Sunday, November 02, 2008

VW, The World's Biggest Company By Capitalisation

The last couple weeks saw a new largest company in the world amidst the turmoil. Share price of Volkswagen went over 1,000 euros a share owing to the immense short covering in the stock. A few months ago, many hedge funds shorted VW when its share price was below 200 euros. Porsche the controlling shareholder correctly let the hedge funds to make huge losses and send VW share prices rocketing more than 500% in a matter of weeks. It was horrendous if you were short the stock. Finally after much blood on the streets, Porsche has stepped in to sell 5% of VW into the open market at a huge profit. Sometimes, running a business poorly can yield the most unlikely benefits. I doubt very much that VW would ever go above 1000 euros ever again.

New York Times - FRANKFURT — Shares in Volkswagen fell by nearly half Wednesday after its main shareholder, Porsche, took steps to ease a quadrupling in the stock price that had pushed some of the world’s biggest hedge funds to the wall.

The move came as the German financial supervisor, Bafin, announced a formal investigation into gyrations of VW stock that briefly made it the most valuable company in the world a day earlier. “We need to take a closer look if there was market manipulation,” a Bafin spokeswoman, Anja Engelland, said.

Porsche said it would dump up to 5 percent of its VW shares — presumably at a great profit — “to avoid further market distortions and the resulting consequences for those involved.” Volkswagen stock, which rose to above 1,000 euros, or to about $1,284, at one point on Tuesday, plummeted on Wednesday to close at 517 euros. That is still well above its close Friday of 210 euros.

Porsche, which has engaged in a creeping takeover of Volkswagen over several years, unleashed a punishing market dynamic this week on investors who believed VW stock would lose value if Porsche took majority control.

These short-sellers, who borrow stock in the hope of buying it back later at a lower price, scrambled to buy shares of VW to cover their bets after Porsche revealed Sunday that it controlled a much larger pool of VW shares than previously disclosed, creating scarcity in the number of shares investors could buy.

Many hedge fund managers were relieved on Wednesday when the share price fell. Funds like Greenlight Capital, Glenview Capital and SAC Capital had bet that Volkswagen’s stock was overvalued back when the price was below 200. The spike in the stock put funds with big positions at risk, and some of those funds could face large margin calls from the banks this week if the stock does not continue to fall.

Porsche, whose own shares jumped Wednesday by 37 percent, flatly denied any wrongdoing. “Porsche has not been active in the market during these share price movements,” it said. “Allegations of price manipulation by Porsche are therefore without foundation whatsoever.”

The episode highlights how Porsche, the sports car manufacturer that keeps investment bankers and hedge fund managers moving at high speeds down the world’s highways, beat both at their own game.

Porsche raised its stake in Volkswagen to 42.6 percent from 35 percent, and said Sunday it had taken options that settle in cash for an additional 31.5 percent. By acquiring options to buy VW shares at a certain price, Porsche was in the position Wednesday to exercise them, and then sell at elevated prices for a colossal profit.

“Presumably they are doing this to earn money, and not to help the hedge funds,” said Jens Schattner, an auto analyst at Sal. Oppenheim in Frankfurt.

With big names and big money at stake, the spectacle has riveted Germany, with some unease but a fair dose as well of schadenfreude among many Germans.

“As opposed to previous speculative bubbles that cost a lot of small investors their money in the stock exchange casino, the chaos around VW shares overwhelmingly hits professional gamblers,” Die Tageszeitung, a left-leaning Berlin newspaper, wrote. “Sympathy does not seem appropriate.”

But with its use of financial derivatives, surprise pronouncements and calculated opacity, Porsche did appear to be acting a bit like one of the hedge funds that a German politician once famously called “locusts” that prey on unsuspecting companies. Indeed, in the 2006-7 fiscal year, Porsche engaged in a similar financial strategy that drew in vastly higher profits than the sales of its cars.

The size of Porsche’s profit on this week’s transactions is likely to remain a mystery until next year, analysts said. Stock option transactions earned Porsche 3.6 billion euros in the fiscal year that ended June 30, 2007, or 62 percent of its pretax profit. It has yet to reveal results for the 2007-8 financial year, and the current transactions will not register until its report in late 2009.

German law does not require Porsche to reveal details of the price at which it bought the cash options, or the strike price at which they can be exercised, the two main variables in the profit calculation.

Porsche’s financial strategy of securing control over Volkswagen has been the brainchild of its chief financial officer, Holger P. Härter, who sits on the larger company’s board. The Schaeffler Group, a maker of roller bearings, used a similar approach to seize control of Continental, one of the world’s largest auto parts makers, this summer.

The German Finance Ministry is now examining whether to broaden disclosure rules to include complex financial derivatives that can be used to circumvent normal disclosure rules on shareholdings.

Porsche and Schaeffler are family-controlled companies, a fact that appears to have limited the political fallout from the rough-and-tumble tactics. Porsche is often held up by German critics of American-style capitalism as a company that makes enviable profits while paying its workers a premium wage.

Ulrich Hocker, director of DSW, a German shareholder protection group, said a player like Deutsche, for example, would have run into a thicket of criticism for using such tactics, being widely held and much more American in its outlook.

“If Deutsche had done this, we would have a terrible uproar,” Mr. Hocker said. “But Porsche is a family company that has the reputation of doing well for their people, and they are using that reputation to the fullest.”

A Clever Move by Porsche on VW’s Stock

On Wall Street, a corner is not just an intersection of two streets. It is also a way to extract huge profits from speculators who had the temerity to sell a stock short.

Now the question is whether Porsche has pulled off a brilliant new-fashioned corner in Volkswagen stock, using derivatives in clever ways that no one had thought of before, or whether it was too clever for its own good.

In a corner, a buyer or group of buyers buys a lot of stock. As the price goes up, short-sellers appear. They borrow stock — perhaps from the very same group — and sell it, hoping to make a profit when the price declines.

Then comes the squeeze. The group, which now owns more shares than exist, demands the return of the borrowed stock. The only way the short-sellers can comply with that request is to purchase shares, and the only one who has shares to sell is the corner group. The group can set its own price, and make a fortune.

One reason you don’t see many corners these days is that they are illegal in most countries. But another is that almost everybody involved tends to lose in the end, with the exception of lucky investors who happened to own the stock before the fun started and can sell into the big run-up in prices.

Those who execute corners usually make lots of money from the short-sellers. But they end up owning a company for which they paid too much. The stock is delisted from the stock exchange, since there no longer are enough public shareholders, so there is no ready market for the stock. If the group that executed the corner used borrowed money, they may be in big trouble.

In the 1920s, the most famous corner in the United States was in stock in Piggly Wiggly, a grocery store chain. The corner was successful, but the man who executed it eventually went broke.

But there have been successful corners. Cornelius Vanderbilt once pulled one off, with members of the New York City Council as the victims. They had tried to profit by shorting a railroad company Vanderbilt controlled, and then revoking the company’s principal asset, a license to operate a street railway. Vanderbilt bought shares, and kept the price from falling. Owning more shares than there were outstanding, he offered to let the council members cover their short positions with only small losses, if they reinstated the license. They did.

The big loser in that corner was a legendary speculator, Daniel Drew, who had proposed the idea to the council members. He was forced to purchase shares at very high prices.

It is Drew who is credited with the saying “He who sells what isn’t his’n, must buy it back or go to pris’n.”

For the cornerer, there is also the risk that rules will change when powerful people get in trouble. That was one of the things that broke the Hunt brothers’ attempted corner in silver back in 1980. The authorities made it almost impossible to bet on silver prices rising, and the Hunts went broke.

Now, from Germany we have a new version of the corner, using derivatives in a way that may have removed much of the risk for the people planning the corner.

Briefly, here are the relevant facts: Porsche, for some reason, wants to control Volkswagen, and has been building up its stake, thereby driving up the price. Hedge funds, figuring the share price would fall as soon as Porsche got control and stopped buying, sold a lot of VW shares short.

Then last weekend, Porsche revealed that it owned 42.6 percent of the stock, and had acquired options for another 31.5 percent. It said it wanted to go to 75 percent.

The result: instant short-squeeze. The German state of Lower Saxony owns a 20 percent stake in VW, which it said it would not sell. That left precious few shares available for anyone else. The shorts scrambled to cover, and the price leaped from about 200 euros to a high of over 1,000 euros. VW became the world’s most valuable company, if you believed that market price.

It appears that Porsche put one over on whoever wrote that option, or options. The options are said to be cash-settled, although we do not know much more about them than that. That means Porsche does not have to buy the shares — which it might have a lot of trouble paying for. Instead, at settlement it merely has to accept the cash difference between the market price and the price it has agreed to pay. The result could be tens of billions of euros in profits, without the headache of owning shares no one else wants to buy.

There has been a lot of speculation about who is on the hook for those options. Of course, those people may have used other derivatives to lay off some of their risk on who-knows-who-else. That is one result of having opaque markets, which Wall Street used to love because it made for higher profit margins. Now it may be one more loss for some already reeling bank or banks.

After all this is done, the VW share price will fall to some more reasonable level. And there are rumors that Porsche has purchased put options, presumably with later exercise dates, to profit from that fall.

By Tuesday night, the establishment was fighting back. Germany’s premier stock index, the DAX, was changed to cut VW’s proportion in it. That allowed index funds to sell stock, adding to the supply of shares, and VW’s shares are back to about 500 euros.

In the United States, there are numerous laws and regulations to stop corners. But Porsche insists it broke no German laws, adding that “allegations of price manipulation by Porsche are therefore without any foundation whatsoever.” It placed the blame on — you guessed it — “speculative short sellers.”

If this works, Porsche will have made billions from a car company at a time when cars are not selling very well. It will not have done that by selling cars, but a profit is a profit.

Of course, rules can be changed, as Nelson Bunker Hunt and William Herbert Hunt learned. The brothers angrily protested that it was unfair to change the rules in the middle of the game, but the rules were changed and the brothers went from billionaires to bankrupts.

If it comes to a question of whether regulators step in, Porsche has the advantage of facing off against short-selling hedge funds. There may not be a less popular group of investors, and their losses would provoke little sympathy.

But banks now have friends in high places. If Porsche’s option coup threatens a major bank, the bank might ask for help. Will governments step in to protect their investments? Stay tuned.

p/s photos: Yoon Eun Hye

1 comment:

solomon said...

Similar squeeze also seen in last Friday Nymex Oil market.

Dali, what is your thought whether this November will have the bear rally? Kind of bizzarre by some analysts downgrade for Malaysia O&G last week, in view that they are from Govt controlled institutions. But, nobody can ask them to change their views (in consistent with Govt views)??

I am just asking myself whether there is any motive behind all this downgrade, even though some of their points merit. Possible for funds to whack all before the next rise?

I think situation now have improved compared weeks ago, credit crunch loosen but companies still do not have incentives to borrow much. Currency swaps btwn Central Bankers are good sign. Plus the VIX in US mkt dropped for the first time in 14 months.