulted in the need for urgent change across the automotive industry. The primary foci of the automotive industry include: adjusting for overcapacity in production, low profitability in new vehicle sales, stagnation of demand in the developed markets, and capitalizing on opportunities in the emerging markets. Auto manufacturers must now make significant investments in developing leading-edge, eco-friendly models, while applying the latest technology; both in vehicles and across their operations, in order to remain competitive. In addition, they must develop new revenue streams through innovative finance models. These finance models should be available to car buyers, and will be customized to meet the needs of consumers through local sourcing. They are also continuing to consolidate manufacturing operations worldwide, while automakers from India and China are simultaneously pushing their way into an already crowded market. Automotive manufacturers across all segments are facing the demands of new market dynamics. In order to operate successfully, they must meet the challenges of this complex market with a multi-dimensional approach. The book Automotive Management in 2020: Navigating the Next Decade of Automotive Industry Transformation provides a thorough, readable analysis, supplemented with extensive data. The analysis outlines options for strategic transformation within the industry, and also possibilities for innovative financial service products. The authors chose a provocative view point that lends itself to thoughtful debate. In this sense, this book will be a valuable contribution to navigating the right path for the global industry. Dr. Alexander Scheidt IBM Global Automotive Industry Leader

Foreword by the Authors

The text oí Automotive Management in 2020: Navigating the Next Decade of Automotive Industry Transformation relates to the needs of automotive manufacturers over the next decade by examining a series of targeted questions, the broadest being: What are the central concerns of the automotive industry in the years to come? Further, we at the German Institute for Corporate Finance, together with IBM (recognized for its vast practical experience from consulting projects and extensive market analyses across the industry), have educed the following five questions for the industry: •

What does the market of the future look like for automotive manufacturers?

•

What are the strategic levers for the future?

•

What are alternative scenarios?

•

What is the importance of Captive Finance Companies (CFCs) for the OEMs?

•

What new business models will differentiate Captive Finance Companies in the future?

Currently, automobile manufacturers are faced with the challenge that they seldom recover their total capital costs. Greater profit margins are primarily achieved through aftermarket sales (parts and service) and financing. The hope of profits through growth in emerging markets has yet to be realized. Even the booming markets in the BRIC nations are not sufficient to counteract the lagging profits of automotive manufacturers, as they, too have been impacted by the strained global economy. Automotive manufacturers will only achieve a solution to the profit dilemma by following a transformation strategy aligned to their business and marketing needs. Currently, the respective approaches of most automotive manufacturers are fundamentally similar, which offers them few possibilities for differentiation. As very few manufacturers can achieve sufficient cost control, it makes sense to focus on those areas where there are still possibilities for differentiation. The goal of this book is to analyze the strategic approaches for automakers in light of new market dynamics, and to show possible options for action. Globalization-centric challenges, new technologies, and strategic refocusing, will accelerate a wave of consolidation for automotive manufacturers, especially among brands. In Part 1, strategic options for automotive manufacturers are outlined. The case of Volkswa-

Foreword

VII

gen and Porsche, which examines horizontal integration and financing, is examined in Part 2 of the book.* In Part 3 we demonstrate why Captive Finance Companies should be an integral component of every manufacturer's strategy. We have attempted to write this book in clear language for those interested in the economic and political aspects, of the industry. It is oriented toward financial managers, controllers, corporate strategists, financial services providers and consultants. We wish to thank IBM for their exhaustive research efforts, and for the funding of this manuscript. Our thanks also extend to the publisher, Oldenbourg, and the employees thereof: especially Dr. Juergen Schechler, a specialist in economics and social sciences, for his consistently pleasant, proficient and constructive collaboration. Further, we thank the individual employees of the German Institute for Corporate Finance and IBM, especially Mr. Nikolaj de Lousanoff (Manager, IBM), who greatly influenced the structure of this book through his analytical approach. We also thank Mr. Eduard Ciorogariu, Mr. Oliver Elsoud, and Mr. Klaus Wassermann, who insured the completion of this book. Mr. Ciorogariu contributed the Porsche/Volkswagen Case Study, Mr. Elsoud led the analyses of Captive Finance Companies, and Mr. Wassermann developed reports on the fiscal strategies of the automotive manufacturers discussed herein. We also thank Ms. Susanne Tomassetti for her corrections, and Ms. Doris Sperber for her excellent illustrations; both played an important role in the development of this book. Frankfurt am Main, February 2010 Jens Diehlmann and Joachim Häcker

The case study "Porsche/Volkswagen" in particular, as well as all other remarks in this book are based on analyses conducted by the authors, to the best of their knowledge. They are based solely on literature research and on publicly available information. We have inspected the information to the best of our knowledge, but are not liable for it (apart from liability for gross negligence). We bear no responsibility for the completeness or accuracy of this data. These analyses and conclusions in this book should not be used as the basis for investments in the stocks of these companies. We bear no liability for any financial actions taken by the reader.

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Contents PART 1 Strategies: Automotive Manufacturers "Quo Vadis"? 1 1.1 1.2 1.3

2 2.1 2.2 2.2.1 2.2.2 2.3 2.3.1 2.3.2 2.4 2.4.1 2.4.1.1 2.4.1.2 2.4.2 2.4.2.1 2.4.2.2 2.4.3 2.4.3.1 2.4.3.2 2.5 2.5.1 2.5.2 2.5.3 2.5.4 2.5.5 2.5.6 2.5.7 2.5.8

Introduction Problem Statement Procedure Definition

3 3 4 5

Overview of the Global Automotive Markets and Manufacturers

5

The Global Automotive market in overview The European Automotive market in overview What Distinguishes the European Automotive market? Market participants - Europe The U.S. Automotive market in overview What distinguishes the American Automotive market? Market participants-The U.S The Asian Automotive market in overview The Japanese Automotive market The Japanese Automotive market in overview Market participants - Japan The Indian Automotive market The Indian Automotive market in overview Market participants - India The Chinese car market Overview of the Chinese car market Market participants - China The Automotive manufacturers Company profile-Volkswagen AG Company profile - BMW AG Company profile - Daimler AG Company profile - PSA Peugeot Citroen S.A Company profile - Renault S.A Company profile - Fiat S.p.A Company profile-Toyota Motor Corporation Company profile - Nissan Motor Co., Ltd

5 7 7 8 8 8 10 10 11 11 12 13 13 14 16 16 17 18 19 22 25 28 31 34 37 40

χ

2.5.9 2.5.10

3 3.1 3.1.1 3.1.2 3.1.3 3.2 3.2.1 3.2.2 3.3 3.3.1 3.3.2 3.4

4 4.1 4.2 4.2.1 4.2.2 4.2.3 4.2.4

Contents

Company profile - Ford Motor Company Company profile - Honda Motor Company Ltd

The strategic options for automotive manufacturers? Geographic positioning India China Chance and risk profile-India/China Alternative motor power Overview of propulsion alternatives Challenges of alternative motor power - value creation & the suppliers Horizontal and Vertical integration, as well as strategic alliances Trends in the automotive supplier segment Challenges of vertical integration Financing strategies for OEMs

Which strategic direction will the OEMs take? Quo vadis - Automotive industry Quo Vadis - OEMs Mass and premium class manufacturers Where do the individual OEMs stand today? Where will the OEMs be in year 2020? Financing challenges

43 46

49 50 50 54 57 58 59 61 62 63 65 65

67 67 69 69 71 76 81

PART 2 Porsche and VW: A Case that Wrote History 5 5.1 5.1.1 5.1.2 5.1.3 5.1.4 5.1.5 5.1.6 5.1.7

Porsche's takeover attempt and financial strategy The takeover attempt 2005-2009 Situation analysis: VW 2005 Situation analysis: Porsche 2005 Why did Porsche enter into VW? Investor Reactions to Porsche's entry into VW Wiedeking and Härter appointed to VW's Board of Directors Build-up of interest in VW and obligatory bidding Reforming Porsche AG into a European Societas Europaea (SE) joint-stock corporation

83 84 84 86 87 89 92 92 93

Contents

5.1.8 5.1.9 5.1.10 5.1.11 5.1.12 5.1.13 5.1.13.1 5.1.13.2 5.1.13.3

The E G rules on VW Law Porsche achieves majority share in VW What is Ferdinand Piëch's position? The Change in Communication between Porsche and VW Reactions of the Market Participants An overview of Porsche's Takeover Strategy Phase 1:VW Share under 20% Phase 2: Edging toward the 30% mark Phase 3: Crossing the 30% Hurdle and making Porsche Automobile Holding SE a holding company Phase 4: Approaching the 75% mark Porsche's Financing Strategy Status Quo 2005: Liquidity from the Operative Business Instating a Eurobond, Two Hybrid Bonds and Increasing the Subscribed Capital Loan from an International Bank Syndicate Porsche's Option Strategy Technical Terms of the Option Trade The Banks'Position Porsche's Position Effects on other market participants The Failure of the Takeover Attempt Conditions Surrounding the Refinance Endanger Business Operations Creation of an Integrated Group State Guarantee from Baden-Württemberg Credit request at the KfW Daimler as a Potential Investor Financial Support from the Qatar State fund Five Conceivable Scenarios Qatar Holding LLC takes a share in Porsche and VW Why the Takeover Failed

5.1.13.4 5.2 5.2.1 5.2.2 5.2.3 5.3 5.3.1 5.3.2 5.3.3 5.3.4 5.4 5.4.1 5.4.2 5.4.3 5.4.4 5.4.5 5.5 5.5.1 5.5.2 5.6

XI

95 97 100 101 103 107 109 109 110 110 111 111 113 116 117 118 119 127 133 134 134 136 137 138 138 139 139 141 142

PART 3 Captive Finance Companies (CFCs): The Future Instrument of Manufacturers 6 6.1

How is the market for automotive financial services classified? Manufacturer-affiliated vs. non-manufacturer-affiliated financial services providers

149 149

XII

Contents

6.2

Financing O E M brands vs. non-OEM brands (foreign brands)

6.3

Integration from a corporate and legal point of view

150

and legal demarcation of CFCs

152

6.4

The traditional product offerings of CFCs

153

6.4.1

Retail leasing

153

6.4.2

Retail financing

153

6.4.3

Dealer financing (wholesale finance)

154

6.4.4

Fleet business

154

6.5

Strategic importance of CFCs

155

7

An overview of globally active CFCs

159

7.1

Ford Motor Credit Company

162

7.2

Toyota Financial Services Corporation

164

7.3

Volkswagen Financial Services

166

7.4

Daimler Financial Services

168

7.5

B M W Financial Services

170

8

Which current business approach is pursued by CFCs?

172

8.1

The traditional captive finance approach

172

8.2

Advanced automotive banking approach

173

8.2.1

Mobility-related services

173

8.2.2

Mobility-neutral services

176

8.3

Comparative overview of services offered

176

8.4

Cross-selling and cross-over in the automotive financial services sector

178

9

How can CFCs strategically newly position themselves, in order to be well prepared for 2020?

18O

9.1

Overview of current refinancing possibilities for CFCs

180

9.2

Equity capital on the CFC balance sheet

184

10

CFC - Quo Vadis?

186

10.1

Strategic options for CFCs

186

10.2

Fields of action for the developed markets of the Triad

186

10.2.1

Pushing financing solutions of used vehicles

186

10.2.2

Development and expansion of fleet customer business

187

10.2.3

Introduction and expansion of products with risk adjusted pricing

188

10.2.4

Establishment of bank branches

188

10.2.5

Transforming a CFC into a bank holding company

190

Contents

10.2.6 10.2.7 10.3 10.3.1 10.3.2 10.3.3

Revision of governance structures and operating concepts Optimization in the areas of refinancing, liquidity management and risk management in concert with the OEM Recommended procedures for the new emerging markets Establishment of finance agencies in Russia, China, India and Brazil New operation strategies for the growth markets Establishment and implementation of financing solutions for the promotion of new mobility concepts

Glossary Bibliography Index

XIII

192 193 195 195 196 197 199 205 213

List of Figures

Figure 1 : Utilisation of production capacities

4

Figure 2: Development of car sales in specific markets (in % )

6

Figure 3: Car density (by unit) as per world region

6

Figure 4: Expected car sales in Western Europe

7

Figure 5: Overview of market shares in Europe

8

Figure 6: Expected car sales in the the U.S

9

Figure 7: Overview of market shares in the U.S

10

Figure 8: Expected sales numbers for ultra-low-cost cars

11

Figure 9: Expected car sales in India

14

Figure 10: Overview of market share in India

15

Figure 11 : Expected car sales in China (in mi. units)

17

Figure 12: Overview of the market share in China

18

Figure 13: Company profile Volkswagen A G

21

Figure 14: Company profile - B M W A G

24

Figure 15: Company profile - Daimler A G

27

Figure 16: Company profile - PSA Peugeot Citroen S.A

30

Figure 17: Company profile - Renault S.A

33

Figure 18: Company profile - Fiat S.p.A

36

Figure 19: Company profile - Toyota Motor Corp

39

Figure 20: Company profile - Nissan Motor Co. Ltd

42

Figure 21 : Company profile - Ford Motor Company

45

Figure 22: Company profile - Honda Motor Company Ltd

48

Figure 23: Shifts in regional distribution

49

Figure 24: Growth of GDP and nominal per capita income in India

51

Figure 25: Number of potential buyers of an ULCC

52

Figure 26: Distribution of income classes

54

Figure 27: Growth of GDP and nominal per capita income in China

55

Figure 28: Comparison of the infrastructure of China and the U.S

56

Figure 29: Chances and risk profiles for India and China

58

Figure 30: Overview of alternative motor power

59

Figure 31: Leading manufacturers of alternative propulsion vehicles

60

Figure 32: Value creation in the drive channel by the manufacturer and the supplier

61

Figure 33: Illustration of the horizontal and vertical integration

63

Figure 34: Structure of manufacturer-supplier relationship

64

Figure 35: Financing strategies of O E M s

66

Figure 36: Consolidation in world automotive market44

68

Figure 37: Transactions in the automotive branch in 2008 and 2009

69

Figure 38: Abstract of the key financial figures from the company profiles (2008)

72

List of Figures

XV

Figure 39: Grouping of the automotive manufacturers in premium and volume segments (2008)

77

Figure 40: Grouping of the automotive manufacturers in premium and volume segments (2020)

81

Figure 41 : P/B ratio of VW, Daimler-Chrysler and BMW, values rounded off (status: 2005 end)

85

Figure 42: Growth of turnover from 2000/2001 -2004/2005

86

Figure 43: Growth of Net Profit Margin 2000/2001 - 2004/2005

87

Figure 44: Return on Equity Ratio, Porsche and the competitors (Status as of: 2004 or 2004/2005)

87

Figure 45: VW shareholding structure after the entry of Porsche (Status as of: Autumn 2005)

88

Figure 46: VW ordinary share, price movement from 12th Sep. 2005 - 30th Sep. 2005

89

Figure 47: Traded volume of ordinary VW shares, 12th Sep. 2005 - 30th Sep. 2005

90

Figure 48: Price movement of Porsche from 12th Sep. 2005 - 30th Sep. 2005

91

Figure 49: Traded volume of Porsche share from 12th Sep. 2005 - 30th Sep. 2005

91

Figure 50: SWOT analysis, Porsche takes over VW

98

Figure 51 : Thresholds and rights of the shareholders Figure 52: Development of VW common stock from Sept. 2005 - Sept. 2009, monthly key rates

99 103

Figure 53: Trading volume of VW common stock, monthly key rates

104

Figure 54: VW stocks structure (As in: 2009)

106

Figure 55: Trading volume of VW common stock, monthly key rates, Nov. 08 - Nov. 09

106

Figure 56: Development of Porsche's VW share quotes from media publications

108

Figure 57: "Cash and cash equivalent" as well as "marketable securities" 2003 - 2005 (in bn Euro) . . . . 112 Figure 58: Porsche's liquidity based on the financial year 2004/2005

112

Figure 59: Ratio comparison, Porsche 2004/2005 and VW 2004

112

Figure 60: Overview of Porsche's Eurobond, split into two tranches

115

Figure 61 : Porsche's hybrid bonds

115

Figure 62: Increase in Porsche's liabilities to banks

117

Figure 63: Basic option terms of technique

118

Figure 64: Pay-off Diagram: Short Call Position of the banks

120

Figure 65: Short Call 1, Position of the banks

121

Figure 66: Short Call 2, Position of the banks

121

Figure 67: Bank loss at a stock price of 250 euro

122

Figure 68: Pay-off Diagram: Covered Call Writing of the banks

122

Figure 69: Covered Call Writing, Banks' Position

123

Figure 70: Maximum profit of the banks assuming Short Call 2 was in the money

124

Figure 71 : Maximum loss of banks at a share price of 0 Euro

124

Figure 72: Pay-off Diagram: Covered Call Writing combined with Protective Put

125

Figure 73: Covered Call Writing Combined with Protective Put, Position of the Bank

126

Figure 74: Gain of the banks, if share price is 140 euro

127

Figure 75: Pay-off Diagram: Long Call Position of Porsche

128

Figure 76: Porsche's earnings from options

128

Figure 77: Porsche's profits from options 2007/2008

129

Figure 78: Long Call 1, Porsche's Position

129

Figure 79: Long Call 2, Porsche's Position

130

Figure 80: Pay-off Diagram, Long Call 2 and Short Put (Porsche's position)

131

Figure 81 : Long Call 130 and Short Put 200, Porsche's position

132

XVI

List of Figures

Figure 82: vw common stock price

133

Figure 83: Integrated Shareholding, Porsche and Volkswagen

137

Figure 84: Porsche's car sales decline, comparing the first half of 2007/2008 with the first half of 2008/2009 Figure 85: Porsches proceeds from share stock option 1 st half-year 2008/2009

143 143

Figure 86: An overview of the significant automotive financial services providers operating in the German market Figure 87: Corporate group structure of Volkswagen AG, Daimler AG, and B M W AG

150 152

Figure 88: An overview of a fleet management' range of tasks

155

Figure 89: Summary of the strategic relevance of CFCs

157

Figure 90: The value chain of the automobile industry

158

Figure 91 : Segmentation of the value chain by value constributions

159

Figure 92: CFC ranking by total number of leasing and financial product portfolio

161

Figure 93: An overview of the Ford Motor Credit Company

163

Figure 94: An overview of Toyota Financial Services Corporation

165

Figure 95: An overview of Volkawagen Financial Services

167

Figure 96: An overview of Daimler Financial Services

169

Figure 97: An overview of BWM Financial Services

171

Figure 98: Product offerings of CFCs

172

Figure 99: Schematic structure of full service leasing and fleet management

175

Figure 100: Expansion possibilities for CFCs

176

Figure 101 : Product portfolio of different CFCs Figure 102: Description of cross-selling and cross-over

177 178

Figure 103: Trend towards higher value vehicles

179

Figure 104: Purchase behavior in the segment for new cars

180

Figure 105: Typical CFC Balance Sheet

181

Figure 106: Asset side as a determinant of the present CFC business activities

182

Figure 107: The liability side as a source of refinancing for CFCs

183

Figure 108: Comparison of key interest rates and CFC profits in %

183

Figure 109: Refinancing structure of CFCs hy1/2008

184

Figure 110: The position of Equity Capital on the CFC Balance Sheet

185

Figure 111 : Presentation of a typical OEM's Corporate Structure

189

Figure 112: Example of CFC-Bank holding

191

Figure 113: Development of credit default swaps (CDS) in the automobile industry

194

Figure 114: Worldwide new vehicle registrations and market shares between 2007 and 2008

195

Executive Summary The goal of this book is to analyse the future strategic approach of automotive manufacturers in view of rapidly changing market requirements. Here, the focus lies on presenting options for action from which a strategic positioning can be derived for the year 2020.

We have approached this goal in three steps.

PART 1

Strategies: Automotive Manufacturers "Quo Vadis"? The investigation into the global automotive market shows the following four relevant options: 1

Geographical positioning to exploit opportunities in growth markets

2

Development of alternative energy propulsion to obtain technology leadership

3

Attaining greater horizontal integration to access new markets; diversify product offerings; and achieve greater scale; as well as vertical integration, to optimise the supply chain

4

Strategic use of Captive Finance Companies, to attain a stronger hold on the market through expansion of the value chain; and greater customer retention

Although each of these four options play a significant role in the ongoing evolution of the automotive industry, the larger focus of this analysis is on the topics related to horizontal integration and the strategic use of Captive Finance Companies (CFCs). These two specific focus areas are expected to lead to major changes for automotive enterprises in the coming years. In analyzing automakers, we found that their respective fiscal and strategic approaches varied widely. In fact, of the 10 premium and volume manufacturers studied here, only 4 followed a clearly defined fiscal strategy. The analysis shows that the automobile manufacturers we analyzed must strengthen their activities with respect to market requirements and core competency in their respective segments.

2

Executive Summary

PART 2 Porsche and VW: A Case that Wrote History The Porsche/VW case is an excellent current example of horizontal integration. Based on publicly available information we will document the chronology of this takeover battle, ongoing since 2005. This includes the finance and communications strategies. We especially focused on the issue of funding of the deal received through options, which has materially impacted the merger battle.

PART 3 Captive Finance Companies (CFCs): The Future Instrument of Manufacturers The strategic importance of the Captive Finance Companies to enable the strategic transformation of automotive enterprises is examined in the last part of the book. We have included a detailed overview of the most important actors in the market, the business model, and a review of various financial products. CFCs serve the manufacturers as a refinancing and customer retention instrument. The current economic crisis has resulted in new challenges, even to this previously profitable business model. Against this background, the financial service providers are forced to strategically redesign/reinvent their business model to continue to be of use to automobile manufacturers. Some attractive options include developing foreign agency banks, used car financing, and extending finance companies to the emerging markets.

•

PARTI

Strategies: Automotive Manufacturers Quo Vadis?

1

Introduction

1.1 Problem Statement Today, there are nearly 1 billion cars on the road worldwide. Since 2007, when global automotive production stood at its peak of 72 million vehicles, the demand for new cars has steadily decreased. Due to the global economic crisis, a sales decrease of 15 to 20% was projected for the year 2009. But, due in large part to government sponsored initiatives (such as Scrap Premium in Germany and Cash for Clunkers in The US) sales of new cars only dropped by 3%, to 67 million units:1 Above all the global automotive industry has remained a strong growth engine and a huge contributor to the well being of people and society, with millions of people living from the automobile.2 The automotive industry is also a critical economic growth driver to the other industrialized countries discussed in this book. In recent years the market for new cars has become increasingly strained. Through the consolidation of manufacturers, market saturation, price wars, and global overcapacity, sales and profits in the traditional business of automotive enterprises have significantly decreased. Figure 1 illustrates overcapacity across a subset of the manufacturers that we studied.

1

Refer to the German Association of the Automotive Industry [VDA] (2009)

2

Refer to the German Association of the Automotive Industry [VDA] (2009)

4

Strategies: Automotive Manufacturers QuoVadis?

BMW

Toyota

GM

Ford

Daimler

VW

Fiat

PSA 2007

Renault 2008

Figure 1: Utilisation of production capacities

Source:

Credit Suisse Equity Research

(2009)

In the coming years, the industry's emphasis will shift from the traditional emerging markets of the Triad (EU countries, North America and Japan) to the developed markets. Product focus is also moving from conventional to alternative propulsion technologies. These long-term trends that began at the end of the last decade have accelerated due to the worldwide recession and require an immediate and strategic response from automotive enterprises.

1.2 Procedure In the following section, we examine these trends in greater detail. We first address the connections between the global automotive markets and their respective participants. Against the backdrop of globalization and a demanding economic environment, potential actions will be evaluated for the industry. We will also compare developmental scenarios in order to make recommendations for specific manufacturers and to assess their viability. Part one of this book will conclude with a vision of the industry in the year 2020.

Overview of the Global Automotive Markets and Manufacturers

1.3

5

Definition

Original Equipment Manufacturer (OEM)

An Original Equipment Manufacturer is a manufacturer that incorporates components delivered by outside suppliers into its own product, then markets and sells the delivered component under its (the OEM's) company name. The term 'original equipment manufacturer' and the term 'automotive manufacturer' are used synonymously in this analysis.3

2

Overview of the Global Automotive Markets and Manufacturers

This chapter will examine the automotive markets of Europe, North America, and Asia. The majority of manufacturers are in these markets and will serve the current and future global automotive industry.

2.1 The Global Automotive Market in Overview The global vehicle market includes two segments: automotive manufacturers (cars, commercial and utility vehicles), and motorcycles. In 2008, motorcycles amounted to only 4.8% share of the total vehicle market. Given such an insignificant portion, we did not consider this segment in our analysis.4 The current economic crisis has significantly impacted the automotive industry. The global turnover of the automobiles and components industry amounted to 2.4 billion US dollars in 2008: a 14.5% deficit from the previous year.5 The BRIC markets, with the exception of Russia, continue to experience enormous growth, while the traditionally profitable markets of Western Europe, Japan, and North America are undergoing decreased sales. Figure 2 shows that negative growth rates (CAGR) are predicted through 2012 for the saturated markets of the U.S., Japan and Western Europe. Significant growth potential exists only in the growing and developing markets of China and India.

3

Refer to Gabler (2009)

4

Refer to Datamonitor (2009a), S. 11

5

Refer to Datamonitor (2009b), S. 9

6

Strategies: Automotive Manufacturers Quo Vadis?

Car sales YoY%

2008

2009

China

7.3

India

2010E

2011E

2012E

CAGR

7.6

2.2

6.4

10.0

6.7

1.8

6.3

7.6

5.5

9.5

6.1

Brazil

13.9

-2.2

-1.9

3.8

1.9

2.9

Russia

15.4

-33.3

5.0

16.7

16.3

1.9

Japan

-5.7

-15.2

0.0

4.8

0.9

-3.3

-16.3

-19.7

17.9

10.4

5.1

-2.1

-8.5

-6.2

-3.5

7.6

3.9

-1.5

1.1

-9.0

3.9

7.9

6.8

1.5

USA West Europe Total

Figure 2: Development of car sales in specific markets (in % ) Source: Credit Suisse Equity Research (2009)

A growing population and low per capita vehicle ownership in India and China have combined for an explosion of growth in their respective markets. Vehicle density (see figure 3) refers to the number of vehicles driven per 1,000 inhabitants. In the U.S., there are approximately 800 more cars per 1,000 inhabitants than in India or China. Europe and Japan also have a markedly higher vehicle density. Future sales in these established markets will consist mainly of replacement vehicles rather than new growth.

India

R 11

China

Ρ17

South America

ΐ

Brazil

95 :

Russia

109 199 228

Japan Germany Western Europe North America ο

1

1

1

1

1

1

1

,

100

200

300

400

500

600

700

800

Figure 3: Car density (by unit) as per world region Source: IWK - Institut for Wirtschaftsanalyse and Kommunikation (Institute for economic analysis and communication) (2009)

— 900

Overview of the Global Automotive Markets and Manufacturers

7

2.2 The European Automotive Market in Overview 2.2.1 What Distinguishes the European Automotive Market? The European automotive market is an amalgam of many markets. Traditionally, however, only the German, French, Italian, Spanish, and British markets were significant producers in the volume segment. Now emerging markets in Central and Eastern Europe, Russia for example, are becoming important volume producers. As Figure 4 shows, there was a heavy decline in sales among Western European producers between 2009 and 2010. Since the low point in the middle of 2008 manufacturers, especially those in the compact and middle class segments, began to show increased sales figures throughout Europe. This is mainly due to government sponsorship programs incentivizing sales. With the phasing-out of government programs, sales have decreased again. Across the European continent, demand dropped 12.5% in 2009. The vulnerability of the European market can be traced not only to the global economic crisis, but also to strategic misjudgements from within the industry. In recent years, the entire automotive industry has assumed ever-increasing sales figures, while neglecting market development. Furthermore, the combination of consolidation, saturated markets, discount battles, global overcapacity, as well as substandard products has left the European automotive industry in a position of jeopardy.

Figure 4: E x p e c t e d car sales in W e s t e r n E u r o p e Source: Credit Suisse Equity Research (2009)

Strategies: Automotive Manufacturers Quo Vadis?

8

2.2.2 Market participants - Europe Europe's automotive market is served by both European and foreign (primarily American and Japanese) manufacturers. In the five traditional markets of Western Europe (Germany, Great Britain, France, Spain and Italy), native manufacturers dominate with a market share of more than 60%. As shown in figure 5, Volkswagen is the clear leader with a market share exceeding 20%, followed by other European OEMs. While U.S. automakers are doing well in Europe, the Asian OEMs hold the smallest share of the market. It should be expected that, in the future, manufacturers from emerging markets (Tata, from India, for example), will enter the market, putting significant pressure on traditional manufacturers, by producing innovative and cost-effective vehicles. This, in combination with a stagnant market and decreased consumer demand, will force traditional manufacturers to rethink their respective strategies; adopting new technology and a radical reorientation toward the market.

25

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Figure 5: Overview of market shares in Europe Source: Deutsche Bank - European Registrations (2009)

2.3 The U.S. automotive market in overview 2.3.1 What distinguishes the American automotive market? The U.S. automotive market is a significant global player, with about 13.2 million vehicles sold annually.6 Like Europe, the American market is also in a sales crisis. According

6

Refer to Credit Suisse (2009c), S. 23

Overview of the Global Automotive Markets and Manufacturers

9

to Credit Suisse (see figure 6), the market suffered a drop in new vehicle sales of 19.7% in 2009, compared to the previous year. The economic challenges stated previously notwithstanding, American automotive manufacturers are faced with industry wide threats of viability. Two of the "big three" American automotive manufacturers (Chrysler and General Motors), declared bankruptcy in mid-2009. Because of outmoded vehicles, Chrysler and General Motors were at once unable to compete in a market increasingly focused on environmental awareness (a result of newly mandated, environmentally focused industry standards restrictions). Over a period of more than twenty years, the "big three" lost the greatest share of their home market to Japanese manufacturers, who offered comparable models and better production capabilities. In addition to Japanese manufacturers, German OEMs effectively penetrated the American market during the current economic crisis. By building new production plants, and establishing more efficient sales networks in the U.S., companies like BMW, Daimler and VW are attempting to increase their share of the weakened American market. Their hope is to negate the effects of the foreseeable collapse of their European market.7 As Europe clamours for control of the U.S. market, Japanese manufacturers such as Honda and Toyota are penetrating the further, because their respective domestic market is stagnant, too. For Europe and Japan, the goal is a controlling stake in the American domestic market.

2011E Car sales Figure 6: Expected car sales in the the U.S. Source: Credit Suisse Equity Research (2009)

7

Refer to Trade Journal (2010)

2012E

YoY %

Strategies: Automotive Manufacturers Quo Vadis?

10

2.3.2 Market participants - The U.S. The U.S. market includes domestic, as well as several foreign manufacturers from Europe and Asia. Interestingly, unlike in the European market, domestic manufacturers in the U.S. do not dominate sales. Instead, Asian manufacturers lead the market with 48.9% of total sales (refer to figure 7). With a market share of 43.7%, American manufacturers are in second place, followed by the Europeans with a market share of 7.3%. With an 18.9% market share, General Motors is barely ahead of Toyota (17.6%). It is uncertain how turbulence in the current market will affect American manufacturers in the future. The question is: How will Ford (the only American manufacturer that did not declare bankruptcy or require government assistance) proceed in light of Chrysler and GM's insolvency. In the current economic climate, the American market may undergo farreaching structural and strategic changes.

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Figure 7: Overview of market shares in the U.S.

Source: Reuters: Auto Industry U.S. (2009)

2.4 The Asian automotive market in overview The increase of free trade agreements and the general opening up of the growing Asian economies of China, India, Korea, Malaysia and Indonesia, are changing the framework of the automotive industry rapidly. Although Japan maintains a long tradition of leadership in global automotive markets, the developing economies of India and China are steadily gaining their respective shares of the industry's attention. Rapidly increasing motorization is also helping them develop some important advantages; however, western OEMs are

Overview of the Global Automotive Markets and Manufacturers

11

also gaining opportunities in those markets. OEMs must carefully consider their strategy and develop new vehicle models to compete in these rapidly developing markets While the production capacities of American and European manufacturers are being utilised less and less in their home markets, production is increasingly being outsourced to India and China. Based on the overcapacity and stagnating demand in the home market, OEMs from America and Europe cannot ignore the enormous growth potential for small vehicles (price segment between 2,500 and 5,000 USD) in these countries. Figure 8 demonstrates the future market potential of the so-called "Ultra-Low-Cost Cars".

15.6

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I 2007

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Figure 8: Expected sales numbers for ultra-low-cost cars

Source: A.T. Kearney (2008)

2.4.1 The Japanese Automotive Market 2.4.1.1 The Japanese Automotive Market in Overview For many years, Japan was the third-largest global producer, behind only The U.S. and Europe.8 But with assembly line innovations, Japan moved to the forefront of the global automotive manufacturing industry.9

8

Refer to Japan Automobile Manufacturers Association, Inc. (2009), S. 62

9

Refer to Reuters (2010)

Strategies: Automotive Manufacturers Quo Vadis?

12

The automotive market is an integral part of Japan's economy. Currently, of over 64 million workers in Japan, 8% (5.15 million) are employed within the automotive industry. This, coupled with the high proportion (21.6% of the country's total exports) of production parts and vehicle exports, demonstrates the importance of the automotive industry to the Japanese economy.10 However, vehicle sales in the Japanese home market have remained stagnant for years. In the year 2009, only 3.9 million new cars were sold domestically, marking a sales deficit of 7%, compared with the previous year. In Japan, there are 451 cars per 1,000 drivers; a relatively saturated market when compared to the neighboring markets of China and India.11 Nevertheless, the national automotive association in Japan predicts that market growth will commence in the next year to approximately 4.8 million units, due to the slowly recovering economy and tax-incentive for low-emission vehicles.12

2.4.1.2

Market participants - Japan

The Japanese market is dominated almost exclusively by domestic manufacturers. Japanese producers control 96% of the market, while international manufacturers comprise only 4%. Toyota dominated its home market in 2009, with a share of more than 30%. Moreover, Toyota's 51% stake in Daihatsu further bolsters its position as the global market leader.13 Despite the economic crisis, the company is on track to sell over 1.3 million new vehicles in the Japanese market in 2010. Nevertheless, the 1.3 million new vehicles still mark a 7% decrease compared to the previous year. This can be explained by the global recession and by the continuing stagnation within the Japanese automotive market. On the global level, sales for Toyota decreased by 13%, due in large part to decreased demand in the American market. It is striking that four manufacturers - Honda, Nissan, Suzuki and Daihatsu - each achieved a market share of around 12.5% in the year 2009. Together, they make up a market share of more than 50%. The European and American manufacturers are competing in the Japanese market for premium vehicles, specifically, Toyota's premium brand, Lexus. In the small and middle class vehicle segment, domestic manufacturers dominate the market. Since Japan's vehicle exhaust emission regulations have consistently remained among the strictest in the world, domestic manufacturers are under constant pressure from the home market to develop new exhaust emission technologies.

10

Refer to Japan Automobile Manufacturers Association, Inc. (2009), S. 2ff

11

Refer to Japan Automotive Manufacturers Association, Inc. (2009), S. 66

12

Refer to Auto.de (2009)

13

Refer to Daihatsu Annual Report (2009)

Overview of the Global Automotive Markets and Manufacturers

13

Toyota is a pioneer in the global hybrid market, because it is already using third generation hybrid technology in its vehicles. Even though Toyota has produced vehicles featuring hybrid drive technology for ten years, and its Prius model was the best-selling new vehicle in Japan in 2009, local rivals Nissan; Mitsubishi, and Honda are catching up in the market, with comparable models. Consequently, the level of atmospheric pollutants (including nitrogen oxide (NOx), carbon dioxide (C02), and other chemical matters), even in Japan's major urban centers, has remained at a near constant level.14 Since 2009, stricter requirements have been put in place for gasoline and diesel vehicles. In fact, the Japanese government is planning to introduce an environmental credit of up to 300,000 Yen (approx. $3,000) for buyers of hybrid vehicles, electric cars, and fuel efficient cars with combustion engines.15 Against this backdrop, Japanese manufacturers are expected to focus on the development of alternative drive trains with great urgency.

2.4.2 The Indian Automotive Market 2.4.2.1 The Indian Automotive Market in Overview In the mid-1990s, foreign investors were still forced to adapt to strict government rules on direct investment in India. Western automotive manufacturers could only enter the Indian market through joint ventures. In 2000, the Indian government cleared the way for direct entry into the market; which led to a rapid increase in suppliers and OEMs. During this economic boom, a new automotive industry, customized to the needs of the Indian market, began to develop. Between 2004 and 2005, more than 1 million new vehicles were sold.16 Five years later, in 2009, car sales in India increased 17% from the previous year's figure; and now amount to 1.8 million vehicles annually.17 Despite the economic crisis, the Indian automotive market has not been affected by the sales slump that continues to threaten the European and American markets. As shown in figure 9, analysts expect a sales increase for the next 3 years. Based on that figure, it appears that India's automotive sales, with an average annual growth rate of 6.1%, will occupy second place over the next two years, behind only China. The vehicle density of 11 cars per 1,000 inhabitants shows the enormous potential for growth in this market. As shown in figure 9, sales of 2.3 million vehicles are predicted by 2012.

14

Refer to Japan Automobile Manufacturers Association, Inc. (2009), S. 29

15

Refer to Green Cars Congress (2009)

16

Refer to IBM Global Business Services (2007b), S. 3

17

Refer to VDA (2010)

14

Strategies: Automotive Manufacturers QuoVadis?

Another aspect of the Indian automotive market is the prevalence of two and threewheeled vehicles: India is the world's second-largest market in this segment.18

Figure 9: E x p e c t e d car sales in I n d i a Source: Ernst & Young: The automotive market in India - an industry overview (2007)

2.4.2.2 Market participants - India India's domestic manufacturers have dominated their market thus far, with a share above 80%. Maruti Udyog Ltd., leads with market share of 53% in the year 2009. As shown in Figure 10, European manufacturers play a relatively minor role in the Indian market. OEMs from other Asian countries and North America, however, have been more successful in India, Hyundai Motors India Ltd, is the most successful foreign producer in the country, with a share of 19% in 2009. Sales for foreign OEMs consist mainly of compact class vehicles, while the domestic OEMs focus on entry level and small vehicle segments. Renault, along with its joint venture partner Mahindra & Mahindra, was the first European manufacturer to compete in the Indian market as they recently introduced an economy class vehicles to the market. 19 Meanwhile, Indian OEMs have continued to advance, and are now setting their sights beyond their borders into the European and American markets.

18

Ref. Ernst & Y o u n g (2007), p. 7

19

Ref. R e n a u l t . c o m (2009)

Overview of the Global Automotive Markets and Manufacturers

15

In 2008, Tata Group purchased Land Rover and Jaguar from the ailing American manufacturer Ford, for 2.3 billion U.S. dollars; thus, gaining access to Western markets outside of India. 20

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Figure 10: O v e r v i e w o f market share in india Source: J.P. Morgan (2010)

Foreign OEMs have built production facilities across India; some dual-purposed to accommodate assembly plants that produce component parts, to avoid prohibitively expensive Indian import regulations. The price of an imported foreign-made new car could double after payment of custom duties.21 As a result, the global OEMs must set up production facilities/assembly plants in India, to keep the price of their vehicles competitive. A positive consequence of local production is a stronger brand image, due to proximity to the consumer base.

20

Ref. Handelsblatt (2008)

21

Ref. E m s t &Young (2007), p. 16

Strategies: Automotive Manufacturers Quo Vadis?

16

2.4.3 The Chinese car market 2.4.3.1

Overview of the Chinese car market

Until the turn of the century, heavy market regulations prohibited foreign firms from operating in China. In the 1980s, there were only two well-known Joint Ventures by foreign car manufacturers: Volkswagen and Daimler. Early on, both OEMs recognized the potential of the nascent Chinese car market, and set up Joint Ventures with Shanghai Automotive Ind. Corp. (SAIC) and Beijing Jeep, respectively. In the mid-1990s, General Motors also entered into a Joint Venture with SAIC. When China entered the World Trade Organization (WTO) in 2001, it was forced to open itself to foreign investments. As a result, the number of joint ventures increased. Between 1994 and 2005, approximately 20 billion US dollars were invested by foreign car manufacturers into China. Further evidence of growth: In 1993 only 220,000 vehicles were manufactured in China, but by 2004,2.34 million vehicles were produced. The sum of investments and vehicles produced reflects the exceptional development of China's automotive industry. The economic crisis has left practically no trace of ill-effect on China's automotive market. According to the German Automotive Association, in 2009 8.4 million cars were sold in the Chinese market; an increase of 47% from the previous year.22 The vehicle density of 17 cars/1,000 inhabitants shows the enormous growth potential of this market. Thus, sales totalling more than 11 million vehicles are predicted for 2012 (see figure 11).

22

Ref. Union of Automobile Industry (2010)

Overview of the Global Automotive Markets and Manufacturers

2008

2011E Car sales

17

2012E

YoY

Figure 11: Expected car sales in China (in mi. units)

Source: Credit Suisse Equity Report (2009)

2.4.3.2 Market participants - China The Chinese market is characterized by a high number of Joint Ventures. Most leading manufacturers from Europe, Asia and North America are already engaged in the Chinese market. The current dominating structure is complex, making delineation of shares and ascribing sales to individual Joint Venture partners difficult. In examining the present situation in this market, one will find the structure very opaque and complex. This makes it difficult to make a clear differentiation of the individual market segment or ascribing of a sale of a car to a Joint Venture partner. The necessity of multiple Joint Ventures lies in governmental regulations that aim for rapid introduction of advanced "knowhow" from the developed markets. One must thereby consider that there is inadequate protection of intellectual property. This represents an enormous risk for the investing OEMs. Since 2004, the Chinese government with its "Automotive Industry Policy" has attempted, to create internationally competitive corporations.23 Additionally, the Chinese government offers financial incentives for mergers and acquisitions of domestic manufacturers. Disadvantageous for foreign OEMs are the competition-aggravating policies of the government. It is evident (see figure 12) that the OEMs, which are present with a broad product portfolio, have a leading market share.

23

Ref. Tang, R. (2009), p. 22

Strategies: Automotive Manufacturers Quo Vadis?

18

vw in h säten- •• m -m GM MI®®ISSB8SMg®8MSeiSEasaSillBli 4.6% Toyota SC MR 3.7% Honda 3 6% Hyundai Nissan .JNMMt iS tàmmem* 3.5% Chery Μ Η · · Μ Η · 2.9% BYD • • • • • • • • • • • a 2.5% Geely 1.9% PSA ®ÜB»8aíS®5aS ι.6% Mazda 1.5% SSÎ SS

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Figure 12: Overview of the market share in China Source:

Nomura

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(2010)

2.5 The automotive manufacturers In addition to an analysis of the global market, it is important to examine several individual OEMs. We examined the largest OEMs with the highest revenues and primarily used SWOT analyses and various financial ratios to form our conclusions. The following company profiles serve as the basis for developing future scenarios.

Overview of the Global Automotive Markets and Manufacturers

19

2.5.1 Company profile - Volkswagen AG An overview of the company Volkswagen AG (VW) is one of the leading global manufacturers, with 61 production sites in Europe, America, Asia and Africa. VW manufactures light vehicles as well as commercial vehicles, and is headquartered in Wolfsburg, Germany. At present, it employs about 370,000 workers, and in 2008, sold 6.2 million vehicles in more than 150 countries. Business areas Volkswagen's business is comprised of both core automotive and financial service operations. Represented brands VW AG produces the following brands: Volkswagen, Audi, Skoda, Seat, Bentley, Bugatti, Lamborghini, Scania and Volkswagen commercial vehicles. VW will also produce the Porsche brand after its recent acquisition that will be discussed in detail in Part 2. Their overall product portfolio ranges from small to luxury class vehicles. In the commercial vehicle segment, it offers medium and heavy trucks, buses and pick-ups.

SWOT-

Volkswagen

AG

STRENGTHS

WEAKNESSES

•

Broad product portfolio

•

•

High R&D investments

Weak geographic distribution

OPPORTUNITIES

THREATS

•

Potential in emerging markets

•

New environmental regulations

•

Further development of alternative energy propulsion

•

Current economic crisis of 2009/2010

20

Strategies: Automotive Manufacturers Quo Vadis?

Financial Summary - Volkswagen AG

Profit and loss statement (€ mn) Revenue R&D Investments EBITDA EBIT Annual net profit

12/2008 113.808 5.102 -6.883 10.388 5.526 4.749

12/2009E 105.242 5.129 -5.399 7.217 2.226 1.445

12/2010E 100.436 4.998 -5.399 8.632 3.561 2.572

12/2011E 105.107 5.157 -5.399 10.302 5.161 3.918

Balance (€ mn) Cash on hand Net debt Liabilities (total) Equity Balance total

13.244 47.585 130.531 37.388 167.919

17.558 47.692 136.642 37.671 174.313

17.885 52.346 141.494 39.061 180.554

19.398 55.545 146.345 41.640 187.985

4.5 9.1 4.9

-7.5 6.9 2.1

-4.6 8.6 3.5

4.7 9.8 4.9

Ratios (%) ROA Return on Equity Profit margin ROIC ROCE

3 12.7 4.2 6.9 5.4

0.8 3.8 1.4 2.2 1.8

1.4 6.6 2.6 3.0 2.2

2.1 9.4 3.7 4.0 3.4

Corporate valuation (x) EV/Sales EV/EBITDA EV/EBIT P/E P/B

0.7 7.7 14.6 7.1 0.4

0.8 11.3 36.7 15.7 0.6

0.8 9.3 22.6 8.8 0.6

0.7 7.6 15.1 5.8 0.6

Growth & margins (%) Revenue growth EBITDA margin EBIT margin

Overview of the Global Automotive Markets and Manufacturers

21

Turnover as per business areas 2008

Turnover as per geographical regions 2008

• Germany

» Automotive sector

• Rest of Europe

• Finance sector

» North America • South America s Asia/Oceania • Africa

Price-Performance Chart

Feb. 09

Aug. 08

Volkswagen (Pref) (L)

F i g u r e 13: C o m p a n y p r o f i l e V o l k s w a g e n A G Sources: Goldman Sachs (Brokerreport), Data monitor

May 09 FTSE W o r l d E u r o p e (EUR) (R)

Strategies: Automotive Manufacturers Quo Vadis?

22

2.5.2 Company profile - BMW AG An overview of the company BMW AG is one of the leading manufacturers in the premium segment, with 24 production sites in 13 countries. Manufacturing focuses on both light vehicles and motorcycles. BMW is headquartered in Munich, Germany. Presently, it employs approximately 100,000 workers. In 2008, it sold 1.4 million vehicles in more than 150 countries. Business areas BMW AG's business is comprised of light vehicle, motorcycle and financial service operations. Represented brands BMW AG produces the following brands: BMW, Mini and Rolls-Royce. Its product portfolio ranges from the middle class to the luxury segments.

SWOT-BMW

AG

STRENGTHS

WEAKNESSES

•

Strong global presence

•

•

High degree of innovation

Weak earnings in all divisions, especially its core markets

•

Strategic shareholder

•

Low economies of scale (¡compared to its competitors)

OPPORTUNITIES

THREATS

•

Potential in emerging markets

•

New environmental regulations

•

Further development of alternative energy propulsion

•

Economic crisis of 2009/2010

•

Promotion of Captive Finance Companies

•

US dollar exchange rate risk

•

Rising raw material prices

23

Overview of the Global Automotive Markets and Manufacturers

Financial Summary - BMW AG

12/2008 53,197 2,825 -4,204 4,357 681 338

12/2009E 49,707 3,033 -3,722 4,450 1,015 588

12/2010E 50,012 3,132 -3,881 61,171 2,573 1,679

12/2011E 51,200 3,366 -4,380 7,431 3,803 2,596

8,107 52,277 79,345 20,273 99,618

8,165 58,394 85,420 20,664 106,084

8,602 63,791 91,253 22,146 113,399

9,380 68,536 96,765 24,349 121,113

-5 8.2 1.3

-6.6 9 2

0.6 12.2 5.1

2.4 14.5 7.4

Ratios (%) ROA Return on Equity Profit margin ROIC ROCE

0.4 1.7 0.6 1 1.36

0.6 2.8 1.2 1.7 1.07

1.5 7.6 3.4 3 1.64

2.2 10.7 5.1 3.7 NM

Corporate valuation (x) EV/Sales EV/EBITDA EV/EBIT P/E P/B

0.3 4.2 26.6 58.8 0.7

0.4 4.1 18.1 36 1

0.3 2.8 6.7 12.6 1

0.3 2.2 4.2 8.1 0.9

Profit and loss statement (€ mn) Revenue R&D Investments EBITDA EBIT Annual net profit Balance (€ mn) Cash on hand Net debt Liabilities (total) Equity Balance total Growth & margins (%) Revenue growth EBITDA margin EBIT margin

Strategies: Automotive Manufacturers Quo Vadis?

24

Turnover as per geographical regions 2008

Turnover as per business areas 2008

• Germany

• Automotive sector

• Rest of Europe

• Finance sector Motorbikes sector

β North America

• Other business area¡

• UK Β Africa/Asia/Oceania • South America

Price-Performance Chart 34 32 30

390

28

360

26

330

24

300

22

270

20

240

18

210

16 Aug. 08

180 Nov. 08

Feb. 09 B M W (L)

Figure 14: Company profile - BMW AG Sources: Goldman Sachs (Brokerreport), Datamonitor

FTSE World Europe (EUR) (R)

Overview of the Global Automotive Markets and Manufacturers

25

2.5.3 Company profile - Daimler AG An overview of the company Daimler AG is a global automotive manufacturer, operating mostly in the premium segment, with 65 production sites; among them: 18 are in Germany, 17 are in the The U.S, with others in Brazil, Canada, France, Japan, Mexico, Turkey, South Africa and Spain. Daimler AG manufactures light vehicles, commercial vehicles, small buses and omnibuses, and is headquartered in Stuttgart, Germany. At present it employs about 272,000 workers and sold 1.3 million vehicles worldwide, in 2008.

Business areas Daimler AG's business is comprised of light vehicle, commercial vehicle, and financial service operations.

Represented brands Daimler AG produces the following brands: Mercedes-Benz, Smart, AMG, Maybach, Freightliner, Western Star, Mitsubishi Fuso, Setra, Orion, and Thomas Built Buses. Its product portfolio ranges from the small car segment to luxury class.

SWOT - Daimler AG STRENGTHS

WEAKNESSES

•

Diversified product portfolio

•

Low profitability

•

High degree of innovation

•

Low margins

•

Strong automotive division

OPPORTUNITIES

THREATS

•

Potential in emerging markets

•

New environmental regulations

Further development of alternative energy propulsion

•

Economic crisis of 2009/2010

•

US dollar exchange rate risk

•

Rising raw material prices

•

26

Strategies: Automotive Manufacturers Quo Vadis?

Financial Summary - Daimler AG Profit and loss statement (€ mn) Revenue R&D Investments EBITDA EBIT Annual net profit

12/2008 95,873 3,055 -3,559 5,853 2,730 1,348

12/2009E 78,500 2,500 4,789 1,227 2,174 1,999

12/201OE 80,180 2,500 -4,789 6,766 3,134 1,725

12/2011E 84,370 2,680 -4,466 8,475 4,704 2,790

Balance (€ mn) Cash on hand Net debt Liabilities (total) Equity Balance total

12,819 56,136 99,495 32,724 132,219

14,702 64,651 111,893 32,101 143,994

14,570 75,143 122,587 33,276 155,863

15,046 84,928 132,848 35,588 168,436

Growth & margins (%) Revenue growth EBITDA margin EBIT margin

-3.5 6.1 2.8

-18.1 1.6 -2.8

2.1 8.4 3.9

5.2 10 5.6

Ratios (%) ROA Return on Equity Profit margin ROIC ROCE

1.2 4.1 1.4 1.9 1.74

-1.4 6.2 2.5 -1.4 -0.1

1.2 5.2 2.2 1.8 2.48

1.7 7.8 3.3 2.4 NM

Corporate valuation (x) EV/Sales EV/EBITDA EV/EBIT P/E P/B

0.5 7.6 16.2 24.5 0.8

0.4 27 NM NM 1

0.4 4.9 10.6 19 1

0.4 3.8 6.8 11.7 1

Overview of the Global Automotive Markets and Manufacturers

Turnover as per geographical regions 2008

27

Turnover as per business areas 2008

I Germany

• Automotive sector

I Western Europe

• Finance sector

I USA

• Commercial vehicles Busses & others

I Rest of America 5 Asia »Other

Price-Performance Chart 45 40 35 30 25 20 15 Jul. 08

Nov. 08

Feb. 09 Daimler AG (L)

F i g u r e 15: C o m p a n y p r o f i l e - D a i m l e r A G Sources: Goldman Sachs (Brokerreport), Datamonitor

May 09 FTSE World Europe (EUR) (R)

Strategies: Automotive Manufacturers Quo Vadis?

28

2.5.4 Company profile - PSA Peugeot Citroen S.A. An overview of the company PSA Peugeot Citroen S.A. is a French automotive manufacturer with production sites in France, Spain, Great Britain, Italy, Brazil, Argentina, Russia and China. PSA manufactures cars, commercial vehicles, automotive accessories and motorcycles. Their headquarters is in Paris, France. At present it employs about 212,000 workers and in 2008 it sold 3.3 million vehicles worldwide. Business areas PSA's business is comprised of automotive, automotive accessory, transport and logistics, and financial service operations. Represented brands PSA produces the following brands: Peugeot, Citroen, Faurecia, Gefco and Peugeot Motorcycles. Its product portfolio ranges from the small to middle class vehicles.

SWOT-PSA

Peugeot Citroen S.A.

STRENGTHS

WEAKNESSES

•

Heavily represented in their home market

•

Low margins

•

High degree of innovation

•

Weak performance in core business

•

Wide product range

OPPORTUNITIES

THREATS

•

Strong potential in emerging markets

•

•

Further development of alternative energy propulsion

•

Economic crisis of 2009/2010

•

US dollar exchange rate risk

•

Rising raw material prices

«

Expansion of strategic alliances

New environmental regulations

29

Overview of the Global Automotive Markets and Manufacturers

Financial Summary - PSA Peugeot Citroen S.A. 12/2008 54,356 2,372 -2,094 3,825 550 -343

12/2009E 45,746 2,377 -1,850 1,631 -998 -1,331

12/201OE 43,386 2,377 -1,850 1,856 -638 -814

1272011E 45,656 2,377 -2,000 2,909 528 87

5,017 22,746 48,570 13,277 61,847

4,023 23,741 46,918 11,888 58,806

3,786 23,971 47,078 10,984 58,062

3,748 24,025 47,078 11,079 58,157

-10.3 7 1

-15.8 3.6 -2.2

-5.2 4.3 -1.5

5.2 6.4 1.2

Ratios (%) ROA Return on Equity Profit margin ROIC ROCE

-0.5 -2.6 -0.6 0.8 2.4

-2.2 -11.2 -2.9 -3.4 -1.6

-1.4 -7.4 -1.9 -1.4 2.8

0.1 0.8 0.2 1.1 4.2

Corporate valuation (x) EV/Sales EV/EBITDA EV/EBIT P/E P/B

0.2 3 21.2 NM 0.2

0.2 6 NM NM 0.4

0.2 5.5 NM NM 0.4

0.2 3.6 20 54.8 0.4

Profit and loss statement (€ mn) Revenue R&D Investments EBITDA EBIT Annual net profit Balance (€ mn) Cash on hand Net debt Liabilities (total) Equity Balance total Growth & margins (%) Revenue growth EBITDA margin EBIT margin

30

Strategies: Automotive Manufacturers Quo Vadis?

Turnover as per geographical regions 2008

Turnover as per business areas 2008

• Western Europe

• Automotive sector

• Central East Europe

• Finance sector

• North America/Africa/Asia

• Accessories sector

• South America

• Transport and logistics • Others

Price-Performance Chart 40 35 30 25 20

15 10 Jul. 08

Nov. 08 ——

Peugeot (L)

Figure 16: Company profile - PSA Peugeot Citroen S.A. Sources: Goldman

Sachs (Brokerreport),

Datamonitor

FTSE World Europe (EUR) (R)

Overview of the Global Automotive Markets and Manufacturers

31

2.5.5 Company profile - Renault S.A. An overview of the company Renault S.A is a globally operating French manufacturer, with 118 industrial and commercial sites worldwide. It manufactures both light and commercial vehicles, with headquarters in Boulogne-Billancourt, France. According to their annual report, in 2008 it employed 130,000 workers. In the same year, it sold 2.5 million vehicles worldwide. In 1999, Renault and the Japanese manufacturer Nissan formed an alliance. In 2002, that alliance was established with the formation of a separately owned limited partnership incorporated in the Netherlands. Each company holds a 50% share in Renault-Nissan B.V., which serves as the strategic management board of the alliance. Through a stock-for-stock deal, the two manufacturers are connected: Nissan has a 15% share in Renault, and Renault has 44% share in Nissan. 24 Business areas Renault's business is comprised of light vehicles and financial service operations. Represented brands Renault produces the following brands: Renault, Dacia, Renault Samsung Motors, as well as a strategic alliance with Nissan. The product portfolio ranges from the small car segment to middle class. SWOT - Renault S.A. STRENGTHS • Strategic alliance with Nissan • Strong global presence •

High degree of innovation

•

Dacia Logan is a model for success

WEAKNESSES • Low margins • Weak performance in core business

OPPORTUNITIES

THREATS

•

• New environmental regulations

Potential in emerging markets

• Further development of alternative energy propulsion

•

Economic crisis of 2009/2010

•

US dollar exchange rate risk

• Rising raw material prices

24

Ref. Renault.com (2009), p. 2

Strategies: Automotive Manufacturers Quo Vadis?

32

Financial Summary - Renault S.A.

12/2008 37,791 1,858 -2,265 1,649 -494 571

12/2009E 31,994 2,150 -2,000 1,219 -919 -2,919

12/201OE 29,484 1,850 -2,000 1,975 -138 11

12/2011E 30,343 2,085 -2,400 2,724 632 714

2,058 27,884 44,415 19,416 63,831

1,815 28,127 45,015 16,199 61,214

696 29,247 45,115 16,182 61,297

696 30,163 46,132 16,878 63,010

Growth & margins (%) Revenue growth EBITDA margin EBIT margin

-7.1 4.4 -1.3

-15.3 3.8 -2.9

-7.8 6.7 -0.5

2.9 9 2.1

Ratios (%) ROA Return on Equity Profit margin ROIC ROCE

0.9 2.9 1.5 -0.7 0.1

-4.7 -18.0 -9.1 -2.1 -1.8

0 0.1 0.0 -0.3 2.3

1.1 4.2 2.4 1.4 3.1

Corporate valuation (x) EV/Sales EV/EBITDA EV/EBIT P/E P/B

0.6 14.4 NM 24 0.3

0.6 14.8 NM NM 0.5

0.6 9.2 NM 78.3 0.5

0.6 6.7 28.9 12.1 0.5

Profit and loss statement (€ mn) Revenue R&D Investments EBITDA EBIT Annual net profit Balance (€ mn) Cash on hand Net debt Liabilities (total) Equity Balance total

33

Overview of the Global Automotive Markets and Manufacturers

Turnover as per business areas 2008

Turnover as per geographical regions 2008

• France

* Automotive sector

• Rest of Europe

• Finance sector

North America • Euromed • Asia/Africa

Price-Performance Chart 70

480

60

430

50

380

40 30 20 10 Aug. 08

Nov. 08 Renault (L)

Figure 17: Company profile - Renault S.A. Sources: Goldman Sachs (Brokerreport),

Datamonitor

FTSE World Europe (EUR) (R)

34

Strategies: Automotive Manufacturers Quo Vadis?

2.5.6 Company profile - Fiat S.p.A. An overview of the company Fiat S.p.A. is a globally operating manufacturer with production sites in Italy, Poland, Brazil, and Argentina. It also holds numerous Joint Ventures and license agreements in, China, India, and Russia, among others. Fiat manufactures cars, commercial vehicles, agricultural and construction vehicles, and automotive accessories. During the ongoing economic crisis, Fiat stepped in to acquire ailing U.S. manufacturer, Chrysler with the support of U.S. government incentives. The corporation is headquartered in Turin, Italy. Fiat employs approximately 198,000 workers, and in 2008, sold 2.6 million vehicles.

Business areas Fiat's business is comprised of automotive, commercial vehicle, parts and production system, financial service and publication and communication operations.

Represented brands Fiat produces the following brands: Fiat, Chrysler, Lancia, Alfa Romeo, Abarth, Maserati, Ferrari, Case Construction, Case ICH, New Holland Construction, New Holland Agriculture, Steyr, Kobelco, Iveco, Iveco Magirus, Astra, Irisbus, FPT Powertrain technologies, Magneti Marelli, Teksid, Comau, La Stampa and Publikompass. The product portfolio in the automotive sector ranges from the small car segment to luxury class.

SWOT - Fiat S.p.A STRENGTHS

WEAKNESSES

«

Diversified product portfolio

•

•

Global acquisitions

Low economies of scale (compared to the competitors)

•

Weak performance in core business

•

Weak performance in the key markets

OPPORTUNITIES

THREATS

•

Potential in emerging markets

•

New environmental regulations

•

Development of alternative energy propulsion

•

Economic crisis of 2009/2010

•

Growing market for trucks, construction vehicles and agricultural vehicles in India and China

•

US dollar exchange rate risk

•

Rising raw material prices

35

Overview of the Global Automotive Markets and Manufacturers

Financial Summary - Fiat S.p.A.

12/2008 59,380 1,497 -5,263 6,015 3,114 1,612

12/2009E 48,213 1,542 -3,500 3,863 730 -458

12/201OE 47,549 1,474 -3,500 4,560 1,245 -141

12/2011E 51,316 1,590 -4,000 5,466 2,032 471

4,661 16,718 50,669 11,101 61,770

5,245 16,135 51,099 10,719 61,818

6,339 15,040 51,529 10,665 62,194

6,350 15,029 51,529 11,224 62,753

Growth & margins (%) Revenue growth EBITDA margin EBIT margin

1.5 10.1 5.2

-18.8 8 1.5

-1.4 9.6 2.6

-7.9 10.7 4

Ratios (%) ROA Return on Equity Profit margin ROIC ROCE

2.6 14.5 2.7 16.8 5.73

-0.7 -4.3 -0.9 4.9 0.87

-0.2 -1.3 -0.3 6.6 3.51

0.8 4.2 0.9 8.8 NM

0.4 3.9 7.6 8.7 0.5

0.4 4.8 25.4 NM 0.9

0.4 3.8 14 NM 1

0.3 3.2 8.6 19.8 0.9

Profit and loss statement (€ mn) Revenue R&D Investments EBITDA EBIT Annual net profit Balance (€ mn) Cash on hand Net debt Liabilities (total) Equity Balance total

Corporate valuation (x) EV/Sales EV/EBITDA EV/EBIT P/E

PIB

Strategies: Automotive Manufacturers Quo Vadis?

36

Turnover as per business areas 2008

Turnover as per geographical regions 2008

m Automotive sector

• Italy Brazil

• Commercial vehicles

• France • USA

• Agriculture and accessories

» Germany

•Other

• UK » Spain • Poland • Turkey »Other

Price-Performance Chart € 16 14 12 10 8 6 4 . 2 Apr. 08

1 Aug. 08

Nov. 08 • Fiat (L)

F i g u r e 18: C o m p a n y p r o f i l e - Fiat S . p . A Sources: Goldman Sachs (Brokerreport), Datamonitor

Feb. 09 FTSE W o r l d Europe (EUR) (R)

Overview of the Global Automotive Markets and Manufacturers

37

2.5.7 Company profile - Toyota Motor Corporation An overview of the company The Toyota Motor Corporation, part of Toyota Group, which is one of the largest, diversified conglomerates in the world, is the leading volume manufacturer with 50 production sites in 27 countries. Toyota manufactures cars, commercial vehicles, and small buses. It is headquartered in Toyota City, Japan, and currently employs approximately 316,000 workers. In 2008, it sold 8.9 million vehicles in 170 countries. Business areas Toyota's business is comprised of automotive and financial service operations. Represented brands Toyota produces the following brands: Toyota, Scion, Lexus, Hino and Daihatsu. Its product portfolio ranges from the small car segment to luxury class. SWOT - Toyota Motor Corporation STRENGTHS

WEAKNESSES

•

•

Solid financial base

•

High brand image

•

Strong presence in Asia

•

High R&D activities

•

Unique production system

Low profitability in the Financial Services business

OPPORTUNITIES

THREATS

•

Potential in emerging markets (particularly in India and China)

•

New environmental regulations

Further development of alternative energy propulsion

•

Economic crisis of 2009/2010

•

Raw material prices

•

Strategies: Automotive Manufacturers Quo Vadis?

38

Financial Summary - Toyota Motor Corporation 03/2009 152,071 6,696 -9,648 NM -3,415 -3,236

03/2010E 134,074 6,074 -6,148 NM NM 993

03/2011E 145,926 6,296 -6,148 NM 6,000 6,437

03/2012E 153,333 6,667 -7,407 NM 7,852 7,904

22,110 46,393 136,750 78,524 215,274

22,933 33,978 141,806 77,890 219,696

26,055 32,830 152,296 82,470 234,766

27,884 85,859 159,328 88,462 247,790

-21.9 3 -2.2

-11.8 5.5 0

8.8 8.7 4.1

5.1 9.4 5.1

Ratios (%) ROA Return on Equity Profit margin ROIC ROCE

-1.4 -4.1 -2.1 NM -1.2

0.5 1.3 0.7 NM -0.2

2.8 7.8 4.4 NM 1.7

3.3 8.9 5.2 NM 2.9

Corporate valuation (x) EV/Sales EV/EBITDA EV/EBIT P/E P/B

NM 22.2 NM NM 1.3

NM 13.4 NM 94.3 1.3

NM 7.8 NM 14.5 1.2

NM 6.8 NM 11.8 1.1

Profit and loss statement (€ mn) Revenue R&D Investments EBITDA EBIT Annual net profit Balance (€ mn) Cash on hand Net debt Liabilities (total) Equity Balance total Growth & margins (%) Revenue growth EBITDA margin EBIT margin

39

Overview of the Global Automotive Markets and Manufacturers

Turnover as per business areas 2008

Turnover as per geographical regions 2008

• Japan

• Automotive sector

• North America

• Finance sector

• Europe

• Other

• Asia/Oceania m Other

91% 34%

Price-Performance Chart 5,500 5,000 4,500 4,000 3,500 3,000 2,500 Aug. 08

Nov. 08

Feb. 09

May 09

— — Toyota Motor (L) Figure 19: Company profile - Toyota M o t o r Corp. Sources: Goldman Sachs (Brokerreport), Datamonitor

TOPIX (R)

40

Strategies: Automotive Manufacturers Quo Vadis?

2.5.8 Company profile - Nissan Motor Co., Ltd. An overview of the company Nissan Motor Co., Ltd. is a Japanese manufacturer with production sites in Japan, The U.S., Canada, Mexico, Australia, New Zealand, South Africa, The Middle East and other Asian countries. Nissan manufactures cars, commercial vehicles, and small buses. The corporation is headquartered in Tokyo, Japan, and currently employs approximately 180,000 workers. In 2008 it sold 3.7 million vehicles. Since 1999, Nissan has maintained a strategic cross ownership alliance with the French manufacturer Renault (see Company profile - Renault S.A.). Business areas Nissan's business is comprised of automotive and financial service operations. Represented brands Nissan represents the following brands: Nissan, Infinity, and Forklift, and its strategic alliance with Renault. Its product portfolio ranges from the small car segment to luxury class. SWOT-Nissan

Motor Co., Ltd.

STRENGTHS

WEAKNESSES

•

•

Strategic alliance with Renault

Weak performance in core business

OPPORTUNITIES

THREATS

•

Potential in emerging markets

•

New environmental regulations

•

Further development of alternative energy propulsion

•

Econom ic crisis of 2009/2010

•

US dollar exchange rate risk

•

Rising raw material prices

41

Overview of the Global Automotive Markets and Manufacturers

Financial Summary - Nissan Motor Co., Ltd. 03/2009 62,496 3,374 -2,841 NM -1,021 -1,731

03/2010E 56,148 2,963 -2,593 NM 593 -304

03/2011E 64,148 3,111 -2,519 NM 1,630 756

03/2012E 67,881 3,481 -2,963 NM 2,000 930

5,627 11,452 54,174 21,674 75,848

7,272 11,407 54,851 21,039 75,890

8,212 8,252 56,141 21,573 77,715

7,045 7,296 58,758 22,648 81,406

-22.1 3.4 -1.6

-10.2 6.3 1.1

14.2 7.1 2.5

5.8 7.2 2.9

Ratios (%) ROA Return on Equity Profit margin ROIC ROCE

-2.1 -8.0 -2.8 -2.1 NM

-0.4 -1.4 -0.5 1.4 NM

1 3.5 1.2 2.9 NM

1.2 4.1 1.4 2.6 NM

Corporate valuation (x) EV/Sales EV/EBITDA EV/EBIT P/E P/B

NM 14 NM NM 1

NM 8.2 NM NM 1

NM 6.2 NM 25.2 1

NM 4.3 NM 20.5 1

Profit and loss statement (€ mn) Revenue R&D Investments EBITDA EBIT Annual net profit Balance (€ mn) Cash on hand Net debt Liabilities (total) Equity Balance total Growth & margins (%) Revenue growth EBITDA margin EBIT margin

42

Strategies: Automotive Manufacturers Quo Vadis?

Turnover as per geographical regions 2008

Turnover as per business areas 2008

• Japan

• Automotive sector

• Europe

• Finance sector

• North America • Other

Price-Performance Chart 900

1,400

800

1,300

700

1,200

600 1,000

500

900

400 . .

300 .

800 700

200 Jul. 08

Nov. 08

Feb. 09

May 09 Nissan Motor (L)

Figure 20: C o m p a n y profile - N i s s a n M o t o r Co. Ltd. Sources: Goldman Sachs (Brokerreport), Datamonitor

TOPIX (R)

Overview of the Global Automotive Markets and Manufacturers

43

2.5.9 Company profile - Ford Motor Company An overview of the company The Ford Motor Company is one of the world's largest automotive manufacturers, with 95 production sites globally. Ford manufactures cars, commercial vehicles, and buses. The headquarters of the concern is in Dearborn, Michigan, U.S. It currently employs approximately 213,000 workers, and in 2008, sold 5.4 million vehicles. Business areas Ford's business is comprised of automotive, commercial vehicles and financial service operations. Represented brands After the sale of Volvo, Ford will produce the following brands: Ford, Lincoln and Mercury. Its product portfolio ranges from the small car segment to luxury class.

SWOT-

Ford Motor

Company

STRENGTHS

WEAKNESSES

•

Strong distribution network

•

•

Strong brand image and tradition

•

Low cash flow

•

Economic Crisis of 2009/2010. Brand image has significantly increased by virtue of being the only US auto manufacturer not taking any goverment assistance during the crisis.

•

Weak presence in some markets

•

Being viewed as innovator in hybrids and electric vehicles

Weak financial performance

OPPORTUNITIES

THREATS

•

Potential in emerging markets

•

«

Development of alternative energy propulsion

•

US dollar exchange rate risk

•

Growing truck market

»

Rising raw material prices

New environmental regulations

44

Strategies: Automotive Manufacturers Quo Vadis?

Financial Summary - Ford Motor Company Profit and loss statement (€ mn) Revenue R&D Investments EBITDA EBIT Annual net profit

12/2008 90,326 5,105 -4,629 1,474 -2,597 -10,137

12/2009E 69,400 4,151 -3,724 1,268 -2,713 -2,301

12/2010E 78,827 3,945 -4,324 6,721 1,917 713

12/2011E 83,805 4,261 4,597 8,628 4,031 2,518

Balance (€ mn) Cash on hand Net debt Liabilities (total) Equity Balance total

10,960 7,114 69,414 -11,270 58,144

11,217 7,703 70,704 -14,822 55,882

11,474 7,620 72,107 -15,490 56,617

13,905 6,403 72,880 -13,499 59,380

Growth & margins (%) Revenue growth EBITDA margin EBIT margin

-16 2 -3

-23 2 -4

14 9 2

6 10 5

Ratios (%) ROA Return on Equity Profit margin ROIC ROCE

-7 NM -11 NM -2

-6 NM -3 NM -1

1 -5 1 NM 1

4 -19 3 NM 3

NM 10.3 NM NM NM

NM 17.5 NM NM NM

NM 3.6 NM 24 NM

NM 2.7 NM 7 NM

Corporate valuation (x) EV/Sales EV/EBITDA EV/EBIT P/E P/B

45

Overview of the Global Automotive Markets and Manufacturers

Turnover as per business areas 2008

Turnover as per geographical regions 2008

• North America

a Automotive sector

• Europe

• Finance sector

I Other

US$

Price-Performance Chart

7 6 5 4 3 2 1 09

Jul. 08

Ford M o t o r C o m p a n y (L)

Figure 21: C o m p a n y profile - Ford M o t o r C o m p a n y Sources: Goldman Sachs (Brokerreport), Datamonitor

May 09 S&P 500 (R)

46

Strategies: Automotive Manufacturers Quo Vadis?

2.5.10 Company profile - Honda Motor Company Ltd. An overview of the company Honda Motor Company Ltd. is an automobile manufacturer with six production sites in Japan, U.S., Canada, Great Britain, and Thailand. It manufactures cars and small buses, and is the world's largest producer of motorcycles. Honda is headquartered in Tokyo, Japan, and currently employs approximately 178,000 workers. In year 2008 it sold 3.9 million vehicles. Business areas Honda's business is comprised of automotive, motorcycle, financial service and industrial equipment operations. Represented brands Honda appears only under its own brand name. Its product portfolio ranges from the small car segment to luxury class.

SWOT-Honda

Motor Company Ltd.

STRENGTHS

WEAKNESSES

•

Diversified product portfolio

•

High personnel costs

•

Superior brand image, especially in Asia

•

Low per employee productivity

• •

Already equipped with alternative energy propulsion Powerful global distribution network

OPPORTUNITIES

THREATS

•

Potential in emerging markets

•

New environmental regulations

•

Further development of alternative energy propulsion

•

Economic crisis of 2009/2010

•

US dollar exchange rate risk

•

Rising raw material prices

47

Overview of the Global Automotive Markets and Manufacturers

Financial Summary - Honda Motor Company Ltd. Profit and loss statement (€ mn) Revenue R&D Investments EBITDA EBIT Annual net profit Balance (€ mn) Cash on hand Net debt Liabilities (total) Equity Balance total Growth & margins (%) Revenue growth EBITDA margin EBIT margin Ratios (%) ROA Return on Equity Profit margin ROIC ROCE Corporate valuation (x) EV/Sales EV/EBITDA EV/EBIT P/E P/B

03/2009 74,905 4,171 -4,438 NM 1,404 1,015

03/201OE 62,370 3,704 -2,889 NM 1,037 944

03/2011E 68,741 3,704 -3,185 NM 4,074 3,007

03/2012E 74,593 4,074 -3,704 NM 4,889 3,642

5,114 12,578 57,864 29,684 87,547

8,971 7,837 54,770 30,845 85,615

8,519 10,141 58,497 32,912 91,409

7,845 11,311 60,323 35,479 95,801

-16.6 6 1.9

-15.9 6.2 1.7

10.2 9.6 5.9

8.5 9.7 6.6

1.1 3.4 1.4 3.9 1.1

1.1 3.1 1.5 0.5 0.6

3.4 9.1 4.4 5.8 1.6

3.9 10.3 4.9 9.6 2

NM 8.7 NM 36.7 1.3

NM 9 NM 39.5 1.2

NM 5.3 NM 12.4 1.2

NM 4.9 NM 10.2 1.1

Strategies: Automotive Manufacturers Quo Vadis?

48

Turnover as per geographical regions 2008

Turnover as per business areas 2008

M Japan

• Automotive sector

• Europe

• Finance sector

North America 13%

• Motorbike sector

BAsia

a Other

Other

Price-Performance Chart ¥ 4,000

1,700

3,500

. 1,500

3,000

2,000

1,500

1 Jul. 08

Nov. 08

Feb. 09

May 09 Honda M o t o r (L)

F i g u r e 2 2 : C o m p a n y p r o f i l e - H o n d a M o t o r C o m p a n y Ltd. Sources: Goldman Sachs (Brokerreport), Datamonitor

TOPIX (R)

49

The strategic options for automotive manufacturers?

3

The strategic options for automotive manufacturers?

The ongoing strategic issues of the industry can be addressed through the following strategic options: 1

Pursuit of better geographic positioning

2

Rapid development of alternative energy propulsion

3

Strategic horizontal and vertical integration, as well as strategic alliances

4

Differentiating financing strategies

In the wake of globalization, demographic developments, and altered consumption behavior, traditional markets have suffered. Meanwhile, emerging markets like China and India are utilizing modified sales and manufacturing structures. Figure 23 shows dramatic industry wide shifts in market demand, by region. Indian OEMs Chinese OEMs Korean OEMs Other OEMs European OEMs

Japanese OEMs

US OEMs

1965

1990 Stage 1

North Europe and Europe are the global maritet leaders due to their technological leadership

Stage 2 Japan catches up due to the knowhow transfer and strategies for continuous improvement

2020

Stage Β South Korea develops powerful abilities through cooperations and alliances

Stage 4 China's automobile industry flourishes through JV with global OEMs

Stage 5 China and India determine the global industry

Figure 23: Shifts in r e g i o n a l d i s t r i b u t i o n Source: A.T. Kearney (2006)

The future markets in China and India are confronted with substantially different market mechanisms from which the European, American, and Japanese manufacturers could potentially profit. However, only OEMs that are prepared to develop their strategic align-

Strategies: Automotive Manufacturers Quo Vadis?

50

ment to meet innovative vehicle concepts, new environmental requirements, and funding needs will survive in the long run.

3.1 Geographic positioning In the following section, the two growth markets, India and China, are considered in detail. When comparing these countries with the other BRIC nations, one notices that they are not only experiencing huge market growth, but also great supplier and production density. For example, Tata Motors is well established in India, and Geely is a technology leader in China; both OEMs have demonstrated advantageous geographic positioning, to gain success in their respective markets. In the context of this analysis, the markets in the other BRIC nations, Brazil and Russia are not our primary focus because their market growth rates do not compare to those experienced by India and China.

3.1.1 India The development of the Indian economy In the past decade, few other countries have developed like India. The surge in consumerism among the young, up-and-coming population has led to increased demand for goods that were once exclusively considered luxury items. With a population of 1.1 billion and persistently positive economic growth, India has developed a middle class as large as that of the United States.25 The middle class, comprised of "young professionals" forms the foundation of India's future economic success. Figure 24 shows the enormous growth of the real GDP and nominal per capita income. In the past ten years, India's real GDP has boasted annual growth rates of up to 10%.

25

Ref. Deutsche Bank Research (2009a)

51

The strategic options for automotive manufacturers?

0 tf» tffi ¿¡S> GDP per capita

— G D P growth (real)

Figure 24: Growth of GDP and nominal per capita income in India

Source: Deutsche Bank Equity Report (2009)

From an industry perspective, a per capita income of 3,000 U.S. dollars enables the average Indian consumer to comfortably purchase a vehicle. Over the past decade, the country's per capita income has doubled from 500 U.S. dollars to more than 1,000 U.S. dollars. Thus, India is firmly on the path to significantly increased mobility, by putting many more vehicles on its roadways. Driven by its rising per capita income and the increasing propensity to consume, India is becoming a hub of the global automotive industry in R&D, production, export, and consumption. This, combined with growth-oriented government policies, paves the way to a promising future for the country. Already, there are more than 208 million households in India that are financially prepared to purchase a car with a ticket price between 2,500 and 5,000 U.S. dollars. And for the majority of those potential customers, this would be the first new car purchase. Shown in Figure 25, the new car's price is of primary importance to potential buyers.

52

Strategies: Automotive Manufacturers Quo Vadis?

Number of potential customers

500 .

Price per vehicle

$2,000

400. I

300

$4,000

$3,000

200 _

100.

0 2006

2008

2010

2012

2014

2016

2018

2020

Figure 25: Number of potential buyers of an ULCC

Source: A. T. Kearney

(2008)

At the $4,000 USD price point, 270 million potential buyers could afford a new car. Moreover, at the "ultra-low-cost" $2,000 USD price, the number of potential buyers doubles. Indian manufacturers, with an inherent grasp of their home market and the needs of the local customer, have established a clear strategic domestic advantage compared to the American and European manufacturers. This is where the potential for American and European manufacturers must begin. To illustrate the home market advantage: in 2007, four of the five best selling vehicles were manufactured by Indian OEMs (establishing their 80% market share). Aside from price, an understanding of local consumer behaviour and the infrastructure of the Indian market must be considered in the market strategy of foreign OEMs seeking a larger share.

Challenges of the Indian automotive market Infrastructure There is a strong correlation between infrastructure and growth in the Indian automotive industry: the market can only experience sustainable growth if the transportation infrastructure develops in tandem. Infrastructure is critical both for the demands of consumers, and to improve the manufacturing supply chain. Roadways are a significant hindrance to industry growth. The narrow and often untamed roads in India are used not only by cars, but by trucks, two and three-wheeled vehicles, bicycles, and pedestrians. According to a study by the German Association for Technical Inspection (TÜV), most of India's roads are in poor condition. Further, 40% of villages do not have access to all-weather roads. Good infrastructure depends on the quality and availability of roadways. Further, a nationwide network of filling and service stations, which India currently lacks, is criti-

The strategic options for automotive manufacturers?

53

cal to reliable transportation infrastructure. Roadway congestion in major cities, caused largely by the increasing number of cars and drivers, is another problem. Traffic jams can reduce travel speeds to between 5 and 10 km/h during peak periods.26 Accordingly, the Indian government recognizes its role in the development of sustainable and modern infrastructure. Environmental protection & raw materials

For OEMs, the areas of environmental protection and raw materials are a special challenge. The difficulty is that safety and security combined with an extremely low sales price are requirements of the Indian market. However, foreign OEMs have so far been unable to provide both safety and security at a low price. Thus, the goal is to manufacture a vehicle that meets both the consumer's and the industry's standards: a low-priced car that meets safety, technology and emissions requirements. Furthermore, due to poor air quality in India, increasingly stricter environmental regulations and emission standards are on the horizon. This is a cause for concern among domestic manufacturers, as well as environmental and safety regulations making entry into a more strictly regulated market difficult. The growing market means greater dependence on gasoline and oil. Unforeseeable developments within the market, and potential statutory regulations, could keep India's automotive industry from growing to its frill potential.27 Financing

The annual income of India's middle class ranges between $2,500 and $10,000 USD (see Figure 26). Moreover, this demographic is expected to double by 2020. In 2008, the annual income of 88.5% of the population was less than $5,000 USD: a level of earning at which the purchase of a new car, with cash, is not feasible. Heretofore, larger investments have been financed through the traditional family network. But due to changes in consumer behaviour, alternative methods of financing will need to be utilized in the future. Accordingly, European and North American manufacturers must extend their focus beyond the sales channel, and develop financing models adapted to the needs of the local consumer. One potential approach is the "Grameen" model, which is a form of microcredit adjusted to local and personal conditions. A second is the Mobility model where the vehicle remains under the ownership of the producer and only utilization costs are paid by the consumer.28 A review of these finance models is of interest not only to the OEMs, but is especially pertinent to Captive Finance Companies, (discussed in part three of this book). Access to financial services, even checking accounts, is still a recent development for much of

26

Ref. TÜV Süd Group (2008)

27

Ref. IBM Global Business Services (2007c), p. 19 ff.

28

Ref. Münkner, H. (2007)

54

Strategies: Automotive Manufacturers Quo Vadis?

the Indian population. Accordingly, it is important to also consider this matter from the financial services sector's perspective, such as reliable evaluations of credit worthiness and risk.

i n c o m e class

2005

G r o w t h rate 31 million

U p p e r class >$10,000

93 million

L o w e r class < $2,500

379 million

$5,000-$10,000

^[ΙΙΙΐ

Target "stuck in the middle"

Expected scenario 2020

S

Volume

3

6

9

Vehicles sold in 2008 (in mn. units)

Figure 40: Grouping of the automotive manufacturers in premium and volume segments (2020)

Source: Author's own proposal

The current trend points toward a convergence by VW and Toyota on the premium market. With their volume market positioning and premium brands (Audi, Porsche, and Lexus) in their product portfolios they will attempt to acquire premium market shares from Daimler and BMW. With their market strength and technological innovations each will exercise considerable pressure on OEMs in the upper class. Concurrently premium manufacturers will attempt a volume market foray with compact models like the BMW 1, Mini, and Mercedes A and Β class. Their attempt aims to achieve economies of scale while maintaining profitability and a superior image. OEMs that fail to follow a clear strategy or are delaying future market position considerations are risking the potential for takeover. In delaying their answer to the question about the future positioning there is the risk of a take-over. Question is, how much elbowroom do they still have, and which scenario will ensue?

4.2.4 Financing challenges Volume and premium manufacturers will face three financial challanges:

Financing of new production sites To meet the global yield pressure faced by OEMs all market players must develop innovative foreign and domestic production sites. In establishing these production sites OEMs

82

Strategies: Automotive Manufacturers Quo Vadis?

will face technical, logistic, and above all, financing challenges. As a consequence of the current sales crisis OEMs will find that funding of new production sites is difficult to obtain due to sales and liquidity shortages. Strategic opportunities in emerging markets demand quick action. Fabricating a production site requires several years, making it difficult to keep up with market trends. This combined with yield pressures, quick action requirements, and liquidity shortages further exacerbates the industry's precarious situation. Only companies possessing a solid capital base and adequate liquidity access will find long term success developing production sites in economically interesting markets. Financing of new technologies Innovation presupposes investment. To develop new propulsion technologies and materials, high R&D investments are necessary. OEMs must evaluate how much capital is available for these investments. It is critical that the manufacturer considers the extent of its research. Capital losses due to bad investments are high, especially in R&D. As a result, the manufacturer must master the balance between outsourcing to the suppliers and in-house development. Building up a financing company New strategic options in India and China are calling for Captive Finance Companies. Each market requires an individual financing adaptation depending on its economic needs. Considering the low per capita income in the emerging markets, a pure sales channel is insufficient for a successful operation. In these countries, potential buyers require financing solutions, and a Captive Finance Company is the only option for boosting sales. However, the strategic use of Captive Finance Companies leaves many gaps in current industry literature. Therefore, the importance and organization of these companies will be discussed in part three of this book.

• PART 2 Porsche and VW: A Case That Makes History

In the first part of this book, the various options available to OEMs were described. In this section, apart from the challenges resulting from the ongoing development of alternative propulsion, the effects of globalization and key market player takeovers come into focus. The economic crisis intensified the financial struggles of several OEMs and brands, reinforcing the wave of consolidation. An example of this is Porsche's acquisition of Volkswagen, which will be examined here with great detail, because of two special characteristics: First, two financially viable companies were involved; and second, the acquisition was attempted by the lower volume producer of the two manufacturers. Furthermore, the use of complex financial instruments and strategies is of particular interest in this attempted horizontal integration.

5

Porsche's takeover attempt and financial strategy

Executive Summary Part 2 of this book explores Porsche's attempted takeover of VW.59 The events of the years 2005-2009 are treated chronologically, beginning with a situational analysis of each company prior to Porsche's pursuit of VW. Also, the motives behind Porsche's participation and investor reactions are discussed. Furthermore, communication between Porsche, VW and the political participants is evaluated with a focus on takeover, financing and option strategies. Through an examina-

59

Part 2 is based entirely on publically available information and statements made herein reflect the opinion of the author.

84

Porsche and VW: A Case That Makes History

tion of the financing approach and the option strategy, a financial construct of the takeover attempt was founded. Also relevant were debt relief alternatives for Poland and an analysis of Qatar Holding LLC's participation.

Introduction When Porsche entered into VW in 2005, it was restricted to minority interest status. However, over the subsequent years, Porsche built its holdings through options; and in March 2008 Porsche announced that it was seeking a minority stake.60 In October 2008, Porsche released a press notice announcing that it held a 42.6% interest in VW; and through cash-settled options, it had access to an additional 31.5%, bringing its total share to 74.1%. In 2009, its holding increased to 75%, with the goal of entering into a control and profit transfer agreement with VW.61 Thus, Porsche possessed the liquid funds to cover the resulting acquisition costs. To obtain legal approval for the takeover attempt, VW law required a qualified majority. However, the new edition of the law, passed by the German Parliament in November 2008, retained the blocking minority at 20%. 62 With that, the Lower Saxony region's power to veto, remained intact. Therefore, Porsche was unable to complete its profit transfer agreement, effectively blocking the takeover attempt.

5.1 The takeover attempt 2005-2009 5.1.1 Situation analysis: VW 2005 In 2005, VW was traded as a potential takeover candidate. The company was undervalued in the stock market and its market capitalization amounted to approx. 15.9 billion euro. Against that figure, its book value was 23.6 billion euro.63 As Figure 41 shows, VW's P/B ratio was the lowest among its German competitors; Daimler-Chrysler and BMW were valued with P/B ratios greater than one, while VW's P/B was only 0.7.

60

Ref. Porsehe-se.com (2008), Porsche's Board of Directors gives green signal for majority holding in VW

61

Ref. Porsche-se.com (2008), Porsche attempts to obtain governing contract

62

Ref. VW Law (2008), § 4 Para. 3

63

Ref. Volkswagen AG Business Report 2005, p. 27

Porsche's takeover attempt and financial strategy

Manufacturer

M a r k e t capitalization ( € mn.)

E q u i t y capital ( € mn.)

85

P/B ratio %

Volkswagen

15.9

23.6

0.7

Daimler-Chrysler

43.9

36.5

1.2

BMW

25.0

17.0

1.5

Figure 41: P/B ratio of VW, Daimler-Chrysler and B M W , values rounded off (status: 2005 end) Source: Volkswagen AG Business Report 2005, p. 27. Daimler-Chrysler AG Business Report 2005, p. 26, 128. BMW Group Business Report 2005, p. 38, 65

On March 4th, 2005, the European Commission filed a suit before the European Court of Justice (ECJ), demanding the examination of a possible repeal of VW law. From the Commission's perspective, certain sections of VW's law violated the free movement of capital guarantee (one of the "Four Freedoms" assigned under EU substantive law) with which paragraphs VW was granted a special status.64 According to the VW Law, a shareholder could not exercise more than 20% of his voting rights in a general meeting, even if his holding in the company entitled him to a vote exceeding that value.65 Further stipulations stated that certain shareholder resolution's could only pass by a greater than 80% majority of eligible voters.56 However, corporate law set the qualified majority at greater than 75%, resulting in a reduction of the required blocking minority, to 20%. The abovementioned law withheld decision-setting power from a single major shareholder, if acting independently. Instead, resolutions could only be passed by a unified set of shareholders. The federal state of Lower Saxony, which primarily represents VW's domestic interests, and thus its main production sites, held a powerful 18% eligible voting share. In order to override the VW Law, a shareholder would have needed a greater than 75% share to hold independent decision making power. The three primary reasons for the takeover attempt in 2005 were: 1

VW's equity capital position exceeded its stock market value by approx. 8 billion euro.

64

Ref. EuGH (2007), Ruling of the Court of Justice (Grand Chamber), p. 1 ff.

65

Ref. VW Law, § 2 Para. 1

66

Ref. VW Law, § 4 Para. 3

86

Porsche and VW: A Case That Makes History

2 VW's excessive liquidity amount to 10 billion euro. 3 The company's divestiture of individual brands to the highest bidder would have released several billion euros more.

5.1.2 Situation analysis: Porsche 2005 Under Wendelin Wiedeking's leadership, Porsche became the most profitable automotive manufacturer in the world. In fact, over a ten year period, its turnover quadrupled. This was largely due to dramatically increased vehicle sales.

100,000

_ t/1 ®

80,000

S Ξ < >υ βο,οοο o β)

jQ E 3 2

40,000

20,000

0

2001

2002

2003

2004 Β

Figure 42: Growth of turnover from 2000/2001 - 2004/2005

Source: Porsche AG Business Report 2004/2005, Porsche Concern in

Turnover

2005 Domestic

Abroad

numbers

Figure 42 documents Porsche's increased total sales growth and the change in the number of vehicles it sold domestically and abroad from 2000 to 2005; along with an accompanying Compound Annual Sales Growth Rate exceeding 10%. Further, during this period Porsche performed particularly well abroad, nearly doubling its foreign turnover within five years. Increased revenue positively impacted earnings, which steadily increased, and Net Profit Margins climbed during the period spanning 2000 through 2005 (in Figure 43).

87

Porsche's takeover attempt and financial strategy

Net Profit Margin

Figure 43: Growth of Net Profit Margin 2000/2001 - 2004/2005 Source: Porsche AG Business Report 200412005, Porsche Concern in numbers

Additionally, Porsche's approximately 23% equity return satisfied its shareholders, who thereby instead its competition (see Figure 44).

Manufacturer ROE

22.78%

VW

Daimler

BMW

2.99%

7.35%

12.68%

Figure 44: Return on Equity Ratio, Porsche and the competitors (Status as of: 2004 or 2004/2005) Source: Porsche Business Report 2004/2005, p. 102, 104. Volkswagen AG 2004 Concern Resolution, p. 40-41. Daimler-Chrysler AG Business Report 2004, p. 100, 102. BMW Group Business Report 2004, p. 51, 53

5.1.3 Why did Porsche enter in V W ? On September 25th, 2005, Porsche announced that it held a 5% minority share in VW. Shortly thereafter, its holding increased to 18.5%. Additionally, Porsche had options on another 3.4%. At that time, its holdings amounted to 3.3 billion euro. Figure 45 shows the shareholding structure of Volkswagen AG in autumn 2005.

Porsche and VW: A Case That Makes History

88

5% • Capital Group

18%

• Lower Saxony • Brandes Investment Partners • Volkswagen AG

11%

• Porsche

3S • Porsche options

19%

a Free float

Figure 45: VW shareholding structure after the entry of Porsche (Status as of: Autumn 2005)

Source: Author's own proposal

It follows that Porsche was the biggest principal shareholder, followed by the Federal State of Lower Saxony. Through options, Porsche was able to increase its interest to more than 20%, thus obtaining a blocking minority status. The primary motives behind Porsche's stake in VW were: 1

Preservation of its low in-house vertical integration

2

Preservation of the strategic alliance

3

Preservation of profitability to secure its independence

Preservation of low in-house vertical integration

At less than 20%, Porsche's in-house vertical integration is the lowest in the entire automotive industry.67 Many production processes are outsourced to external companies, where they are carried out with greater cost effectiveness. Indeed, VW is one of Porsche's most important suppliers, because it manufactures the bodies for the Cayenne and Panamera models. A takeover of VW by a financing investor would have stripped Porsche of this asset. Moreover, the concern would have been required to either outsource to another manufacturer, or utilize in-house production for the job: The latter resulting in increased cost, and therefore profit loss.

67

Ref. Porsche Business Report 2004/2005, p. 4

Porsche's takeover attempt and financial strategy

89

Preservation of the strategic alliance More than just being its most important supplier, VW is also an effective development partner for Porsche. Both companies share, among other things, knowledge and development costs. Without VW, Porsche would have been unable to take on additional projects which required heavy funding. The Porsche Cayenne, a result of the Cayenne-Touareg project, exemplifies the importance of the Porsche/VW strategic alliance: In the 2004/2005 fiscal year, Cayenne's share of Porsche's total sales was 47%. 68

Preservation of profitability and own independence Porsche's profitability is based on cost reduction and continuous sales growth, and its collaboration with VW has decisively shaped these two determinants. Porsche will only maintain its independence through long-term profitability; accordingly, continued collaboration with VW is essential.

5.1.4 Investor Reactions to Porsche's entry into VW VW share Figure 46 shows VW's ordinary share performance between the 12th and 30th of September, 2005. Beginning September 22nd, 2005, a VW share was quoted at slightly more than 50 euro; and initially, the news of Porsche's minority stake did not push that price.

Figure 46: V W ordinary share, price m o v e m e n t f r o m 12th Sep. 2005 - 30th Sep. 2005 Source: Google finance (2009), Historical prices

68

Ref. Porsche Business Report 2004/2005, Porsche concern in numbers

Porsche and VW: A Case That Makes History

90

Figure 47 illustrates the traded volume of VW's ordinary shares shortly before and after Porsche's announcement. The trend line shows above average trading in VW securities from September 21st through 27th. During this period, Porsche may have acquired VW ordinary shares, thus increasing demand and therefore traded volume.

20,000,000 Traded volume (stocks) 15,000,000 Trendline 10,000,000

Figure 47: Traded volume of ordinary VW shares, 12th Sep. 2005 - 30th Sep. 2005

Source: Google finance (2009), Historical

prices

Porsche share Porsche shareholders were sceptical about the company's press release. In fact, after the ad hoc announcement, Porsche's share price dropped 10.39%.69 Indeed, Figure 48, below, shows the sudden share price decline that occurred on 26th September 2005.

69

Ref. Google finance (2009), Historical prices

Porsche's takeover attempt and financial strategy

680

660 640

620 600 580

Porsche stock price iri €

Figure 48: Price movement of Porsche from 12th Sep. 2005 - 30th Sep. 2005

Source: Google Finance (2009), Historical

prices

Figure 49 provides the volume traded in Porsche shares between September 12th and 30th, 2005. The first trading day after Porsche's announcement of its minority interest in VW, trading volume rose. Accordingly, the falling price of the shares indicate that many investors sold their Porsche stock soon after the company's announcement.

1,000,000

Traded volume (stocks) 800,000

600,000

400,000

200,000

I "*"' I J *

1

I t V

T>

TP-

Figure 49: Traded volume of Porsche share from 12th Sep. 2005 - 30th Sep. 2005

Source: Google Finance (2009), Historical

prices

Porsche and VW: A Case That Makes History

92

5.1.5 Wiedeking and Härter appointed to VW's Board of Directors At the end of 2005, CDU politician Christian Wulff, who represented the VW Supervisory Board's principal shareholder, Lower Saxony, spoke out against Wiedeking and Härter's appointment to the board. Meanwhile, he demanded the early resignation of VW's Supervisory Board Chairman Ferdinand Piëch. While Piëch occupied his position as chairman, he concurrently held a 13% stake in Porsche: A conflict of interest, according to Wulff, who pointed out that Porsche's disproportionately high representation among VW's board members, put Lower Saxony at risk. However, Wiedeking did not want to be obstructed in collaborating in the restructuring efforts. Porsche's success depends on the close collaboration with VW and VW's performance as well. At the end of April 2006, the parties concerned compromised: A neutral party would occupy the position of Chairman of the Supervisory Board, upon the completion of Piëch's term in office. Moreover, Wulff approved Wiedeking and Härter's appointment to the board. In December 2006, Martin Winterkorn replaced Bernd Pischetsrieder as the Managing Director of VW. Shortly thereafter, the chief restructuring specialist and board member, Wolfgang Bernhard, left the company, possibly due to his strained relationship with Winterkorn. Looking ahead to the spring 2007 cessation of his term in office, Piëch sought re-election, and garnered backing from Works Council Chairman Bernd Osterloh and the head of Porsche, Wendelin Wiedeking. The result: Christian Wulff's compromise was rejected and on April 19th, 2007, Piëch was re-elected as Chairman of the Supervisory Board for five more years.70

5.1.6

Build-up of interest in V W and obligatory bidding

Meanwhile, Porsche increased its interest in VW to 27.3%. In March 2007, through option business, it acquired an additional 3.6%.71 According to the German Stock Corporation Act, when it crossed the 30%-threshold, Porsche was bound by contract to submit a bid to the other shareholders for the remaining ordinary and preference shares. Porsche publically announced that it did not intend to acquire VW; and accordingly, it limited bidding to the legally prescribed minimum price of 100.92 euro per ordinary share, and 65.54 euro per preferred share. The acceptance period extended from April 30th

70

Ref. Volkswagenag.com (2007), Prof. Dr. h. c. Ferdinand K. Piëch elected as the Chairman of the Board of Directors of Volkswagen AG

71

Ref. Porsche-se.com (2007), Porsche AG exercises options for the ordinary shares of Volkswagen AG

Porsche's takeover attempt and financial strategy

93

to May 29th 2007. At the end of this period, an ordinary share listed at 111.39 euro72 and a preferred share at 74.54 euro.73 The pronounced discrepancy between the going rate and the actual market value (offer below market value) resulted in a 0.06% acceptance rate. Meanwhile, Lower Saxony increased its voting share to 20.36%, effectively achieving blocking minority status.

5.1.7 Reforming Porsche AG into a European Societas Europaea (SE) joint-stock corporation During a general meeting on June 26th, 2007, Porsche AG shareholders voted to reform the group as a European Societas Europea (SE) joint-stock corporation with the new name "Porsche Automobil Holding SE". Further, a new co-determination and profit loss/transfer agreement was made between Porsche AG and Porsche SE, wherein the latter appropriated management of the VW stake. The company's shareholding structure remained unaltered, and AG investor holdings were automatically transferred to SE stocks.74 The formation of Porsche SE caused conflict between the concern and VW employees, who were anxious about their lack of power within the new company structure. Indeed, Porsche and its employees formed a negotiating committee for the purpose of debate about the new co-determination and Profit/Loss transfer agreement and had not invited excluded VW employees to participate. Below, the content of the co-determination and Profit/Loss transfer agreement is divided into six core points: 1

Porsche SE's Supervisory Board is comprised of 12 members.

2

Employers and employee representatives have an equal numbers of seats.

3

Porsche's supervisory board is populated exclusively by Porsche employees.

4 If Porsche's stake in VW exceeds 50%, three of the six employee seats will be allocated to members of the VW's Works Council. 5

The co-determination and Profit/Loss transfer agreement will not be altered before its original expiration date (a ten year period).

72

Ref. Google Finance (2009), Historical Prices

73

Ref. Google Finance (2009), Historical Prices

74

Ref. Porsche-se.com (2009), Porsche SE

94

6

Porsche and VW: A Case That Makes History

Any change to the agreement will require a 2/3 majority vote by Porsche employee representatives.

Bernd Osterloh, Chairman of the VW Works Council and IG Metall Lower Saxony felt disadvantaged by the above mandates; particularly the last three, by which, Osterloh believed, VW's workforce would be underrepresented on Porsche's Supervisory Board. VW employed 30 times as many employees as Porsche and should therefore have more to say in the joint concern.75 Further, even with a majority share in VW, Winterkorn (or any VW representative) was appointed to the Supervisory Board, while Wiedeking and Härter were each offered a seat. VW representatives feared that, with daughter company status under Porsche, proposed cost cuts would pass which would be the case if Porsche's holding increased to more than 50% and VW law was repealed by the ECJ. Wiedeking spoke out once again for cost cutting measures, thereby speaking against VW's in-house tariff and cross-subsidization among its factories and brands. Moreover, the likelihood of job cuts increased under Wiedeking's plan, and VW employee representatives, with only three seats on the Supervisory Board, were powerless to stop it. When talks with Wiedeking and Härter failed to effect compromise, Osterloh filed suit against Porsche in Stuttgart's labour court, demanding Porsche SE's exclusion from the trade register, per European Stock Corporation Law. According to Osterloh, VW had a governing relationship with Porsche at the time of the parent company's founding: In which case, according to applicable law, Porsche should have conferred with VW during the negotiation process.76 Porsche's defense council, the solicitor firm Freshfields Bruckhaus Derringer, challenged the purported governing status between Porsche and VW with two arguments: First, Porsche's share in VW, at 31%, was quantitatively short of meeting the eligible majority voting share requirement. Second, VW Law, which was still valid, limited the exercisable voting-eligible share to 20%. Stuttgart's Labor Court dismissed the case, siding with the defence: At that time, Porsche had no governing interest in VW.77 On November 13th, 2007, Porsche SE was officially entered in the trade register.

75

Ref. Arbeitsrecht.de (2008), Porsche-Mitbestimmungsvereinbarung is effective - for the time being

76

Ref. Arbeitsrecht.de (2008), Porsche-Mitbestimmungsvereinbarung ist eífective - for the time being

77

Ref. Arbeitsrecht.de (2008), Porsche - Co-determination Agreement is effective - for the time being

Porsche's takeover attempt and financial strategy

95

5.1.8 The ECJ rules on V W Law Since Porsche's entry, Wiedeking continuously criticized VW Law and demanded its repeal. He garnered support from the European Commission, which was of the opinion that § 2 Para. 1 and § 4 Para. 1 and 3 of VW Law violated Articles 43 EG and 56 EG. 78 For the purpose of clarity, the abovementioned paragraphs of VW Law (translated to English) are reproduced below.79 § 2 Para. 1 VW

Law

"If a shareholder owns shares with total nominal amount of more than the fifth part of the equity capital, then his right for voting will be limited to the number of votes which is allowed by the shares with total nominal amount of the fifth part of the equity capital." »

Voting rights of a shareholder are limited to 20% regardless of his holding.

§ 4 Para. 1 VW

Law

"The Federal Republic of Germany and the state Lower Saxony each have the right to delegate two seats on the Supervisory Board to eligible shareholders." •• Germany and Lower Saxony can each delegate two members to the Supervisory Board of V W regardless of the size of their holding. § 4 Para. 3 VW

Law

"Resolutions of the general meeting, for which a majority, which includes at least three fourth of the equity capital at the time of passing of the resolution, is necessary according to the Stock Corporation Act, will require a majority of more than four fifth of the equity capital of the company represented at the passing of the resolution." •• Majority resolution requires approval by more than 80% of the equity capital existing at the time of passing of the resolution. According to German Stock Corporation Act, majority resolutions require approval by more than 75% of the equity capital existing at the time of the passing the resolution. This corresponds to reduction of the blocking minority from 25% to 20%.

A violation of Article 43 EG could not be proven. Against that, the EuGH found the connection between § 4 Para. 3 with § 2 Para. 1 and the existence of § 4 Para. 1 in the VW

78

Ref. EuGH (2007), Ruling of the Court of Justice (Grand Chamber), p. 2

79

Ref. EuGH (2007), Ruling of the Court of Justice (Grand Chamber), p. 3

96

Porsche and VW: A Case That Makes History

Law as illegal against the Article 56 EG.80 This article prohibits "restriction of capital flow between the member states". Under that term come the capital transactions, above all direct investments of natural or juridical persons, through which the economic relations are built up between the finance provider and the company and which give the investor the possibility for having a share in the management of the company actively according to the national stock corporation act.81 The ECJ distinguishes three types of restrictions that result from national measures:82 1

National measures that obstruct the acquisition of shares of a particular company

2 National measures that limit the acquisition of a particular company's shares 3 National measures that prevent third member state investors from acquiring stock in a particular company

The Federal Republic of Germany argued that VW's case was neither a national measure nor was it restriction related. Instead, the law was based on an agreement made among all claimants at that time and was not a resolution made solely by the state. There was no restriction, because Lower Saxony was granted no special rights: Like every shareholder, it may not exercise more than 20% of its voting rights. Moreover, any share holder, including Lower Saxony, holding 20% of the ordinary shares, possessed blocking minority status. The ECJ challenged the Federal Republic of Germany on both points. Only the state is authorized to exercise legislative power and since VW's case cited this sanctioned law, Germany was operating within its rights as a state. Further, VW Law cannot be modified by the approval of its original claimants: Instead, any new law must be enacted by the state. Therefore, VW Law must be assessed as a national measure. The ECJ agreed that the 75% majority required to pass certain general meeting resolutions, as prescribed by the German Stock Corporation Act, can be increased via shareholder approval. However, in VW's case, raising the required voting majority was forced on the shareholders through national measures. If the ECJ assumed that Germany and Lower Saxony each held 20% at the time VW law was passed, § 4 Para. 3, implicated the protection of state interests.

80

Ref. EuGH (2007), Ruling of the Court of Justice (Grand Chamber), p. 16

81

Ref. EuGH (2007), Ruling of the Court of Justice (Grand Chamber), p. 5

82

Ref. EuGH (2007), Ruling of the Court of Justice (Grand Chamber), p. 6

Porsche's takeover attempt and financial strategy

97

Combined with § 2 Para. 1, which limits exercisable voting right to 20%, the state effectively obtained greater influence via low investment. As a result, the shareholders were hindered, in view of the interplay of the regulations just mentioned, to take part in VW and its management and control according to their conceptions. Therefore, these regulations restricted the free flow of capital "in the sense of Art. 56 Para. 1 EG [.. ,]".83 Moreover, the ECJ confirmed that Germany's and Lower Saxony's disproportionally high delegation powers (§ 4 Para. 1) were curtailing the rights of the other shareholders, because each was able to continually exercise its powerful influence with low investments. Germany's argument that the Supervisory Board lacked decision-making authority was dismissed by the ECJ. Moreover, the Supervisory Board was entrusted with the authority to both appoint and depose its chairman; and to establish or relocate production sites, branches, etc., thereby confirming its decision-making power. An uneven distribution of power within the Supervisory Board (in this example, in favor of the state) restricts shareholder's rights and scares off potential investors. The ECJ pointed out that § 4 Para. 1 of VW Law was inadmissible, because in combination with Art.56 Para. 1 EG, it restricted the free flow of capital.84 Based on the reasoning discussed herein, on October 23rd, 2007, the ECJ declared the illegality of VW Law. Then, Germany announced the ruling's immediate implementation, and the abovementioned paragraphs lost their legal validity, thereby allowing Porsche to fully assert its voting rights in VW.

5.1.9 Porsche achieves majority share in V W On March 3rd, 2008, just a few months after the repeal of VW-law, the Porsche Supervisory Board granted the committee the ability to increase its Volkswagen shares to more than 50%.85 Six months had to pass before the increase could take effect, because share expansion requires an anti-trust law inspection. Below, the economic advantages and possibilities, disadvantages and associated risks, associated with Porsche's acquisition of VW are discussed. The following SWOT analysis (refer to Figure 50) contrasts the positive and negative aspects of Porsche's acquisition of VW.

83

Ref. EuGH (2007), Ruling of the Court of Justice (Grand Chamber), p. 6 - 11

84 Refer to ECJ (2007), Decision of the court (Grand Chamber), S. 12 - 14 85

Refer to Porsche-se.com (2008), Porsche supervisory board gives the green signal for majority stake in VW

98

Porsche and VW: A Case That Makes History

Strengths • Preservation of cooperation agreement " Cost reduction through economies of scale e.g. common purchase • Access to capital & Know How Opportunities • Development of new customer segments • Avoidance of C02 Regulations

Weaknesses • Deal pressurises liquidity • Power struggle between managers • The brand Porsche loses exclusiveness

Threats • Time management and complexity • Production cannibalism • High PMI-Costs

Figure 50: SWOT analysis, Porsche takes over VW Source: Author's own proposal

Close study of the above chart reveals that the negative points outweigh the positives. To enter cooperative agreements or share knowledge and development costs, Porsche need not acquire VW, only continue the strategic alliance. The acquisition of VW would stress Porsche's liquidity and cause power struggles among the leaders of both companies. Further, the Porsche brand could lose its exclusivity and therefore its status as a niche producer. Additionally, the execution of the takeover would take up time, which could lead to the neglect of operative business. Moreover, leadership within a niche producer setting is different from the management style of a global company, which is more complex. And one more aspect: The brands Bugatti, Bentley and Lamborghini, VW's premium segments, are Porsche's direct competitors, and by taking over VW, Porsche may cannibalize its products. The biggest hurdle of the takeover process would be integrating VW under the umbrella of Porsche SE. Indeed, its success would depend upon the compliance of VW workers, who would necessarily accept Porsche as their new employer, and assimilate themselves within company culture. It should be noted, however, that prior events have weakened the sympathy of the VW work force for Porsche. In March 2008, all signs pointed toward a planned takeover of VW. However, at that time, no one expected Porsche to own more than 75% of VW stocks.86 Six months later, Porsche revealed in a press release that it owned 42.6% of VW's equity, and access to cash-settled call options for an additional 31.5%. In the then-given situation, Porsche's maximum holding rested at 74.1%, but the company announced that it would increase its shares to more than 75% in the coming year, with the end goal of entering a Co-determination and Profit/Loss Transfer Agreement.87

86

Refer to Porsche-se.com (2008), Porsche refutes speculations regarding accumulation of 75% in VW

87

Refer to Porsche-se.com (2008), Porsche aims for a control contract

Porsche's takeover attempt and financial strategy

99

What registering threshold exists, and what are the shareholder's rights? Figure 51 shows the various registration thresholds and explains the rights available to the investor relative to his respective holding.

" Delisting

100%

• Possibility to integrate the stock corporation into a stock corporation • Possibility for Squeeze-Out

95%

> 75%

• Shareholding disclosure threshold • Special shareholder resolution threshold (required for the implementation of integration and merger proposals, entry into domination agreement, other major restructuring proposals, changes to articles including capital increase) • Abolition of director's seat

> 50%

» Shareholding disclosure threshold • Reservation of shareholders in the board of directors » There is a possibility to block or allow regular decisions (e.g. profit split, no confidence vote against the management)

• Mandatory contribution of a company offer of the share to the shareholder

30%

• Shareholding disclosure threshold • There is a possibility to block committee decisions

> 25%

• Shareholding disclosure threshold

10

• Shareholding disclosure threshold « Right insists to convene the general assembly, to set points on the agenda of the assembly, to raise claims against the management as well as initiate special Investigations

5%

Figure 51: Thresholds and rights of the shareholders Source: Author's

own

proposal

100

Porsche and VW: A Case That Makes History

For most decisions, a simple majority (50%) suffices; though some decisions require a qualified majority (greater than 75%). These include: •

Statute changes (Per § 179 AktG) 88

•

Capital change actions (Increases and reductions) (per § 222 AktG) 89

•

Dismissing Supervisory Board members (per § 103 AktG) 90

•

Merger decisions (§ 262 AktG)91

Accordingly, Porsche SE requires a qualified majority: 1

For legal approval of the VW takeover

2

To attain a co-determination and Profit/Loss Transfer Agreement, for the purpose of allocating VW's liquid funds to cover takeover costs

5.1.10

What is Ferdinand Piëch's position?

Ferdinand Piëch has directed events at VW since 1993, when he was the company's chairman. In 2002, he became chairman of the Supervisory Board. Under his leadership, Martin Winterkorn succeeded Bernd Pischetsrieder, in 2007, as VW AG's chairman. When Wiedeking brought VW's Supervisory Board under the scrutiny of the ECJ, VW leaders criticised him. However, Piëch said nothing about Wiedeking's behavior. In fact, he remained neutral regarding the reorganization of Porsche SE's co-determination agreement, when, as a Porsche shareholder, he should have given his approval. One interpretation of his behavior is that the integration of VW under the Porsche holding company would have been extremely lucrative for him, because of his family's considerable holding in the concern. Indeed, the dismissal of VW's board and the reduction of its works committee's power left the Porsche and Piëch families with nearly limitless authority. Moreover, Ferdinand Piëch and Wolfgang Porsche would head the newly formed company.

88

Refer to AktG, § 179

89

Refer to AktG, § 2 2 2

90

Refer to AktG, § 103

91

Refer to AktG, § 2 6 2

Porsche's takeover attempt and financial strategy

101

From this position of leadership, Piëch hoped to realize his dream of heading a universal manufacturer, of fering everything from convenient compact cars to luxurious sports cars in its portfolio. His goal is to displace Toyota as the world market leader.

5.1.11 The Change in Communication between Porsche and VW The content of Porsche and VW's communication strategy is divided into three phases: Phase 1

Entry into VW

Phase 2

Restructuring of Porsche AG as a Società Europea (SE) and demanding the dismissal of VW's board

Phase 3

Acquisition failure and Porsche's resulting debt load

In Phase 1, Porsche and VW joined as co-partners. In Phase 2 and Phase 3, conflict arose precipitated in their communication and contributed to their mutual aggravation. Phase 1

Entry in VW

After Porsche announced its entry into VW, it was awarded great praise. Politicians and unionists were relieved that Porsche's decision enabled a resolution confined within the German Auto industry through which VW would remain protected from the threat of a hostile takeover. VW representatives welcomed the long-term consolidation of its shareholder structure and spoke of a deepening cooperation between the two companies. Phase 2

Restructuring of Porsche AG as a Società Europea (SE) and demanding the dismissal of VW's board

Porsche AG's conversion to an SE occurred simultaneously with Wiedeking's demand for the dismissal of VW's board. Even before he chided VW's leadership philosophy, Wiedeking criticized the existing product cannibalization among some Audi and VW model series. Further, he questioned the viability of the brands Bugatti, Bentley and Lamborghini: A platform from which to inquire about the purchase strategy implemented by Ferdinand Piëch during his tenure as VW's chairman. The reorganization of the co-determination agreement, a consequence of the planned conversion of Porsche AG into an SE, initiated the ongoing conflict between Porsche and

102

Porsche and VW: A Case That Makes History

VW's employer representatives. In addition to filing a complaint in the Stuttgart labour court against Porsche SE's entry into the trade register, VW Works Council chairman Bernd Osterloh advised the worldwide VW workforce to demonstrate against the reduction of its employer representatives' power (by Porsche); thereby receiving the approval of Christian Wulff, who recognized that Lower Saxony's interests were at risk. Porsche works council's Uwe Hück submitted: Had Osterloh and Berthold Huber (IGMetall Lower Saxony) been informed about the negotiation process, VW would have adopted the co-determination agreement. Wiedeking's plea to the ECJ to overturn VW's law amplified the conflict, opening it to political involvement. In turn, Wiedeking asked the involved politicians to refrain from intervention in companies that are involved in international competition. In October 2007, the ECJ ruled that VW's board, as it stood then, was unlawful. By January 2008, Federal Justice Minister Zypries submitted a draft of VW law that addressed the points previously deemed unlawful. However, in § 4 Sec. 3, the blocking minority remained at 20%. Because the ECJ only considered the combination of § 4 Sec. 3 with § 2 Sec. 1 and § 4 Sec. 1 to be unlawful, the federal government concluded that cutting out the last two paragraphs would address the judgment. If the language of that draft was implemented, VW would be prevented from making its own decisions without the approval of Lower Saxony, who owned a 20.36% blocking minority stake. Wiedeking wrote Ms. Zypries and demanded the immediate rejection of the draft, citing an executed legal opinion; the logical outcome of which calling for the dismissal of VW's board. In response to ongoing opposition to the modification of VW law, on September 12th, 2008, 40,000 VW employees demonstrated in Wolfsburg's business district against Wiedeking's demand to overturn VW law. In fact, Wiedeking himself was in a VW Supervisory Board meeting and heard the demonstrating workforce outside. In November 2008, 13 months after the ECJ overturned VW law, the German state government finally passed the new bill. Phase 3

Failure of the takeover and Porsche's fall into debt

In May 2009, Porsche confirmed that its plan to take over VW had failed and instead, an integrated automobile company should be formed. Porsche's massive debt load caused by the takeover attempt and resulting conflicts, negatively affected the discussion climate. Ferdinand Piëch (who until this point had remained a neutral participant) caught the speaker's eye at a PR conference in Sardinia, and substantiated that VW would take the dominant role in merger discussions with Porsche. He cited Porsche's accumulated debt as a key hurdle that would burden VW's balance. Further, Piëch was skeptical of Wiedeking's future with Porsche if the concern was integrated as the tenth brand in VW's portfolio. Porsche reacted immediately to Piëch's statements. Works council chairman Hück interpreted Piëch's inflammatory statements as a violation of trust, due diligence, and

Porsche's takeover attempt and financial strategy

103

discretion: all confidentiality obligations that he was subject to as a supervisory board member of Porsche AG and Porsche SE. Moreover, Hück said that he was contemplating legal action. Further, in a letter personally addressed to Piëch, Wiedeking indicated his belief in this premeditated attack to depreciate Porsche's value; and his intent to pursue legal action. 6,500 Porsche employees demonstrated in Zuffenhausen, Weissach, and Ludwigsburg against Ferdinand Piëch, integration into VW, and for safeguarding the concern's independence. The shareholder's statements led to disputes along the Porsche and Piëch family lines. Indeed: Wolfgang Porsche feared a reduction of the company's value, which, he speculated, would trigger damage claims by the preferential shareholders if the concern was sold to VW. Porsche owners planned a crisis meeting in mid-May, 2009, to deliberate about the future of the company. A discussion with Piëch was planned, too. However, he chose to stay away from the meeting.

5.1.12 Reactions of the Market Participants In the following section, VW investor reactions to the events of the last four years are discussed. For this purpose, Figure 52, below, maps the rate flow of VW common stock from September 2005 to September 2009. For the purposes of this analysis, month-end key rates were referenced.

Figure 52: Development of VW common stock from Sept. 2005 - Sept. 2009, monthly key rates Source: Yahoo! Finance (2009), Historical rates

104

Porsche and VW: A Case That Makes History

From June to September 2005, the VW share increased from 37 euro to 51 euro, because investors predicted the entry of a financial investor into VW. Therefore, they wanted to secure dividends, and then sell to the anticipated investor at a higher price.

12,000,000

Traded volume (stocks)

9,000,000

6,000,000

3,000,000

μ®

Φ

^

Φ

cfc^

Φ

Φ

η ό\ ^

1 1 tf

^

^

,ό1 φ" Φ .Φpp.·„o* ^di-.tf

Figure 53: Trading volume of VW common stock, monthly key rates

Source: Yahoo! Finance (2009), Historical

rates

Figure 53 shows that shortly before Porsche's entry, the trading volume of VW common stock rose sharply. Likely, in addition to investors, banks that had concluded option contracts with Porsche purchased VW securities in order to reduce risk, further driving up demand. Since Porsche's increased involvement, VW's rate increased continuously. Indeed, as soon as Porsche extended its shares, rates and trading volume increased in direct proportion. Many investors speculated about a potential takeover of Volkswagen by Porsche, and therefore increased their ownership of VW stocks.

Other notable aspects of the rate flow and trading volume were: •

November 2006 Porsche raised its VW share to 27.4%. The price of VW common stock was at 82.25 euro, and had nearly doubled in a year (November 2005: 44.55 euro). From October to November 2006, the trading volume increased by 206%.

•

January-March 2007 The trading volume showed another enormous increase (251%) from January to March. By March, VW stock was at 112.50 euro. After Porsche increased its share to above 30%, media reports that indicated an imminent acquisition of VW were published. Accordingly, over the next months, share prices were driven even higher.

Porsche's takeover attempt and financial strategy

105

•

October 2007 VW stock held at 197.90 euro, corresponding with a 387% increase in three years. In the following months, the rate slipped to 150 euro; possibly because of the ECJ's dismissal of VW law.

•

March 2008 Porsche published a press release, according to which the supervisory board agreed to a majority share in VW. Then, VW common stock increased again, this time exceeding the 200 euro mark in the months that followed.

•

October 2008 The financial crisis reached the German market, VW stock was resistant, initially, and on October 28th 2008, worth more than 1,000 Euro. Short sellers reacted with panic buys when Porsche's stated that it held 42.6% VW common stock plus 31.5% cash-settled call options in bonds; and as a result, drove prices up. And taking into account Lower Saxony's major share, the free float diminished to 5.9%.

•

November 2008 Porsche triggered 5% of its call options based on cash settlement. The VW rate normalized, but the stock was still overvalued.

•

January 2009 Porsche attained a 50.76% majority share and the rate of VW's shares levelled off above 200 Euro. By May 2009, it was finally clear that Porsche could not stem the takeover.

•

August 2009 Qatar entered into VW, as its third major shareholder. Then Qatari state funded Qatar Holding LLC sold Porsche the majority of its VW options, securing access to around 17% of common stock.92 As a result, the free float sank to 11% and VW stocks began to fall.

92

Refer to Foreign office (2009), Qatar entered VW and Porsche

106

Porsche and VW: A Case That Makes History

Figure 54: VW stocks structure (As in: 2009)

Source: Porsche-se.com (2009), Shares in Volkswagen increased to above 50%. Foreign office (2009), Qatar entered VW and Porsche

Figure 54 illustrates the new shareholder structure, provided that Qatar Holding LLC would exercise all options held. VW stock is volatile and at risk of rate fluctuations: A condition of its intrinsic lack of diversification (because the majority of the stock is in the hands of three major shareholders: Porsche, Lower Saxony, and Qatar Holding LLC). Moreover, the stock is "marketdependent," because the three major shareholders don't actively trade in the market and have instead made long-term investments.

Figure 55: Trading volume of VW common stock, monthly key rates, Nov. 08 - Nov. 09

Source: Yahoo! Finances (2009), Historical rates

Porsche's takeover attempt and financial strategy

107

Figure 55 illustrates the decline in trading volume, ongoing since November 2008, which has caused VW common stock to react sensitively to high sale and purchase orders (both of which result in rate fluctuations). Meanwhile, the tradability of the stock has decreased. The combination of the two abovementioned properties puts the stock at risk of private shareholders, who favour short-term investments. Further, intermittent rate jumps can bring huge losses and due to low tradability, the risk remains that the stock will not immediately re-sell: Thereby negating the viability of the stock, decreasing demand, and lowering the price further.

5.1.13 An overview of Porsche's Takeover Strategy There are numerous indicators that Porsche planned to acquire VW from the very beginning. Indeed, Wiedeking and Härter drew up a detailed acquisition strategy and presented it to the Porsche and Piëch families (including Ferdinand Piëch). The strategy proposed that Porsche would acquire VW shares primarily through option transactions. Five advantages of the acquisition strategy: •

Porsche knew, based on the exercise price of the options, how much to pay for each common share and thus was able to effectively manage costs.

•

Call options do not require a purchase. If VW stocks are available more cheaply on the market, Porsche can let the options lapse.

•

Until the beginning of 2007, it was not necessary to report call options with redemptive rights to the German Federal Financial Supervisory Authority (BaFin) even if the investor's holdings met or exceeded the registration threshold.

•

Even after 2007, it was not necessary to report to the BaFin if the investor owned sufficient shares to meet or exceed the registration threshold.

•

Up to the time the options were exercised, the number of VW shares accessible by Porsche remained unknown.

The acquisition strategy was divided into four phases: Phase 1

VW stake is below 20%

Phase 2

Edging toward the 30% mark

Porsche and VW: A Case That Makes History

108

Phase

3

Exceeding the 30% mark, and the creation of Porsch SE as a holding company

Phase 4

Approaching the 75% mark

• In the course of year 2009 the stake should be built to 75%

• Januar 2009: Porsche acquires majority stake of VW

φ

(Λ

ra • Oktober 2008: Porsche holds 42.6% in VW • Additionally options exist for further 31.5%

• September 2008: Porsche raises stake to 35.14% " Board of directors has already permitted majority stake m Φ i/1 ra .c Q.

• March 2007: Porsche increases to 30.9% by exercising options • Mandatory offer to VW stock holders is limited to minimum price set by law • November 2007: Porsche Automobile Holding SE Is registered in the company register

Η

• November 2006: Porsche increases to 27.4% by exercising options • Board of directors permits development to 29.9%

• 25.09.2005: Porsche declares the entry In VW • A little later the shares are raised to 18.5%; the company has options on further 3.4%

• Before 25.09.2005 Porsche had already secured 5% of the VW common shares through option dealing and evaded the notification threshold

Figure 56: Development of Porsche's VW share quotes from media publications Source: Author's own proposal

Figure 56 depicts the phases of Porsche's stake in VW, based on share quotes published in the media and in Porsche press releases. Next, the individual phases of Porsche's involvement in VW are explored in detail.

93

The figures are based, among other things, on the following sources: Porsche-se.com (2008), Porsche increases its VW share to 35.14%; Porsche-se.com (2008), Porsche supervisory board gives the green light for majority stake in VW; Porsche-se.com (2008), Porsche aims for control contract; Porsche-se.com (2009), share in Volkswagen increased to above 50%.

Porsche's takeover attempt and financial strategy

109

5.1.13.1 Phase 1: VW Share under 20% When it entered into VW in September 2005, Porsche laid the foundation for its subsequent takeover attempt. Wiedeking called the engagement a strategic investment, which would secure the existing cooperation agreement and Porsche's independence. What the manager neglected to say then was that Porsche planned to gain enough influence to take part in the restructuring of VW. Wiedeking, who brought Porsche great success, seemed like the right man for the job: but to see this vision to fruition, he needed more power. From the very beginning, while Wiedeking and Härter were purchasing VW shares, they stuck to option transactions thereby circumventing the statutory 5%, 10% and 15% registration thresholds. When the VW share was declared, Porsche already had 5% of the shares. Next, it increased its holdings to 18.5%. Neither the 5% plus nor the increase to 18.5% resulted in a registration obligation. Therefore, the assumption is that Porsche's minority share was achieved through either cash-settled call options or call options with redemptive rights: This, because until January 2007, ownership of call options with redemptive rights did not need to be declared, even if the owner exceeded one of the abovementioned registration thresholds. To clear up any suspicion, it can be assumed that Härter completed his option transactions through multiple banks. All financial institutions held VW shares for short-term securities and remained under the then-legal registration threshold of 5%. After exercising their call options, the banks sold their VW shares and, thereby, Porsche increased its holding to 18.5%, without a previously issued notice of vote. As shown in figure 45, Porsche had options for an additional 3.4% of the shares.

5.1.13.2 Phase 2: Edging toward the 30% mark Coinciding with the announcement of its 18.5% minority share, Porsche announced that the scope of its engagement with VW would not, in any case, come to require issuance of a mandatory offer to the other shareholders: Fifteen months later, that very thing happened. To accomplish this, Porsche did not buy VW shares directly: Instead, it (again) acted through its options. This way, Porsche effectively "sneaked" its way to the 30% mark within one year. The initial 8.5% share was increased to 21 % plus, and in November 2006, the company exercised VW common stock options at around 4%, with holdings totalling more than 25%. Two days later Porsche's share increased to 27.4%.

110

Porsche and VW: A Case That Makes History

5.1.13.3 Phase 3: Crossing the 30% Hurdle and making Porsche Automobile Holding SE a holding company In March 2007, Porsche exercised another option and exceeded the 30% by 9%. The subsequent mandatory offer for the remaining 69.1% of VW common stock and preference shares was restricted to the statutory minimum price. Some market participants interpreted the low mandatory offer as proof of an actual lack of interest by Porsche in the prospect of acquiring VW: When in reality, this step allowed the concern to secretly own a majority share in VW. This is because, by law, an official takeover offer may only be given only once. Therefore, Porsche could now proceed to the next registration threshold: 50%. Further indication that Porsche planned to takeover VW was the conversion of Porsche AG into a Società Europea (SE), an issue decided on by the shareholders at the end of June 2007, and entered into the trade register five months later. The holding company's creation provided for a quick integration of VW into Porsche. Moreover, the reorganization of the co-determination agreement further reduced the influence of VW's leadership and the influence of its employer representatives.

5.1.13.4 Phase 4: Approaching the 75% mark After it submitted the mandatory offer for VW's remaining shares, Porsche refuted reports that speculated an increase in its holdings to 75%. Behind the scenes, however, Porsche acquired more and more VW shares through option business. And in March 2008, one year after it submitted the mandatory offer, Porsche openly stated that it was seeking a majority stake in VW.94 In September of the same year, it increased its VW share to 35.14%.95 One month later, a press release declared that the company held 42.6% of voting shares, plus 31.5% cash-settled call options; bringing Porsche's share in VW to 74.1%. Moreover, Porsche announced that it wanted to increase its share to above 75% in 2009 and planned to enter into a Co-Determination and Profit/ Loss Transfer Agreement.96 For this to be the case, Porsche would have to dip into VW's liquid funds to cover acquisition costs. Härter succeeded once again in bypassing a registration threshold: Because cash-settled options contain no redemptive right of the share, but are instead based on cash payment, Porsche did not have to make a press release, even though the scope of the call options exceeded the 50% registration threshold.

94

Refer to Porsche-se.com (2008), Porsche supervisory board gives green light for majority stake in VW

95

Refer to Porsche-se.com (2008), Porsche increases its VW share to 35.14%

96

Refer to Porsche-se.com (2008), Porsche aims at control contract

Porsche's takeover attempt and financial strategy

111

Again, Härter and Wiedeking spread their business among various banks, which were in turn responsible for paying the difference between the strike price and actual market value, when exercising call options. The banks had VW shares for exchange cover. They disposed of these shares in the exchange after the call options were implemented, to cover the losses from the equalisation payments. Porsche, again, offered itself as buyer, in order to acquire 75% of the VW common stock in one move.

5.2 Porsche's Financing Strategy Porsche's financing and acquisition strategies were similarly structured. Many analysts posed the question: How could a company the size of Porsche even think of taking over VW? Indeed, immense financial resources were required to execute such a transaction, while continuing operative business as usual; and Porsche has made necessary provisions in the years since its entry. The acquisition of VW was financially sustained with and by: 1

Liquidity from operating business

2

Instating one Eurobond and two hybrid bonds, and increasing the subscribed capital

3

Borrowing from a syndicate of international banks

4 Profits from option transactions

5.2.1 Status quo 2005: Liquidity from the Operative Business Prior to 2005, Porsche was continuously profitable and liquid. Management succeeded in increasing its liquid assets and profits from short-term securities on an annual basis. Figure 57 shows the constant rise of the cumulative item "Ready funds and stocks" from current assets, 2003 to 2005.

112

Porsche and VW: A Case That Makes History

Figure 57: " C a s h a n d cash e q u i v a l e n t " a s w e l l as " m a r k e t a b l e securities" 2003 - 2005 (in b n Euro) Source: Porsche business report 2003/2004, p. 102. Porsche business report 2004/2005, p. 104

Figure 58 shows Porsche's liquidity at the end of business 2005. The company was capable of settling its short-term obligations of 1.78 billion euro almost entirely with its 1.75 billion euro cash reserve. Therefore, the Liquidity 1st Grade is almost 1.

Current Ratio 0.98

3.65

3.97

Figure 58: Porsche's liquidity b a s e d o n the financial year 2004/2005 Source: Porsche business report 2004/2005, S. 104, 140, 142

The current ratio shows that one quarter of Porsche's then-current assets was enough to cover its short-term obligations. Moreover, its 3.77 billion euro debt load was sufficiently covered by the positions "cash", "marketable securities", and "trade receivables", which added up to 3.87 billion euro: Porsche was de facto completely debt-free.

; f g

• 1

OIROI (1)

18.55%

1.82%

Net Profit Margin

11.85%

0.80%

Return on Equity

22.78%

2.99%

Equity Ratio

35.22%

18.87%

Figure 59: Ratio comparison, Porsche 2004/2005 a n d V W 2004 Source: Porsche business report 2004/2005, S. 102, 104. VW business report 2004, pp.40 - 41

Porsche's takeover attempt and financial strategy

113

Figure 59 shows that Porsche is profitable. For the purpose of comparison, key VW figures have been included. Please note: Porsche offsets its financial year by six months, so the business year concludes at the end of July. At the end of the 2005 business year, Porsche was decidedly more profitable than VW. To be sure, there are two ratios indicative of profitability, and both should be closely evaluated: The return on equity capital and the Net Profit Margin. Porsche's 23% return on equity (compared to VW's 2.99%) is an excellent result. In fact, much of the competition was far behind Porsche in this category. For example: Daimler-Chrysler with 7.35%" and BMW with 12.68%.98 Porsche's Net Profit Margin was also above-average at 11.85%, with an outstanding cost structure. Here again, Porsche outperformed the other manufacturers. While BMW booked a 5 cent per euro profit margin" and Daimler-Chrysler 1.74%100, VW's performance lagged at 0.8%. Porsche generated a 12 cent per euro profit, after expenditures were subtracted; while VW failed to generate even 1 cent. Acquiring 18.5% of VW shares, plus 3.4% of its call options cost Porsche approximately 3.3 billion euro. And since after subtracting supplies and short-term obligations around 4.7 billion euro in cash was still available, the shares were financed with operating liquidity.101

5.2.2 Instating a Eurobond, Two Hybrid Bonds and Increasing the Subscribed Capital To understand why the hybrid bond was selected as the financing instrument for Porsche's acquisition attempt, it is necessary to first sketch its core highlighting its advantages and disadvantages. A hybrid bond is also called an "eternal bond" or "perpetual bond" and its features are very similar to a stock. Listed below are the main features of the hybrid bond: 102

97

Refer to DaimlerChrysler business report 2004, p. 100, 102

98

Refer to BMW business report 2004, p. 51, 53

99

Refer to BMW business report 2004, p. 51

100 Refer to DaimlerChrysler business report 2004, p. 100 101 Refer to Porsche business report 2004/2005, p. 4 102 Refer to Häcker (2009), The hybrid bond as asset instrument and financing instrument, p. 7

Porsche and VW: A Case That Makes History

114

•

No restriction period

•

Returns above-average interest

•

Issuer has an advance termination right (after approximately 7 - 1 0 years)

•

The amount and regularity of the interest payments vary depending on company performance

•

Second-tier

Hybrid bonds are considered to be Mezzanines in that they combine the advantages of equity capital financing and outside capital financing. While the financial resources gained from issuing these bonds counts as equity capital, the resulting interest earnings are relegated in the form of tax-deductible pre-emptive expenditures as outside capital.103 Per the IFRS, the following conditions must be fulfilled in order for a hybrid bond to be credited as equity capital:104 •

No termination rights for investors (repayment time of the bonds is issuer dependent)

•

No enforceable obligation for regular interest payments (creditors cannot demand interest payments)

•

Second-tier (in the event of the issuer's insolvency, the claims of the hybrid bond owner are fulfilled only after all other creditor's claims are fulfilled)

•

Durability and/or sustainability of the committed capital (no fixed duration)

The use of hybrid bonds is advantageous for a number of reasons; for example, the release of fresh capital for investments. But in contrast to the increase in capital, there is no dilution of the shares, because there are no additional shareholders. Furthermore, the interest payments minimize the taxable profit. Apart from investments, hybrid bonds are also used to increase the equity capital quote, with the goal of improving the company rating.

103 Refer to Hacker (2009), The hybrid bond as asset instrument and financing instrument, p. 18 104 Refer to Häcker (2009), The hybrid bond as asset instrument and financing instrument, p. 20

115

Porsche's takeover attempt and financial strategy

Porsche issued a Eurobond and a hybrid bond at the beginning of 2006 in the capital market. A second hybrid bond was issued in December 2007. 105 The Eurobond amounted to around two billion Euro, and was divided into two tranches (refer to Fig. 60).

V o l u m e in € mn. 1

1,000

2

900

Period 5 years

Jan. 2011

3.5% p.a.

10 years

Jan.2016

3.875% p.a.

Figure 60: Overview of Porsche's Eurobond, split into t w o tranches Source: Porsche business report 2005/2006, p. 145

Figure 61 shows the main features of the hybrid bonds issued by Porsche.

Hybrid b o n d

V o l u m e in mn.

1

1,000 $

7.2%

January 2006

2

1,000 €

6.25%

December 2007

I Nominal interest

Issued

Figure 61: Porsche's hybrid bonds Source: Porsche SE business report 200712008, p. 163

The purpose of issuing the Eurobond and the first hybrid bond When the Eurobond and the first hybrid bond were issued (denominated in USD), Porsche commanded a 2.7 billion euro inflow of cash, four months after its engagement with VW. The purposes of the issuance were: to partially cover share costs and, related to that, to bolster liquidity. Because the US hybrid bond was balanced on the equity side, it strengthened the capital basis. Further, it met USD currency safeguarding requirements. In fact, the equity ratio for the end of the 2005/2006 showed an increase from 35.2% to 36.8%; 106 which impressed that Porsche wanted to improve its credit rating, in order to appear favorably in the internal ratings systems of banks. It is probable that a significant amount of fresh capital was used to conclude VW common stock option transactions in order to meet the 30% mark: Comprising the "other operational profits" and "other operational spending" categories of the 2005/2006 business report, which is essentially based on option transactions.107

105 Refer to Porsche-se.com (2007), Porsche SE successfiilly instates one billion Euro

106

Refer to Porsche business report 2005/2006, p. 26

107 Refer to Porsche business report 2005/2006, p. 123, 124

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Porsche and VW: A Case That Makes History

In early 2007, Porsche then took a loan. The company had owned more than 30% in VW. To prepare it to issue the mandatory offer to the other VW shareholders, a syndicate of international banks extended a 35 billion euro credit line to Porsche; but as the acceptance rate was very low, the company failed to folly utilize its credit limit, which resulted in the credit line reduction to 10 billion euro.

The purpose of issuing the second hybrid bond and increasing the subscribed capital In December of the same year, Porsche issued a second hybrid bond of one billion euro. Only a month later, at January 25th 2008, Porsche decided to increase the subscribed capital by 129.5 million euro to 175 million euro. The financial resources were provided by redeployment of retained earnings.108 Additionally, at the AGM the board was given the authority to raise the subscribed capital by another 22.75 million euro by the beginning of 2012, by issuing common or preferential stock. 109 Issuance of the second hybrid bond and the subscribed capital increase again served to strengthen the equity base. According to § 272 HGB, the shareholders are liable with the subscribed capital for the company's liabilities against third parties.110 This increase and Porsche's available securities increased in direct proportion. Once again, it appeared that Porsche was preparing to take out a loan, by improving its balance sheet, to ensure favourable credit conditions: In February 2008, this proved accurate.

5.2.3 Loan from an International Bank Syndicate In February 2008, Porsche completely exhausted its ten billion euro loan, taken out in early 2007.111 The syndicate finally included 15 banks (earlier 30 banks) and was headed by the financial institution Barclays. The credit line, granted with very favourable terms, was originally earmarked to cover the payment from the original mandatory offer for the remaining VW shares. The ten billion euro mostly involved short-term obligations.

108 Refer to Porsche business report 2007/2008, p. 162 109 Refer to Porsche business report 2007/2008, p. 162 110 Refer to HGB § 272 111 Refer to Porsche-se.com (2008), Porsche SE used up a credit limit of 10 billion Euro

117

Porsche's takeover attempt and financial strategy

Year

2007

2008

Difference

Short-term obligations 000's €

2,195,604

12,116,257

9,920,653

Long-term obligations 000's €

42,790

59,214

16,424

Figure 62: Increase in Porsche's liabilities t o b a n k s Source: Porsche business report 200712008, p. 169

Figure 62 demonstrates the quick rise of Porsche's short-term liabilities to credit institutes over a one year period. The required interest payments varied between 0.75% - 7.50% and corresponded with a 1.98% increase from the previous year.112 But Porsche did not use the funds to purchase additional VW shares. Instead, they were used to turn a profit: conceivably, in large part, to invest in cash-settled call options on VW stocks. Insight into the complicated option strategy that Porsche adopted for its VW takeover is offered below.

5.3 Porsche's Option Strategy Because of the option transactions, VW and the other market participants were unable to ascertain how many shares Porsche had access to. Through its option strategy, Porsche pursued its short-term and long-term goals. In the short term, the option transactions would generate enough capital to ensure the purchase of VW stock at a fixed price in the long term. The option strategy is populated by three components: •

A call option on VW common stock with cash settlement

•

A call option with pre-emptive right to VW common stock

•

A call option for VW shares

The company acquired two call options for VW common stock, each with a different strike price and exercise date: In fact, even the exercise type varied. While one option consisted of a cash settlement, the other one guaranteed preferential rights to VW common stock. Additionally, it sold an option which granted its contract partners the right to sell VW stocks to them at a fixed price and/or initiate cash settlements.

1 1 2 Refer to Porsche business report 2007/2008, p. 170

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Porsche and VW: A Case That Makes History

While the contract partners were able to limit their potential losses, the options were not only extremely profitable they also posed a high risk for Porsche. For the purpose of comprehensibility, Porsche's strategy is analyzed from two different perspectives: First, the banks', and second, the contract partners'. After that, Porsche's perspective is discussed. Finally, the effects of the option strategy on other market participants is explained, by taking a look at the consequences of the explosion of VW share prices in October 2008. To express the infallibility of this explanation of Porsche's strategy, each step is accompanied by a numerical example. The use of fictional numbers was unavoidable, because Porsche has yet to openly declare its financial figures. However, the values selected here are based on estimates by renowned banks and are therefore realistic. As an introduction to the topic, an overview of the functional terms of the option trade is given below.

5.3.1 Technical Terms of the Option Trade To understand the option trade, it is essential to also understand the technical terms of the option trade. See Figure 63, below, for a chart of the most important terms and their meaning. To clarify the term "stock option" was used in the analysis of Porsche's takeover attempt. Apart from Call options, there is any number of different option types, with different base values.

Call Option

Gives its owner the right, but not the obligation, to buy a stock at a defined time for a defined price

Put Option

Gives its owner the right, but not the obligation, to sell a stock at a defined time for a defined price

Base price (exercise price)

Defined price for which the stock can be bought or sold

Go long

Buy Call or Put

Go short

Sell Call or Put

Cash-settled

Payment of the difference between the base price and the market rate

Delivery

Stock is handed over against money

Figure 63: Basic option terms of technique Source: Bloss/Ernst/Häcker (2008)

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Porsche's takeover attempt and financial strategy

Depending on the ratio between strike price and price of underlying of the base value, a call option (Call) is either "in the money", "at the money", or "out of the money". •

in the money:

Strike price < Price of underlying

0,5 < δ < 1

•

at the money:

Strike price = Price of underlying

δ = 0,5

•

out of the money:

Strike price > Price of underlying

0,5 > 5 ^ 0

For a sale option (Put), the inverse is true. Delta (δ) is a dynamic indicator, sensitive to rate changes of the base value (here: VW stock). For options, it lies between 0 and 1 and makes a statement about exercise probability. If an option is exactly at the money, the exercise probability is 50% (δ = 0.5). The further an option lies out of the money, the nearer δ is to 0, because the exercise probability is reduced. Accordingly, a δ close to 1 indicates that the option has a high exercise probability, and so, is deep in the money.

5.3.2 The Banks' Position In the option business, the banks took the position of writing calls (Short Call) and received fixed premium payments. The profit was limited to the premiums received, but the loss potential was unrestricted, independent of whether the options were stock or cashsettled. Two different call contracts were made with Porsche: Short

Call 1

Call option with immediate exercising and high premium based on handing over stock

Short Call 2

Call option with later exercising, meaning higher strike price and lower premium, with a fixed cash settlement

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Porsche and VW: A Case That Makes History

Profit

Figure 64: Pay-off Diagram: Short Call Position of the banks

Source: Author's own proposal

Figure 64 represents the Pay-off Diagram of the banks that sold two calls to Porsche. As soon as the base value (VW stock) exceeded the base fixed price, the banks' profits started to sink. However, if the market price of the base value was at or below the strike price, the call would have been worthless and the banks would have pocketed the premium. HYPOTHETICAL EXAMPLE 1. The banks gave Porsche a call option with a strike price of 70 euro and a payable premium of 15 euro. The option can be exercised immediately. •• Short

Calli

2. The banks gave another call option with a later exercise date. The strike price is 130 euro and the premium is 10 euro. •• Short Call 2 3. The VW stock is at 85 euro. •• On the exercise date of Short Call 1 4. On the exercise date of the second call, the VW shares listed at 100 euro. 5. On the exercise date of the second call, the VW shares listed at 130 euro. 6. On the exercise date of the second call, the VW shares listed at 250 euro.

Porsche's takeover attempt and financial strategy

121

In Figures 65 and 66, the profit or loss that the banks have generated through calls, (at their respective stock prices) is shown.

Position

Share Price

Short Call 1

Premium

Profit/ Loss

3

85 €

-15 €

15 €

0 €

Premium

Profit/Loss

Figure 65: Short Call 1, Position of the banks Source: Own

illustration

Short Call 2

Position

Share Price

4

100 €

0 €

10 €

10 €

5

130 €

0€

10 €

10 €

6

250 €

10 €

-110 €

-120 €

Figure 66: Short Call 2, Position of the banks Source: Own

illustration

Figures 65 and 66 emphasize the above statements about the direct relationship between the banks' reduced profit and increasing stock prices and the resulting losses: The profit remained constant as long as the stock rate was equal to or less than the strike price. Since Short Call 1 was exercised so shortly after it was made, we will concentrate on Short Call 2, below.

EXAMPLE On the exercise date of the 130-base call, VW stock listed at 250 euro. The call was deep in the money and the Short owed 120 euro (difference between current price and strike price) to the Long. When the stock changed hands, the Short bought it at market price, under current market conditions, and sold it to the long for 130 euro. The premium only partially compensated for the loss (110 euro, in both cases).

Porsche and VW: A Case That Makes History

122

• M o n e y In Money Out

(Base price

-250 €

& Premium)

Balance m

β

_110€

130 € * 10 €

Figure 67: B a n k l o s s a t a stock price o f 250 e u r o Source: Author's own proposal

Figure 67 illustrates the banks' inflow and outflow of cash from the given example, and calculates the balance (profit or loss of the transaction). To safeguard against the risk of loss, the banks deposited the calls that were sold with VW shares, which were purchased on the market. The number of shares likely corresponded with the number of concluded call options with a 130 euro strike price. Accordingly, an option strategy called Covered Call Writing was used.

Profit

/ Stock

/

Covered Call

Short Call 2

base value

Figure 68: P a y - o f f D i a g r a m : C o v e r e d Call W r i t i n g o f t h e b a n k s Source: Author's own proposal

Figure 68 shows the banks' Pay-off Diagram of a Covered Call. The banks' purchase of VW stock was below the strike price of the 130-base calls sold to Porsche. If the stock prices increased, the banks would acquire rate profits, which would prevent rate losses in the event of falling stock prices.

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Porsche's takeover attempt and financial strategy

FICTIONAL

EXAMPLE

1. Bank sells a call option with a strike price of 130 euro and a 10 euro premium to Porsche.

•• Short Call 2 2. Bank purchases a VW share at the current price of 85 euro. 3. On the exercise date, the VW share lists at 100 euro. 4. On the exercise date, the VW share lists at 130 euro. 5. On the exercise date, the VW share lists at 250 euro.

Position

Share Price

Premium

Profit/Loss

2

100 €

15 €

0€

10 €

25 €

3

130 €

45 €

0 €

10 €

55 €

4

250 €

165 €

-120 €

10 €

55 €

Price gain

Short Call 2

Figure 69: Covered Call Writing, Banks' Position

Source: Author's own proposal

In the event of a Covered Call, the gains compensate for the difference in payout of the Long Call (see item 4, Figure 69). Because Short Call 2 was based on cash settlement, the banks must pay Porsche 120 euro (difference between current price of underlying and strike price). Then, Porsche sells the share at the current price (250 euro); this covers the expense of the equalization payment. The balance of case inflow and outflow is 130 euro. After subtracting the sale price (85 euro) and adding the premium (10 euro), the banks' profit is 55 euro. If in Short Call 2, stock was delivered instead, the banks would have had to sell Porsche the shares for 130 euro. If the stocks were unavailable, losses of 120 Euro would have been generated; a result of the purchase (applicable market conditions = 250 euro) and then sale (at the fixed strike price =130 euro) of the share. However, since the stock was purchased at an earlier date and a lower price, the banks managed to turn a profit. In item 4 of Figure 69, the gains amounted to 165 euro, because the banks paid 85 Euro per VW share. Considering the agreed upon strike price, the banks made 130 euro off of Porsche. Their profit shrunk from 165 euro to 45 euro, resulting in a net profit of 55 euro, because the premium was added.

124

Porsche and VW: A Case That Makes History

A Money Out .35 €

Money In (Base price & Premium)

— ••••

Balance 55

€

130 € + 10 €

Figure 70: Maximum profit of the banks assuming Short Call 2 was in the money

Source: Author's own

proposal

Figure 70 sets out the income and expenses that would result if Short Call 2 was in the money, and the banks secured VW stocks. The writer's maximum profit consists of the premium and the gains. This is determined by subtracting the original purchase price of the stock (here: 85 euro) from the strike price (here: 130 euro). Even if the current stock price is greater than the strike price, the rate profits do not increase, because the shares must be sold at the strike price of the Long Call; otherwise, a cash settlement must take place. If the share price falls below the original purchase price, losses will occur. The Call then expires, because: •

Current price < purchase price < strike price

Maximum loss occurs when the share price is at 0 euro, and results from the following calculation:

. , °feS Stock rate

_ _ _

Purchase price of the stock 85 €

0 €

Premium 10 €

h m ••••

Balance -ic ^ "75 €

Figure 71: Maximum loss of banks at a share price of 0 Euro

Source: Author's own

proposal

Figure 71 shows the maximum loss of the banks, based on an 85 euro share price. If the price falls to 0 euro, losses may amount to 85 euro, but are partially covered by the premium. To absorb losses, the banks acquired Puts on the VW shares, and agreed upon a cash settlement. Porsche wrote the Put contracts. Therein, the number of Puts corresponded with the number of VW shares purchased and accordingly, the number of call options sold

125

Porsche's takeover attempt and financial strategy

to Porsche with a strike price of 130 euro. The strike price of the Long Puts was markedly greater than the 130 euro strike price of the Short Calls. Therefore, the premium that the banks had to pay Porsche was greater than the premium recovered through the Short Calls. As long as the VW share price remained greater than the strike price of the Put, the banks let it fall: But as soon as the share price fell below the strike price of the Put, they cashed in, and were paid the difference. This way, the Long Put guaranteed the banks a minimum price per VW share that was greater than the price they paid for the Covered Call: Thus, it functioned as a Protective Put.

Profit

Stock y

> Price of base value

Figure 72: Pay-off Diagram: Covered Call Writing combined with Protective Put

Source: Author's own proposal

Figure 72 demonstrates the Covered Call in combination with the Protective Put. FICTIONAL EXAMPLE 1. Bank sells a Call Option with a strike price of 130 euro and a premium of 10 euro, owed to Porsche.

» Short Call 2

Porsche and VW: A Case That Makes History

126

2. Bank purchases a VW share at the current market price of 85 euro. 3. Bank purchases a Put Option with a strike price of200 euro and an owed premium of 15 euro. The Put Option is cash-settled, and has the same exercise date as Short Call 2. On the exercise date, the VW share lists at 70 euro. 4. On the exercise date, the VW-share lists at 100 Euro. 5. On the exercise date, the VW-share lists at 130 Euro. 6. On the exercise date, the VW-share lists at 160 Euro. 7. On the exercise date, the VW-share lists at 250 Euro.

Position

Share Price

Price loss

Short Call 130

Long Put 200

Cum. Premium

H nU ·

3

70 €

0€

-15 €

0€

130 €

-5 €

4

100 €

15 €

0 €

0€

100 €

-5 €

110 €

5

130 €

45 €

0€

0 €

70 €

-5 €

110 €

6

160 €

75 €

0 €

-30 €

40 €

-5 €

80 €

7

250 €

165 €

0 €

-120 €

0 €

-5 €

40 €

110 €

Figure 73: Covered Call Writing Combined with Protective Put, Position of the Bank Source: Proprietary

presentation

Figure 73, above, suggests that the Protective Put consumed premium, but protected the banks from any fluctuation in price. The premium payments were settled, and the banks owed Porsche another 5 euro per Put. The banks' gain varied between 40 and 110 euro, per the listed base value. The losses were amortized through cash compensation payments on the Long Put. As long as the share price remained above 85 euro and below 200 euro, the Covered Call and the Protective Put generated gains. EXAMPLE Share price stands at 140 euro.

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Porsche's takeover attempt and financial strategy

Money Out (Share price & premium for „ .. Long Put)

»

-85 € + (-15 €)

Money In (Base pnce & premium)

130€ + 10€

Money In Long Put (Baseprice, , . . current snare price)

™

_ , B ?^nCe 100 €

200€-140€

Figure 74: Gain of the banks, if share price is 140 euro

Source: Proprietary

presentation

Figure 74 indicates the cash inflow from the Covered Call and the Protective Put. The banks paid 85 euro for a VW share and incurred significant gains of 45 euro, at a price of 140 euro, because the basic price of the Short Call amounted to 2.130 euro. 60 euro (strike price minus current market price) were owed from the cash settled Put Contract. After the deduction of the premium, a 100 euro gain remained.

5.3.3 Porsche's Position Once again, it must be emphasized that, unlike share purchases, options dealings by companies do not register with BaFin and accordingly are not made public. Because of this stipulation, investors may inconspicuously purchase a large numbers of shares. In all probability, at the time of its entry into the concern, Porsche held various call options on VW shares (underlying) with a contractually determined strike price, divided into two types:

TYPE 1 Call Options, which were designed for the delivery of shares, with a strike price that was in line with the share's current market price.

» Long Call 1 TYPE 2 Highly speculative Call Options, which were designed for cash compensation, with a strike price that significantly exceeded the share's current market price.

» Long Call 2 Both option types correspond with Short Call 1 and Short Call 2. The determined exercise date for the Highly Speculative Long Call 2 occurred later than did Long Call 1. Additionally, Porsche was responsible for paying the premium for each call. Long Call 2's premium was less costly than Long Call 1 's, because the latter was in the money (or close to it), and the former was out of the money. Thus, Long Call 1 indicated a greater δ because its exercise probability was greater than that of Long Call 2.

128

Porsche and VW: A Case That Makes History

It is evident now that a significantly lower premium is required for an option with low exercise probability than is required for an option possessing a higher exercise probability.

Profit

Figure 75: Pay-off D i a g r a m : L o n g Call Position of Porsche Source: Proprietary presentation

Figure 75 illustrated Porsche's Long Call Position. When the market price VW base value stock exceeded the determined price, profits increased. At the point when the share price equaled the combined determined strike price and premium, Porsche achieved break-even status. The loss potential is limited to the premium. Aware that Porsche's announcement of entry into VW would increase VW's share price over time, Wiedeking and Härter executed their Call options, which were designed for the delivery of the security paper (Long Call 1). VW share price increased, and on Long Call 2's exercise date, the market price exceeded the strike price significantly. Porsche then executed its cash-settled options and pocketed the difference, resulting in huge revenues. The entries from hedge strategies experienced considerable growth as well (2510%) since Porsche announced its entry into VW. Figure 76 below confirms this.

Financial y e a r

E a r n i n g s f r o m s h a r e o p t i o n s in 0 0 0 ' s €

2005/2006

767,169

2006/2007

6,926,751

2007/2008

19,256,284

Figure 76: Porsche's e a r n i n g s f r o m o p t i o n s Source: Porsche SE business report 200612007, p. 141. Porsche SE business report 200712008, p. 146

Porsche's takeover attempt and financial strategy

129

With its gains, Porsche invested in additional VW shares and options; and its options dealings led to further procurement of liquidity.

Earnings from share options in 000's €

19,256,284

Expenses from share options in 000's €

12,422,487

Accounting balance in 000's €

6,833,797

Figure 77: Porsche's profits from options 2007/2008 Source: Porsche SE Business report 200712008, p. 146, 147

Figure 77, above, illustrates Porsche's gains from its option dealings during 2007/2008. The 6.8 billion euro balance contributed to Porsche's 8.6 billion euro pre-tax profit and even exceeded its sales revenue. 113

FICTIONAL EXAMPLE

1. Porsche buys a call option with a strike price of 70 euro and a premium of 15 euro. The option can be executed immediately. 2. Porsche buys an additional call option with later exercise date and a strike price of 130 euro. The premium costs 10 euro and the option is cash-settled. 3. The VW share price listed at 85 euro. 4. On the exercise date of the second call, the VW share listed at 100 euro. 5. On the exercise date of the second call, the VW share listed at 130 euro. 6. On the exercise date of the second call, the VW share listed at 250 euro.

Position

Share Price

Long Call 1

Premium

Profit/Loss

3

85 €

15 €

-15 €

0 €

Figure 78: Long Call 1, Porsche's Position Source: Proprietary

presentation

113 Compare to the Porsche SE business report 2007/2008, p. 122

130

Porsche and VW: A Case That Makes History

Position

Share Price

4

100 €

0 €

-10 €

-10 €

5

130 €

0€

-10 €

-10 €

6

250 €

120 €

-10 €

110 €

L o n g Call 2

Premium

Profit/Loss

Figure 79: Long Call 2, Porsche's Position Source: Proprietary presentation

Figures 78 and 79 illustrate Porsche's profit and loss from its Call contracts, with respect to share prices. Since Long Call 1 was exercised immediately after the acquisition, Long Call 2 is the focus here. Since Porsche's management placed emphasis on the rapid increase of VW's share price, they were fine with signing put-contracts with the banks; wherein they acted as the option writer (Short Put). For the banks, these were Protective Puts used to safeguard against the effects of any decrease in VW share price. The number of retained, cash-settled Short Puts equaled the number of calls with a 130 euro strike price. Contingent on the strike price, the Short Puts yielded a higher premium than the accrued premium of Long Call 2. Thus, the due premiums were completely amortized by the due premiums for calls with 130 euro strike price. Porsche financed the premium payments for Calls with a 70 euro strike price from its then current liquid funds. The Short Puts had a strike price of 200 Euro. Porsche was sure that these were deep out of the money at the time of exercising and thus the cash settlement payments would be omitted. The risk for Porsche was that the VW share price fell below. Then Porsche would have to pay the banks the difference to the strike price (200 Euro).

Porsche's takeover attempt and financial strategy

Profit

131

VW-Share

Short Put

> Price of the base value

Figure 80: Pay-off D i a g r a m , L o n g Call 2 a n d S h o r t Put (Porsche's position) Source: Author's own proposal

Above, Figure 80 illustrates the above-discussed Call and Put contracts from Porsche's perspective and is the reflective picture for Figure 72, where the position of the banks is given. It can be seen in the illustration that Porsche was exposed to a high loss potential, when the market share price undershot the strike price of the Short Puts. The maximum loss would occur if the share price hit 0 euro. In that event, the Long Call would lose its value, and be without value and the Put-contract would carry in a settlement payment of 200 Euro for every Short Put.

FICTIONAL EXAMPLE 1. Porsche acquires a cash-settled call option with a 130 euro strike price and a 10 euro premium. 2. Porsche goes short on a put-contract with the banks. The strike price of the put option is 200 euro and the option is cash-settled. The received premium is 15 euro per Put. The Put and the ISO-Call have the same exercise date. 3. On the exercise date, the VW share listed at 100 euro. 4. On the exercise date, the VW share listed at 130 euro. 5. On the exercise date, the VW share listed at 250 euro .

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Porsche and VW: A Case That Makes History

Figure 81 shows Porsche's profit and loss from each option contract and at each respective share price. Once the Short Put is out-of-the-money, Porsches maximum profit is limit-

Position

Share Price

3

100 €

4 5

Long Call 2 130

Short Put 200

Cum. Premium

0€

-100 €

5 €

-95 €

130 €

0 €

-70 €

5 €

-65 €

250 €

120 €

0€

5 €

125 €

Figure 81: Long Call 130 and Short Put 200, Porsche's position

Source: Author's own proposal

Next, three possible scenarios, resulting from Porsche's Option Strategy, are examined. Scenario 1 represents Porsche's expectations, while Scenario 2 represents its "Worst Case". Scenario three represents a more moderate development between the two extremes. EXAMPLES Scenario 1 - The VW share stands at 250 euro Porsche's announcement of its entry into VW resulted in an increased share price (250 euro on the Long Call 2 and Short Put exercise date). The banks pay 120 euro (difference between the strike price and market price of the option) to Porsche. The Short Put is out-of-the-money and loses its value. Porsche uses its profit to cover the stock option and further expansion of its VW shareholding. EXAMPLES Scenario 2 - The VW share stands at 100 euro After the initial increase in value of VW stock, the share price levels out at 100 euro. The financial crisis and the uncertain future of VW law causes a decrease in share price. As a result, Porsche's option strategy fails. Then, Long Call 2 loses its value, because of its out-of-the-money status. Next, the banks exercise their Puts (with a strike price of 200 euro). Accordingly, as the writer of a cash-settled option, Porsche must pay 100 euro per Put: The company loses billions to speculative trading. EXAMPLES Scenario 3 - The VW share stands at 170 euro The VW share value holds at 170 euro in this scenario, because at that price, both the Long Call and the Short Put are in-the-money. Although the banks owe Porsche 40 euro, Porsche owes the banks 30 euro. Accordingly, the payment flow is settled, and Porsche receives its 10 euro.

Porsche's takeover attempt and financial strategy

133

5.3.4 Effects on other market participants Since Porsche's announcement of its entry into VW at the end of2005, the VW share price experienced a constant upswing, and achieved its maximal value of at 1005.01 euro per common share on October 28th, 2008. At end of business that day, it closed at 945 euro. 114 For a moment, VW's market capitalization reached 295 billion euro. VW was the world's most valuable company even out-performing Exxon Mobil.

VW stock price in €

Figure 82: VW common stock price Oct. 23rd, 2008- Oct. 30th 2008 (closing prices)

Sources: Google Finance (2009), Historical

Prices

Figure 82 documents the price explosion of VW securities. Within two business days, the closing price exploded, from 210.85 euro to 945 euro: a 448% increase. Short sellers, who banked on a falling VW share price, were responsible for the price increase. Indeed, their collective expectation was fueled by the financial crisis that ripped through the US and Europe beginning in the Fall of 2008, negatively impacting many automotive manufacturers along its way. Moreover, the share showed steady gains, and according to analysts, was over-rated. And so, short-sellers borrowed VW shares against a cash payment, for a fee, set a return date, and liquidated their stock in the market. In total, short sellers sold approximately 12%- 15% of VW common stock in the exchange. 115

114 See Google Finance (2009), Historical Prices 115 See Welt.de (2008), Porsche is selling a parts of its VW shares again

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Porsche and VW: A Case That Makes History

Two days before the price explosion, Porsche announced that it would retain 42.6% of its VW common stock, and would have access to an additional 31.5%,116 via options; a critical event for short-sellers. Combined with the Lower Saxony's 20% share, 94.1% of the securities were firmly held; and only 5.9% were in free float. For the speculators, a race for the sought after VW common stock began, because they required these to fulfill their contracts with the lenders. Panic purchases ensued, in effect skyrocketing the share price. Short sellers suffered huge losses and were forced to pay a substantially higher price to repurchase their shares than they achieved through the sale of the same. The price increase even dominated the Dax, which rose 240 points on October 28th: 170 of those points were founded in VW stock. To keep the Dax value realistic, the SEC revaluated VW's share in the index, and concluded that it should be reset to 10%. For Porsche, the "Best Case" was fulfilled, and on October 29th it exercised 5% of its cash-settled call options, thereby posting immense profits.

5.4 The Failure of the Takeover Attempt On January 5th 2009, Porsche increased its holding in VW to 50.76%, by purchasing common stock with liquid funds:117 By all indications, Porsche was preparing for quick acquisition of VW. However, in May 2009, the takeover attempt was declared a failure. This, because of an enormous liquidity bottleneck triggered by, among other things, tens of billions of euro that Porsche borrowed in the previous year. In March 2009, Porsche's credit was to run down and Porsche's immediate fear was to seek new financing opportunities. Given that they had accepted higher credit terms, this situation was inevitable. Next, Porsche sought an investor. It was unclear whether or not fresh capital was needed for the planned increase of its stake in VW (to more than 75% holding). VW, meanwhile, began to examine the possibility of acquiring Porsche.

5.4.1 Conditions Surrounding the Refinance Endanger Business Operations Within one year, the world economy changed dramatically. The financial crisis hit Europe, and banks either filed bankruptcy or fought to survive. As a consequence, credit lenders adopted stricter guidelines for issuing credit.

116 See Porsche-se.com (2008), Porsche is trying for a strebt Beherrschungsvertrag an 117 See Porsche-se.com (2009), Shareholding in Volkswagen is moved to over 50%

Porsche's takeover attempt and financial strategy

135

This all occurred just as Porsche's attempt to refinance fell through. In 2009, Porsche announced that it wanted to increase its holding in VW to more than 75%; and to do so, in addition to a credit extension, it required capital totalling 2.5 billion euro. Nine foreign consortium members rejected Porsche immediately: Particularly banks in the US, already under scrutiny for the subprime crisis. In fact, American banks like Merrill Lynch, Citigroup, and J.P Morgan distanced themselves from the international consortium. Finally, the consortium decreased to 15 banks- mainly German financial institutions. Some banks not only granted delayed repayment, but increased the credit offer. Further, new members joined the consortium (the only way to settle the debts of the foreign banks that left the consortium). Listing of the 15 consortium members:118 1

Barclays Capital, syndicate manager (Great Britain)

2

Commerzbank (Germany)

3

LBBW (Germany)

4

Deutsche Bank (Germany)

5

UBS (Switzerland)

6

Credit Suisse (Switzerland)

7

Santander (Spain)

8

Bayern LB (Germany)

9

BNP Paribas (France)

IO Calyon (France) 11

UniCredit/HVB (Italy, Germany)

12

Helaba (Germany)

13

Intesa (Italy)

14 West LB (Germany) 15

DZ Bank (Germany)

118 See Porsche-se.com (2009), Porsche is securing the credit line of over Ten billion Euros

136

Porsche and VW: A Case That Makes History

Porsche was subject to new conditions for its ten billion euro refinance. The sum was divided into two areas: the first of which 3.3 billion euro was subject to full repayment within one year and the second, 6.7 billion euro, was granted an optional credit extension after twelve months. Moreover, the banks were not prepared to offer the additional 2.5 billion euro. However, Porsche was free to seek the sum from new financiers. The interest rates were adjusted, and due to the overall negative economic forecast, were set to EURIBOR + 500 base points. Taking into account processing and preparation fees, an effective interest of approx. 9% was calculated. In addition to poor economic conditions, Porsche's previous stance against the banks negatively affected its credit terms. Moreover, in 2008 Härter did not invest the 10 billion euro, as the banks expected, into the expansion of Porsche's holding in VW; instead, he invested the capital to generate profit. As a result, his investment generated a return, which surpassed the interest payments that were due. This approach did little to improve the company's relationship with the banks. From a sum of ten billion euro with a 9% interest rate, expenditures amounting to 900 million euro were calculated. This amount stressed Porsche's liquidity and endangered operational business.

5.4.2 Creation of an Integrated Group At the beginning of May, Porsches' acquisition plans were rejected. The company then sought to form an integrated automotive group with VW, under which all ten brands would maintain guaranteed independence; though leadership positions and responsibilities of the integrated group were subject to negotiation. While Porsche suffered a liquidity deficit (net debt) of nine billion Euros, VW boasted an 11 billion euro net liquidity. VW offered Porsche cross-ownership, under which Volkswagen AG would own a 49.9% share, worth 4 billion euro, in Porsche AG. Porsche AG would own the remaining 50.1%, Figure 83, below, illustrates the power shift that would result from cross-ownership.

137

Porsche's takeover attempt and financial strategy

50.76%

50.1%

V W AG

Porsche AG

t

49.9%

Figure 83: Integrated Shareholding, Porsche and Volkswagen Sources: Author's own proposal

The formation of this cross-ownership would necessitate the full cooperation of the Porsche and Piëch families; additionally, an unaffiliated investor would join on VW's behalf. Moreover, VW's considerable holding would restrict Porsche and Piëch's decision making power. However, Ferdinand Piëch, already an influential figure in VW, would gain considerably more power. VW representatives presented their offer directly to Porsche's Supervisory Board chairman, Wolfgang Porsche foregoing negotiations with Wendelin Wiedeking. Allegedly, VW offered Porsche an ultimatum which, for the time being, Wolfgang Porsche rejected.

5.4.3 Guarantee from Baden-Württemberg During its hunt for investors, Porsche contacted the federal state of Baden-Württemberg. The Prime Minister, Günther Öttinger, offered the prospect of aid, without concrete measures. One option was a state funded grant, which would offer Porsche sufficient backing to secure additional credit. The topic prompted debate in parliament. While the Christian Democratic Union party (CDU) was non-committal, the German Liberal party (FDP) rejected the possibility of state funding since Porsche was controlled by two families, each with private assets totalling billions of dollars, who were fit guarantors. The FDP preferred state support to be offered to entrepreneurs in need of financial support.

138

Porsche and VW: A Case That Makes History

5.4.4 Credit request in the KfW At the beginning of June 2009, Porsche applied for a 1.75 billion euro loan from the KfW bank group, with its retained VW securities, pledged at 1.7 times the actual value, as collateral. Additionally, Porsche was ready to offer the same conditions to the international consortium of banks. Porsche spokesman Anton Hunger campaigned for the company; underscoring that its years of high tax payments justified its credit claim. The bank's committee was chaired by state political figures that joined the debate about Porsche's eligibility for a loan. In fact, Christian Wulff sat as Lower Saxony's representative on the Consultation Committee. He suggested that Porsche liquidates its VW stock in order to obtain fresh capital. Prime Minister Günther Öttinger and KfW board member Axel Nawrath, on the other hand, spoke out for offering credit to Porsche. Indeed, they suggested that the loan would be a lucrative business move on the part of the banks consortium because, every month, the loan, with little risk, could generate a 6 million euro profit. The final decision rested with the Federal Government's Steering Committee, chaired by four secretaries of state. Under the secretaries were the former federal minister of economics, Karl-Theodor of Guttenberg, and the former federal Minister of Finance, Peer Steinbrück, who refused to extend credit to Porsche. After the bank consortium issued its first rejection (with the possibility for improvementand re-examination), Porsche announced that it would seek alternative credit sources.^

5.4.5 Daimler as a Potential Investor In the Summer of 2009, Daimler was considered as a potential investor in Porsche. Allegedly, Daimler pledged financial support, with the condition that Porsche liquidate to the concern part of the holding company (Porsche SE) or a portion of its VW options. As an investor, Daimler hoped to gain access to VW technology; specifically, a solution to reduce the carbon dioxide output of its entire fleet of models. Accordingly, Volkswagen was already utilizing advanced ecological drive systems and environment technology. Collaboration with VW would have also improved Daimler's small car segment. Indeed, utilization of VW motor technology would have proved economically viable for the development of the A class and Smart model successors. Moreover, synergy potential existed in co-purchasing opportunities. The problem, however, was this: Even with a stake in Porsche, Daimler would need approval for guaranteed access to VW technology. For access to said technology, a control

119 See Porsche-se.com (2009), Porsche is not placing any new credit request with KfW

Porsche's takeover attempt and financial strategy

139

and profit payment contract would have to exist between VW and Porsche, which cannot be realized without the continuance of VW law and its missing components. Industry experts said that the entry of Daimler into Porsche was improbable, because at the time, Daimler was burdened by financial difficulties resulting from the economic crisis. Additionally, the antitrust office would have likely interfered because Daimler was already a market leader in the utility vehicle segment and Volkswagen has a separate utility vehicle segment and significant holding in both Scania and MAN. Through cooperation with VW, Daimler would have attained a controlling market position in that field. In the end, Daimler AG did not invest in Porsche.

5.5

Financial Support from the Qatar State fund

Porsche found an investor in the Qatar state fund - Qatar Holding LLC. The Emir of Qatar offered a verbal promise to Porsche management, the terms of which were flexible: Porsche could either sell Qatar VW securities or a portion of the holding company.

5.5.1 Five Conceivable Scenarios Analysts from the investment bank Kepler Research have analyzed various investment structures of Qatar Holding LLC in Porsche and the effects thereof on Porsche's 9 billion euro net debt. They estimated the book value of Porsche's option package at 6 billion euro (Long calls and Short Puts, VW shares). Their calculations suggested that 4.3 billion euro was a realistic sale price. After tax deductions (tax rate: 30%), Porsche would receive 3 billion euro.120 They estimated a 4.6% interest rate. However, if the price of VW basic stock was less than the price of the Short Puts, option holders would be subject to significant losses, resulting from cash compensation owed to the banks. In the event that the option package failed to generate interest, it would expire without value. Moreover, it would generate neither cost nor profit for Porsche.121

SCENARIO 1 Qatar Holding LLC owns a share in Porsche Automobile Holding SE The supervisory board grants a capital increase of 2.5 billion euro, straight from Qatari state funds, for which it receives 25% of the voting rights in the holding company.

120 See Kepler Research (2009), Two birds with one stone: upgrade to buy, S. 4 121 See.Kepler Research (2009), Two birds with one stone: upgrade to buy, S. 4

Porsche and VW: A Case That Makes History

140

After the gains are taxed (tax rate: 30%), Porsche has an additional 1.75 billion euro available to pay toward its net debt. Thus, the interest-bearing payables will shrink to 7.25 billion euro, freeing the company from interest payments totalling approximately 80 million euro.122 The scenario has two disadvantages for the previous shareholders: First, the pay-out ratio of the new common stock would dilute the voting rights of the Porsche and Piëch families; and second, Qatari Holding LLC would have enough shares for a blocking minority.

SCENARIO 2 Qatar Holding LLC owns a share in Porsche Automobile Holding SE, and buys the option package Porsche's net profit increases to 4.75 billion euro, and is used in its entirety to pay down debt, shrinking interest-bearing obligations to 4.25 billion euro, and saving 218.5 million euro in interest payments.

SCENARIO 3 Qatar Holding LLC buys the option package, and makes a contribution in kind to Porsche Automobile Holding SE After the purchase, Qatari Holding LLC exercises its options, and with approximately 20% holding, it becomes the third largest investor in VW, after Porsche and Lower Saxony. Next, the LLC participates in the holding company buy using the Volkswagen shares as investment in kind. Porsche's holding in VW increases from 51% to 71%. 123 Furthermore, 3 billion euro could be used to decrease debt. Scenario 3 offers little improvement for Porsche. At the conclusion of the Domination and Profit/Loss Transfer Agreement, it would own more than 80% of VW shares. Whether its holding totalled 51 % or 71 % does not change the fact that Lower Saxony's approval is required in the decision making process.

SCENARIO 4 Qatar Holding LLC buys only the option package The Porsche and Piëch families forgo capital gains. Porsche uses its net profits from the 3 billion euro sale of the option package to partially repay its debt. The advantage of this scenario is that no new shareholder enters the holding company.

122 See Kepler Research (2009), Two birds with one stone: upgrade to buy, S. 8 123 See. Kepler Research (2009), Two birds with one stone: upgrade to buy, p. 8

Porsche's takeover attempt and financial strategy

141

SCENARIO 5 Qatar Holding LLC buys only the option package, and the families accept a capital increase The 900 million euro capital increase is added to the 3 billion euro. The families buy all the common voting shares, to avoid any potential financial dilution, bringing Porsche's total capital inflow to 3.9 billion euro. Considering that the two families opposed the sale of company shares (at that time) to a third party to avoid any lessening of their collective power, the implementation of one of the final two scenarios is probable. The best case scenario for Porsche, and the worst case scenario for VW, is number 2. Even though Qatar Holding is a foreign investor, its investment in the concern would allow Porsche to repay a significant portion of its owed debt and generate enormous interest savings. Moreover, the sale of the option package would solve both the liquidity and option risks.124 Thereby, Porsche's negotiation stance during the integration proceedings would improve. In addition, Qatar Holding LLC would own about 20% of VW common stock. If it chose to exercise the option package, according to Kepler Research, it would own a controlling stake.

5.5.2 Qatar Holding LLC takes a share in Porsche and VW On August 14th, 2009, VW's "Worst Case" (scenario 2) seemed to happen. On that day, Porsche SE signed two contracts with the Qatar Holding LLC. 125 1. Contract

The Qatari state funds will take share in Porsche Holding.

2. Contract

The Qatari state funds buys a majority of the VW share options from the company.

The state funds agreed with Porsche that both participate in the holding company and also take over a significant part of the VW options. In connection with the first contract, they bought 10% of the Porsche SE common stocks from the family shareholders. In addition, they took over options on the VW common stocks of 17% and options on VW preference shares of 50% which were also in the possession of Porsche. Furthermore,

124 See Kepler Research (2009), Two birds with one stone: upgrade to buy, p. 1 125 See Porsche-se.com (2009), Qatar is the common stockholder of Porsche

142

Porsche and VW: A Case That Makes History

the investor counteracted the existing syndicated loan of 265 million Euros. Through the sale of a majority of the V W options, Porsche received access to approx. a billion euro, which were deposited with the banks as security for the option deals. The Qatar Holding LLC supported that this shareholding was a strategic and long-term investment. One welcomed the planned fusion between Porsche and V W and wanted to ensure, together with the family companies, that both companies get a successful path. 1 2 6 In addition to striving for an attractive return, the investor has established a valuable partnership with the participation, with which the technological progress of the Qatar emirate will be supported in future. In the middle of December 2009, the Qatar Holding LLC had exercised all bought options on V W common stocks and was third-largest shareholder in V W with 17%. The company was assured a supervisory board mandate for Porsche Automobile Holding SE and two supervisory board mandates for the Volkswagen AG. The fight for takeover was thus ended.

5.6 Why the Takeover Failed Porsche's support of the acquisition of V W hinged on three assumptions, none of which were fulfilled:

1

Constant improvement in terms of profitability and liquidity of business operations

2

The complete abolition of V W law

3

Financial assistance from the banks in the form of credits

ASSUMPTION 1 Through the years, Porsche achieved great success. Its sales, profitability, and liquidity increased continually. Even its entry into V W could not burden its long-term liquidity. In fact, by offering hybrid loans and a Euro loan, it effectively generated new liquid funds. But, at the beginning o f 2 0 0 9 , the global economic crisis negatively impacted Porsche's sales figures, which fell, within one year, by about 26.7% to 34.266 vehicles. 1 2 7

126 See Porsche-se.com (2009), Qatar is the common stockholder of Porsche 127 See Porsche SE half-yearly financial report 2009, S. 4

143

Porsche's takeover attempt and financial strategy

Rest of World

24,897

North America

16,209

4,152

Germany

5,630

0

5,000

15,000

10,000

25,000

20,000

Jan. 09

30,000 Η

Jan. 08

Figure 84: Porsche's car sales decline, comparing the first half of 2007/2008 with the first half of 2008/2009 Sources: Porsche S £ half-year financial statement

2009, p. 5

Figure 84, above, illustrates the impact of the economic crisis, by comparing the sales decline (ranging from 26.3% to 27.2%) of global automotive leaders. In response to dwindling sales figures, Porsche curbed its production. 128 The sales slump manifested itself in turnover, which dropped by 12.78% compared to the previous year, according to the interim financial report in 2009. 129 In spite of that, Porsche succeeded in quadrupling its profit, 130 due to the 6.8 billion euro profit generated through VW option sharing (the pre-tax total is expressed in Figure 85, below).131

Earnings from stock options in mn. €

45,718

Expenses from stock options in mn. €

38,878

Balance in mn. €

6,840

Figure 85: Porsches proceeds from share stock option 1st half-year 2008/2009 Sources: Porsche half-year financial statement

2009, p. 22, 23

128 See Porsche SE half-yearly financial report 2009, S. 5 129 See Porsche SE half-yearly financial report 2009, S. 12 130 See Porsche half-yearly financial report 2009, S. 12 131 See Porsche half-yearly financial report 2009, S. 5

144

Porsche and VW: A Case That Makes History

However, profits from the cash-settled options depended upon an increasing VW share price. Further, in addition to the sales slump, net liquidity decreased by nine billion euro, when Porsche rushed to purchase enough VW stock to increase its holding form 30% to 50%. 132 As it turned out, Porsche was unable to fund the acquisition through its own means.

ASSUMPTION 2 Once the ECJ issued complaint regarding the alleged illegality of certain sections of VW law, Parliament, in November 2008, approved a new version thereof. Accordingly, special delegation rights in the VW Supervisory Board once reserved for representatives from Central and Lower Saxony (§ 4 paragraph 1 VW law) were removed. Further, each shareholder was immediately entitled exercise his full voting rights, which were no longer restricted to 20%, as was stipulated by § 2 paragraph 1 of VW law. However, certain decisions made during general meetings still required approval by an 80% majority. Thus, the controlling stake remained at 20%, and Lower Saxony retained its right to veto. In spite of protests on behalf of Porsche and the EU commission, the federal government adopted the new regulations as law. Further, the ECJ's criticism of the combination of § 4 paragraph 3 with § 2 paragraph 1 was sufficient to abolish § 2 paragraph 1 ; in order to prevent an errant link of the two sections, and thus, to uphold the prescribed judgement. Consequently, Porsche was prevented from signing a domination agreement and a profit transfer agreement. Thereby, the concern was denied access to VW's liquid capital, which could have served to settle debt incurred during the acquisition process. Further, Porsche failed to attain the qualified majority status necessary to legally approve the takeover.

ASSUMPTION 3 Under normal circumstances, the banks would have supplied Porsche with the necessary capital. But the new credit climate following the global economic crisis necessitated new lending standards, which Porsche certainly felt during its 10 billion euro refinance in spring, 2009. Likewise, Porsche's behaviour during the reorganization of its credit terms factored in to the banks' decision making. The concern failed to utilize the credit extended to it in March 2008, to expand its stake in VW, as was originally proposed. Instead, Porsche invested the loan, for a high return effectively generating capital that Porsche would apply to its interest payments. Moreover, Porsche lacked sufficient liquidity (a 9 billion euro deficit, specifically) to maintain its business operations.

132 See Porsche Half-yearly financial report 2009, S. 6

Porsche's takeover attempt and financial strategy

145

Furthermore, Porsche taunted VW for years, via the media, with talk of a potential acquisition, but the banks were well aware of the existing risks. To be clear, Porsche was unable to secure ample funding to pay back its loans, and so, in turn, the banks restricted any further extension of credit to the concern. At the end of 2009, the supervisory boards of both companies began preparations for the acquisition of Porsche by Volkswagen AG. Through 2011, Porsche will be classified as the tenth brand under the VW umbrella. 133

133 See Zeit.de (2009), VW wants to create facts for Porsche takeover

• PART 3 Captive Finance Companies (CFCs): The future instrument of manufacturers

In the second part of this book, Porsche's attempted takeover of VW was presented and discussed chronologically while the focus was placed on the applied financial instruments and strategies utilized during the process. Building on part one of this book, it became apparent that finance will be of particular importance for implementing an OEM's strategic course of action. Without an integrated finance strategy or adoption of new finance products, there will be no strategic corporate transformation possible anymore in the automotive industry. From an organizational point of view, there are two business divisions within an OEM which mainly deal with all issues regarding finance. On the one hand, there is the corporate finance department of an OEM and on the other hand, there is the manufacturer-affiliated financial services provider (also known as Captive Finance Companies or CFCs). The following section puts focus on CFCs as strategic instruments of OEMs. The findings of part 1 and part 2 of this book suggest that OEMs need to realize that their manufacturer-affiliated financial services provider is not only a simple sales promotion tool but also - and most importantly - a strategic financial instrument and thus, needs to be deployed accordingly. Part 3 of this book is concerned with understanding the basis of this specific segment of the financial services industry. Germany's automotive financial services market is considered as one of the most developed ones and thus, will be used representatively for the following analyses. It is also beneficial to these analyses that German CFCs located their global headquarters in their home market while each of their operative units has a banking licence for their respective markets. Moreover, nearly all globally relevant CFCs - also with operative units - are active in the German market. The importance of these three characteristics of Germany's automotive financial services market will be illustrated in later chapters.

148

Captive Finance Companies (CFCs): The future instrument of manufacturers

What is a manufacturer-affiliated financial services provider or a Captive Finance Company? Captive Finance Company (CFC) In the automotive industry a manufacturer-affiliated financial services provider is a business unit which offers original or derivative financial services in the market. 134 The services provided are directly or indirectly related to the vehicle and are commonly offered by companies specialized in this market. As opposed to full-service banks which deliver the entire spectrum of financial products and services, CFCs especially focus on financing and leasing products. 135 Depending on the product portfolio, country-specific requirements or the strategic direction, CFCs operate as leasing or financial services providers, fleet management companies or automotive banks in the respective market. In the subsequent analysis, the term CFCs is used to describe all of the above-mentioned specialized companies. If CFCs intend to offer banking products as well (and most German CFCs do or plan to do) they are subject to the German "Kreditwesengesetz" (German Banking Act) and hence, need a banking licence. Additionally, the term "Bank" must be incorporated into the company name. Consequently, the term "Autobank" (automotive bank) was coined to differentiate this type of business and its scope of operation from other financial services providers in the financial industry. According to corporate law, CFCs are predominantly legally independent subsidiaries or business divisions within the corporate group. 136 The most common legal forms of CFCs are "GmbH" (limited liability company) and "AG" (corporation/public limited company). The German manufacturer-affiliated financial services providers operate globally as BMW Financial Services, Daimler Financial Services and Volkswagen Financial Services. Yet, in their domestic market they operate as BMW Bank GmbH, MercedesBenz Bank AG and Volkswagen Bank GmbH.

134 See Lorenz, J. (2001), p. 29 135 See Kratzer / Kreuzmair (2002), p. 21 136 See Stenner, F. (2010), pp. 1

How is the market for automotive financial services classified?

149

Executive Summary The automotive financial market has evolved into one of the largest sources of profit for automobile manufacturers in the last years. These CFCs have gradually broadened their product portfolio from traditional leasing and financing products over banking services such as deposit banking to mobility-related products and services. In major markets such as the USA, Europe and Japan, the mission of CFCs is primarily to increase vehicle sales and to enhance customer loyalty. In the course of the global economic and financial crisis, CFCs have been increasingly gaining importance as a strategic instrument for manufactures in terms of refunding. Moreover, they are instruments especially indispensable for a manufacturer's business expansion into the emerging markets of India and China where financial infrastructure is largely unavailable.

6

How is the market for automotive financial services classified?

6.1 Manufacturer-affiliated vs. non-manufacturer-affiliated financial services providers In the past years, the market for automotive financial services products has experienced an enormous inflow of market participants owing to its attractive business opportunities. In addition to manufacturer-affiliated financial services providers - which will be examined closely in the following - traditional commercial banks, full-service banks, independent leasing companies and even car rental companies can increasingly be found in this market. The following Figure 86 provides an overview of significant CFCs and non-CFCs in the German automotive financial services market.

Captive Finance Companies (CFCs): The future instrument of manufacturers

150

Captive Finance Companies

Non-Captive Finance Companies Independent financiers

VOLKSWAGEN

GMAC

F I N A N C I A L SERVICES A G

w

Volkswagen Bank

(@)

II

EBV·

BANK

π VR LEASING

5 Leasing

FordBank

Porsche Financial Services BMW Financial Services

TOYOTA

Commercial banks

D A I M LE R Daimler Financial Services

Santander

Deutsche Bank [ Z l COMMERZBANK A

Figure 86: An overview of the significant automotive financial services providers operating in the German market

Sources: Author's own proposal

CFCs - given their proximity to manufacturers - have a competitive edge over non-Captives especially in the area of new vehicle sales. In addition to transferring a positive brand image of the respective manufacturer during the financing discussions at the pointof-sale, it offers advantages in respect to shaping sales conditions. Moreover, CFCs also benefit from the option of cross-financing with OEMs in terms of designing attractive conditions for new vehicle sales and from their edge on information in determining the residual value as well as from offerings such as model-specific conditions for promotional purposes. Accordingly, the network of licensed dealerships is of strategic importance to CFCs. Despite having an enormous variety of available sources of information licensed dealerships are the first contact persons for car purchasers. This circumstance provides CFCs with the opportunity - at this important interface between customers and OEM - to successfully place their leasing and financing products and thus, gaining an edge over non-CFCs.

6.2 Financing OEM brands vs. non-OEM brands (foreign brands) The primary objective of CFCs is to promote sales of the OEM's vehicles by means of its product portfolio of services and financial solutions. By collaborating closely with OEM's brands, CFCs are able to enhance and hence, strengthen customer loyalty to the vehicle brand while supporting private and corporate clients as well as dealerships. Dif-

How is the market for automotive financial services classified?

151

ferences in a CFC's branding can be very well seen on German CFCs operating in their home markets. Volkswagen Financial Services AG operates in the German market with the operative subsidiaries Volkswagen Bank GmbH, Volkswagen Leasing GmbH and Volkswagen Versicherungsdienst GmbH. Through these subsidiaries, VW Financial Services offers customer financing and leasing products as well as insurance and direct banking solutions for its brands Volkswagen, Audi, Seat and Skoda. The financing business for new and used vehicles is conducted through Volkswagen Bank GmbH by its independent brands Volkswagen Bank, Audi Bank, Seat Bank, Skoda Bank and Auto Europa Bank. In contrast, BMW Financial Services delivers its financing, leasing and banking products for all of its three corporate group brands BMW, Mini and Rolls-Royce exclusively through the BMW Bank GmbH for the German market. A differentiated branding is not part of BMW's domestic corporate strategy. The reformation of the "Gruppenfreistellungsverordnung" (Block Exemption Regulation) in 2002 presented new financing challenges for Captives regarding both their OEM's brands and foreign brands. This provision ensures the liberalization of the European automotive market by offering dealers the opportunity to establish their sales and service subsidiaries - independently from OEMs - across Europe. 137 Since then, the number of "mega dealers" has been continuously increasing. In 2007, every seventh car sold in Germany was purchased from this type of car dealer.138 From that time on, CFCs have inevitably been beginning to focus on the issue of financing non-OEM brands. Providing financial services through multi-brand dealerships poses - on the one hand - enormous potential of reaching customers of non-OEM brands. Yet, on the other hand, competing CFCs and non-Captives also consider multi-brand dealers as an attractive target group and thus, serving multi-brand dealerships poses the potential risk of losing parts of customer base to the competition. A clear strategy of German CFCs is to avoid product cannibalization among corporate brands. For this purpose, they have selected - among others - an internet-based market presence with a neutral brand name (BMW Bank with Premium Financial Services, Volkswagen with AutoEuropa Bank and Mercedes-Benz Bank with Creditracer).139

1 3 7 See Diez/Reindl/Brachat (2005), pp. 131 1 3 8 See institute for automobile economy (2008) 1 3 9 See http:/www.premiumfs.de, www.autoeuropabank.de,www.creditracer.de

152

Captive Finance Companies (CFCs): The future instrument of manufacturers

6.3 Integration from a corporate and legal point of view and legal demarcation of CFCs Figure 87 provides a picture of the differences essential to integration and legal demarcation among the three German automotive manufacturers: Volkswagen AG, Daimler AG and BMW AG. An examination of the status quo of integration and legal demarcation of CFCs is relevant to the issues of setting up bank branches and internationalization which will be discussed in later chapters.

Volkswagen Financial Services AG

Volkswagen Bank GmbH

Daimler Financial Services AG

Automobile

Volkswagen Leasing GmbH

BMW Bank GmbH

MercedesBenz Bank AG

BMW Leasing GmbH

Alphabet Fuhrpark Management GmbH

100%

BMW Vertriebs GmbH

98%

BMW Vertriebs GmbH & Co. OHG

I 2%

MercedesBenz Leasing GmbH

MercedesBenz Banking Services GmbH

Figure 87: Corporate group structure of Volkswagen AG, Daimler AG and BMW AG

Source: Author's

own proposal,

status

2008

Volkswagen and Daimler combine their respective global business and financial services business units through legally independent subsidiaries. Daimler Financial Services AG and VW Financial Services AG operate as separate legal entities and conduct their operative business in the respective country through subsidiaries - whereas BMW Financial Services is the trade name of BMW Bank GmbH and a business line within the BMW AG. BMW's operative financial services units are affiliated to the OEM in various ways (e.g. department, subsidiary, etc.) in their respective country.

H o w is the market for automotive financial services classified?

153

The external perception of each CFC is shaped differently depending on classification and corporate self-concept. As an example, VW Financial Services operates as an independent subsidiary with its own annual report and a very detailed and significant internet presence. In contrast, Daimler Financial Services AG and BMW Bank GmbH are managed as sub-segments in their OEM's annual report and hence, their internet website provides only very basic information.

6.4 The traditional product offerings of CFCs 6.4.1 Retail leasing The two leasing options most relevant to the automotive industry are operating leasing and finance leasing. Both leasing options differ mainly in the assumption of investment risks, i.e. residual value risk.140 These leasing alternatives cater to the unique requirements of the lessee and the purpose of the specific leasing object. Especially, the legal, accounting and taxation aspects are of interest to corporate clients when selecting a leasing product. Operating leasing is usually a short-term lease contract which is terminable anytime. Therefore, the investment and payment risks are borne by the lessor, i.e. the CFC. As the lessor is interested in prolonging the leasing contract, CFCs also bear the maintenance and servicing expenses.141 As opposed to operating leasing, finance leasing is a so-called installment purchase because it begins with renting the investment object which ultimately results into its purchase. The investment risk is therefore borne by the lessee who is also responsible for maintenance and service.142

6.4.2 Retail-financing Besides leasing, standard financing and final installment financing are also of central importance in automotive financing. Financing is characterized by its higher monthly rates as not only vehicle use but also purchase intention is of paramount. Standard financing is a traditional loan agreement. The entire loan amount necessary to purchase a vehicle is paid in fixed monthly rates over a specified time period. 143 As long

140 See Göller, Κ. (2008), pp. 119 141 See Städtler, A. (2009), pp. 18 142 See Federal agency for financial services supervision (2009) 143 See Olfert / Reichel (2005), pp. 310

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Captive Finance Companies (CFCs): "the future instrument of manufacturers

as the loan agreement exists, there is a so-called "Leihvertrag" between debtor and credit institution granting the right to use the vehicle. Transfer of ownership will come into effect once the amount borrowed is fully paid back. Owing to the flexible structure of final installment financing, customers have the choice between purchasing the car, financing the remainder of the loan or returning the vehicle. This type of financial solution is a known as three-way-financing.

6.4.3

Dealer financing (wholesale finance)

The central distribution channel of automobile manufacturers is their own dealership network. Financing a dealer's vehicle inventory requires specially tailored financing solutions. The objective of wholesale financing is to assist dealerships in financing vehicle inventories as well as providing working capital and loans for investment purposes. These financial solutions are also to be delivered through Captive Finance Companies.144 As OEMs and dealerships are engaged in an interdependent relationship it is the role of CFCs to promote sales at the point-of-sale by means of dealer financing. Owing to their wholesale financial offerings, CFCs assume a decisive role in maintaining a car dealer's business activities with new, used and showcase cars. Competition in the field of dealer financing has been intensified due to the mentioned market liberalization through the GVO act of 2002 and the focus of competitors on the business of automotive financial services. Non-Captives penetrate this market with attractive financing conditions, premium and commission schemes. For maintaining the attractive wholesale finance business - corresponding to an average share of 15% to 20% of accounts receivable145 - and thus, supporting the corporate group results, CFCs are increasingly required to offer lucrative conditions not only to end customers but also to dealerships.

6.4.4

Fleet business

Fleet business or fleet management refers to the systematic planning, organizing and steering of a vehicle fleet for corporate clients.146 It comprises all strategic and operative tasks necessary for operating a vehicle fleet. The scope of service may include analysis, organization and management of the fleet.147 By utilizing this service, corporate clients

144 See Stenner, F (2010), pp. 214 145 See Stenner, F (2010), pp. 214 146 See Stenner, F (2010), pp. 115 147 See Stenner, F. (2010), pp. 115

How is the market for automotive financial services classified?

155

p a s s o v e r t h e a d m i n i s t r a t i o n o f their entire v e h i c l e fleet t o t h e fleet m a n a g e m e n t b u s i n e s s o f C F C s . F i g u r e 8 8 illustrates t h e t a s k s o f f l e e t m a n a g e m e n t i n detail.

Fleet Analysis

Fleet Organisation

Fleet Management

As is-Analysis:

Vehicle selection / Vehicle procurement

Invoice control:

• Maintenance costs • Vehicle costs

Vehicle registration / Vehicle logistics

• Checking, booking, archiving of documents

Vehicle selection:

Financing alternatives / Composition of contract types

Reporting:

• Petrol / Diesel / alternative drives (Hybrid, natural gas, etc.)

Services

• Cost curves, vehicle comparison

Car Policy:

Vehicle exploitation

• Company car scheme » Car service transfer agreement Insurance: • Bridgeover of existing and development of new insurance concepts Garage selection: • free garages / direct garages Disposition planning: • Exchange of existing vehicles Figure 88: A n overview of a fleet management's range of tasks Source: Stenner, F. (2010), p. 115

6.5 Strategic importance of CFCs T h e c o n c e p t o f o f f e r i n g f i n a n c i a l s e r v i c e s a s part o f t h e d o w n s t r e a m strategy in a u t o m o t i v e m a n a g e m e n t p r o v e d to b e a p r o f i t a b l e b u s i n e s s in t h e p a s t y e a r s . D o w n s t r e a m strate g y is t h e strategy o f C F C s t o b u i l d l o n g - t e r m c u s t o m e r l o y a l t y b e y o n d car p u r c h a s e . 1 4 8

148 See Ad banjo, D. (2008), pp. 42

156

Captive Finance Companies (CFCs): The future instrument of manufacturers

The outstanding balance of receivables from leasing and financing in Germany has more than doubled between 1997 and 2008. It amounted to over 88 billion Euros in 2008. The penetration rate - which measures the share of car sales financed through loans or leasing of total registered vehicles of a brand - increased from 39% in 2004 to an average of 42,2% in 2008 in the German market. 149 Hence, for the first time more than four out of ten new cars in Germany were financed through CFCs. This development points out that CFCs have a high level of strategic importance within the corporate group. The increasing importance of CFCs is attributed to - among others - the stagnant automotive market, overcapacity of global manufacturers, decline in profitability of manufacturers and dealers as well as to the increasing intensity of competition.150 OEMs pursue the corporate strategy of diversifying their activities into profitable business areas in the financial services sector by means of their CFC. Through their financial subsidiaries, OEMs generate additional income which serves as stabilizers in times of crisis. Despite significantly declining profits in the highly cyclical automotive industry, the financial subsidiary of the Daimler group was able to achieve a profit of 457 million Euro in 2008 by accounting for over 32% of total corporate result.151 An important reason for the current popularity of CFCs might be the "one-stop-shopping" mentality of customers. The modern customer prefers to purchase - in addition to the vehicle - customized products ranging from financial solutions to car disposal from one hand. As a result, CFCs do not only support auto mobility but also enable customers financial mobility. Brand loyalty is especially strengthened through supplementary financial services and effective customer relationship management which in turn has a positive impact on the repurchase behavior of customers (see Figure 89).

149 See working group of the banks and leasing companies of automobile industry (2009) 150 See Roland Berger Strategy Consultants (2005b), p. 9 151 See Daimler Group AG (2008a)

How is the market for automotive financial services classified?

157

Sustainable growth driver

Stabilization of group results

Figure 89: Summary of the strategic relevance of CFCs

Source: Author's own

proposal

Figure 90 illustrates the components of an automotive value chain which are relevant to CFCs. Apparently, automotive financial services companies have gradually expanded into new business areas through vertical integration. CFCs' attempt of accompanying customers along the entire value chain resulted in a broadened finance product portfolio including financial services for spare parts and accessories as well as financing for used cars.

158

Captive Finance Companies (CFCs): The future instrument of manufacturers

Research & development

Pats production

Integrated saleslogistics & ^„^¡„,,. regulation

Financing & Leasing 1

1

After Sales, repairing. maintenance

Sales

1

Financing of the storage inventory of dealership

1

Automobile insurances, residual debt insurances, wheels- and tyre insurance, warranty insurance to the end customer Full-Service Leasing as well as fleet management for end customers as well as corporate customers

Captive Finance Company

1

Μ Remarketing Disposal

Mobilityservices

Remarketing

Offerings of various ownership- or use models (car on demand)

• Services and processes in the field of premature contract termination as well as further utilisation of the vehicles

Insurance Services

Financing as well as leasing of new and used cars to the end customer via point of sale or direct sale

OEM

Assembly

Integration of public transport

OEM & Capitve Finance Company

Figure 90: The value chain of the automobile industry

Source: IBM Global Business Services (2010)

The value chain analysis of automotive manufacturers reveals that one third of the profit made in the European market is achieved through CFCs and their financial services such as financing and insurance products. Figure 91 indicates that services and spare parts with earnings of 16% and 18% respectively will strongly gain importance while profits from the main business - production and sales of automobiles - will be losing its lead.

An overview of globally active CFCs

F/E Production

Sales

Financing/ Leasing/ Insurance

Rental

Spare partsproduction

Spare parts-sale {Dealer}

159

Service/ Secondhand Maintenance vehicles

Σ

Figure 91: Segmentation of the value chain by value contributions 152 Source: IBM Global Business Services (2008)

Based on the conclusions of this chapter options for OEMs in deploying CFCs strategically will be examined in the following sections.

7

An overview of globally active CFCs

The analysis of the globally active CFCs inevitably involves a separate examination of their ownership structure. When it comes to deploying CFCs as a strategic instrument, a controlling stake is vital for automobile manufacturers. This circumstance is crucial for the analysis following. The examination of, for example, GMAC Financial Services' ownership structure discloses that Cerberus Capital Management owned shares of up to 51% until the end of 2008. 152 Financing of the Fiat Corporate Group brands as well as Jaguar, Land Rover, Chrysler, Jeep and Dodge is handled in a joint venture of FGA Capital S.p.A with Crédit Agricole (50% stake since December 2006). 153 Likewise, behind the financial offerings

152 See IBM Global Business Services (2008a), p. 7 153 See FGA Capital (2010)

160

Captive Finance Companies (CFCs): The future instrument of manufacturers

of the brands Honda, Mitsubishi, Tata and Hyundai, third parties can be found as licensed partners for sales financing. Only clearly identifiable and market-relevant manufactureraffiliated financial services providers are taken into account for further analysis. In order to build up a picture of world-wide operating CFCs, the following companies will be described with their respective product volume (see Figure 92): Banque PSA Finance, BMW Financial Services, Daimler Financial Services, Ford Motor Credit Company, Porsche SE, RCI Bank, Toyota Financial Services, Volkswagen Financial Services and Volvo Financial Services. The purpose of using the product portfolios of the respective CFC for this analysis owes to the fact that the focus of a CFC's business operation is largely determined by its product offerings. However, deposit portfolio is not considered in the ranking because of its small range and the limited access to sources of information. Attributes critical to the comparability of CFCs are elaborateness, transparency and quality of the annual report. Distinct differences in annual reports can be found among globally active CFCs. Hence, each of the financial services business line of Volkswagen group, Ford group and Peugeot S.A., for example, publish a separate but detailed annual report while Daimler and BMW are merely publishing a separate income statement and balance sheet within the consolidated balance sheet report. This resulted from two circumstances: differences in reporting requirements among legal accounting principles such as those found among French-GAAP, US-GAAP and the German HGB. Furthermore, the company's respective corporate strategy and legal form plays a role. To ensure a high level of comparability, the corporation's consolidated financial statement was used for data collection. Here, the separation of financial and industrial business lines has to be forgone in the short-term because a leasing product portfolio includes operating leasing which cannot be attributed unambiguously to the financial business line. Separating the activities of CFCs from those of OEM's is also difficult because CFCs are to some extent responsible for business operations within the industrial business line (e.g. rental of real estate). 154 Breaking down a financial product portfolio has also proved to be very complex. Account receivables from financial services are administered differently. Furthermore, neither Daimler nor Ford offer any details on the composition of financial solutions for, and account receivables from end customers nor disclose finance leasing. Despite these difficulties, the following figure provides an good overview of the global scale of CFCs.

154 Operating Leasing is referred to as "leased property assets" in German corporate financial statements while it is usually directly referred to as Operating Leasing in English financial statements.

An overview of globally active CFCs

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