The VW Debt Trap Has Porsche Bitten Off More than It Can Chew?

Automaker Porsche's takeover of the much larger VW Group seemed ingenious at the time. But then the crisis came along, bringing a sharp decline in car sales. Now Porsche is finding it increasingly difficult to make enough money to cover the interest on its billions in loans.

According to a member of Porsche's supervisory board, the situation is "serious, very serious." But the company's two top managers seem unperturbed, at least whenever cameras are nearby. That's when Porsche CEO Wendelin Wiedeking and Chief Financial Officer Holger Härter seem to be engaged in a contest to look as optimistic as possible, as was the case at the Geneva Motor Show in early March. By that time, the small, family-owned business had acquired a majority stake in Europe's biggest motor vehicle manufacturer, the Volkswagen Group. "This is a coup," says Wiedeking, "that no one would have thought we, a little carmaker from Zuffenhausen, were capable of."

He is right about the fact that Porsche's takeover of VW is considered the biggest coup in recent corporate history. The luxury and sports-car maker, based in Stuttgart's suburb of Zuffenhausen, acquired an automotive group with 14 times its sales and 60 times its production volume. In addition, Porsche succeeded in performing a one-time feat in the last fiscal year: Thanks to deals involving VW options, the company's profits exceeded its sales.

Judging by the profit figures, things are going exceedingly well for Porsche. But another number is causing problems for Wiedeking and Härter: Porsche is saddled with €9 billion ($11.9 billion) in debt. The company accumulated an additional €6 billion ($7.9 billion) in debt in only the first six months of the current fiscal year when Porsche increased its share in VW to 50.8 percent. This raises the question of whether Porsche may have bitten off more than it can chew with the VW deal.

How can the company pay the estimated €600 million ($790 million) in annual interest on its loans if its own automobile sales have plunged in the current economic crisis? And what if VW pays no dividend or only a small dividend in the coming year to majority shareholder Porsche? Has Porsche made the same mistake with Volkswagen as automobile parts maker Schaeffler did when it acquired tire maker Continental?

For a long time, hardly anyone was asking these sorts of questions because Porsche raked in profits of €10.5 billion ($13.7 billion) on VW options alone in the last two fiscal years. These figures created the impression that, thanks to shrewd financial transactions, the takeover of the VW Group was practically financing itself.

But the figures only appeared briefly in the balance sheet before disappearing again because Porsche was determined not to make its money with market speculation. CFO Härter reinvested the money to buy VW stock, the price of which had gone up sharply. Whereas VW stock was trading at less than €40 ($53) a share at the beginning of the takeover, Porsche was later forced to buy the stock at prices in excess of €200 ($264) a share.

The profits on the options disappeared as quickly as they had accumulated. Moreover, Porsche had to take out a loan for €10 billion ($13 billion) to buy the VW stock. Because of that loan the company, long accustomed to success, is suddenly in hot water.

Playing Poker with the Banks

Just how serious the situation is for Porsche became apparent on March 24. It was the day the €10 billion loan was scheduled to be refinanced, leading to a dramatic game of poker.

The supervisory board, which consists primarily of members of the Porsche and Piëch families, which own the company, met at the Porsche R&D center in Weissach, near Stuttgart. The official purpose of the meeting was to discuss the results of the first six months of the 2008/09 fiscal year. Most of all, however, Ferdinand Piëch, Wolfgang Porsche and the other family representatives were expecting a message from the conference room of a Frankfurt hotel, where Porsche CFO Härter was negotiating with bank representatives over the €10 billion loan.

Porsche's Liquidity

Porsche's Liquidity

Only a year earlier, a consortium of five banks, led by Merrill Lynch, had easily approved the loan at favorable terms for Porsche and without lengthy negotiations. At that time, the financial crisis had not yet brought the banking system to the brink of collapse. But now Merrill Lynch is a subsidiary of Bank of America, which is not showing a particularly strong interest in the lending business in Germany. Other banks are either unwilling or unable to issue loans of the magnitude Porsche requires. This time, Härter found himself negotiating the loan, not with five, but with 15 banks. And they made sure that he -- and the entire Porsche-Piëch clan -- were kept sweating until the last minute.

The family members had already discussed emergency plans. What would have happened if the banks did not refinance the loan? Porsche would have had to repay €10 billion.

According to a close associate of the family, this would not have put the company at risk for bankruptcy. Both Porsche and the family clan have billions in assets. Nevertheless, they would have had to raise a great deal of money very quickly. Options that were explored included selling subsidiaries, such as Porsche Engineering, Porsche Design or Porsche Consulting, to VW, but this would have raised legally sensitive issues. It would have given other VW shareholders occasion to take legal steps against such purchases because they could be interpreted as a financial bailout for majority shareholder Porsche.

Porsche could also sell the options on VW shares it still owns. They are worth several billions euros on paper because the price of the VW share is still high. In practice, however, these shares can only be sold in small bundles. If Porsche were to redeem a larger number of the options with the banks, the banks would sell VW shares in return. This would cause the price of VW shares and the value of the options to fall.

No Simple Solution

Another option that was considered was whether the families could bring another company they own into Porsche Automobil Holding: Europe's largest auto dealer, which is headquartered in Salzburg, Austria, and boasts annual sales of just under €13 billion ($17 billion). This would increase Porsche Holding's equity capital, but it would not solve its cash flow problems.

There was no simple solution. The Porsche and Piëch families were convinced that the banks were not fundamentally against issuing a new loan but were merely delaying as long as possible to negotiate the highest possible rates. Nevertheless, the families were forced to accommodate the banks more than they had wanted to. First, they had to satisfy the banks' requirement that Porsche pledge its VW shares in return for a new loan. Only after he made that promise was CFO Härter able to report from Frankfurt that the banks had given their approval for €8.5 billion ($11.2 billion). The negotiations for the remaining €1.5 billion ($2 billion) continued until shortly before midnight.

But this doesn't solve the problem yet. Porsche received the new loan under the condition that it would repay €3.3 billion ($4.4 billion) of it within half a year. Before the ink dries on the agreement, CFO Härter will have to begin searching for new sources of funding.

This situation was apparently not anticipated in the grand plan with which Wiedeking and Härter had carefully prepared the VW takeover. Two developments took the two executives by surprise. First, the financial crisis has led to a sharp decline in car sales, shrinking profits in the core business. As a result, Porsche has less cash than expected to pay the interest on its loans.

Second, the two Porsche executives had expected the so-called Volkswagen Law to be brought down sooner. The controversial law restricts individual shareholders to a 20-percent portion of voting rights, regardless of how much they own. Its abolition would have allowed Porsche to acquire 75 percent of VW shares and sign a control and profit transfer agreement with the VW Group, so that the Porsche board members would have been telling their VW counterparts how to run their business. More important, it would have given Porsche access to VW's cash reserves, which still amounted to €8 billion ($10.6 billion) at the end of last year.

Porsche could have used VW's money to pay off some of its debt, but that plan will not materialize in the foreseeable future, because a central aspect of the VW Law will remain in effect: Even in the form amended by the federal government, the law continues to guarantee the State of Lower Saxony a veto at VW.

The EU Commission indicated last week that it will not file an objection to this new VW Law with the European Court of Justice, at least not now. For Porsche, this means that its executives in Stuttgart cannot reach any important decisions at VW without the approval of Christian Wulff, the governor of Lower Saxony. And if there is one thing Wulff will deny Porsche, it is access to VW's cash.

Wiedeking Discovers Diplomacy

For Porsche CEO Wiedeking, all of this translates into a series of painful experiences. He urgently needs money for Porsche, but he cannot get his hands on VW's billions. He is unable to exert the control he had imagined he would have over VW at its headquarters in Wolfsburg. And, finally, he is dependent on the goodwill of the banks. Wiedeking, a man who was never at a loss for words about VW executives, politicians or bankers, is now forced to take an unaccustomed approach: diplomacy.

Porsche's Structure

Porsche's Structure

Suddenly the Porsche CEO is praising VW management for doing "an outstanding job" and sweet-talking Lower Saxony Governor Wulff by characterizing "cooperation with him on the VW supervisory bBoard" as "very positive." And although Wiedeking has said nothing about the bankers he once accused of greed and incompetence, at least he has said nothing negative.

CFO Härter is currently negotiating with a few banks over the possibility of Porsche issuing a bond so that it can satisfy the terms of its loan agreement and pay off the €3.3 billion ($4.4 billion) tranche. However, Porsche would have to pay more interest on the bond than on its current loan. The second option for obtaining fresh cash would be an increase in share capital.

The Porsche and Piëch families are still at odds over how to liberate their company from its current debt trap. But the balance of power between Stuttgart and Wolfsburg has already shifted, once again, in favor VW CEO Martin Winterkorn. "The tail is no longer wagging the dog," says one VW executive, who notes that Wiedeking now knows that Porsche needs VW -- and not the other way around.

For now, Porsche has introduced strict cost controls with the objective of cutting €200 million ($264 million) in costs in the current fiscal year. At its R&D Center in Weissach, there are fears that Porsche engineers could be the hardest-hit by the new cuts. Their jobs are now considered the most expendable, the argument being that Porsche could cut back its own R&D spending by relying more heavily on VW technology in the future.

Any protests by the Porsche engineers will likely fall on deaf ears, now that Porsche must bring costs down and, most of all, reduce its debt. "It hangs over us like a Sword of Damocles," says one Porsche executive, although he says that any comparison with Schaeffler is not only off the mark, but malicious to boot.

He has a point. Together, Schaeffler and Continental owe twice as much as Porsche. Besides, the Continental shares, which Shaeffler purchased for a lot of money, have lost three-quarters of their value. In contrast, the VW shares Porsche bought for about €18 billion ($24 billion) are now worth €35 billion ($46 billion).

Meanwhile, there is speculation in Wolfsburg that Porsche co-owner Ferdinand Piëch has come up with a completely different solution.

Porsche Automobil Holding is currently the biggest shareholder in both companies, with 50.8 percent of VW shares and 100 percent of shares in the Porsche sports car company. But now VW could buy the sports car company's automobile business from Porsche Holding. This would turn Porsche Holding into purely a finance company, one that still holds its shares in the VW Group. But the VW Group could run the entire operating business, which would include the Volkswagen, Audi, Bentley and Porsche brands.

A deal like this would enable Porsche Holding to cancel almost all of its debts, but for Porsche it would also mean relinquishing its power -- a worst-case scenario for Porsche strategists Wiedeking and Härter. This was not the way they had imagined the great VW coup, which Wiedeking likes to compare with a game of chess.

"Step by step, we, the world's smallest independent car maker, are approaching an alliance with Europe's biggest producer of motor vehicles," Wiedeking said last November when he presented Porsche's balance sheet. He conceded that there might difficulties along the way, but that in the game of chess it would simply be a question of time.

Of course it's also a question of results.

Translated from the German by Christopher Sultan


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