Volkswagen and Porsche

- Corporate Finance Case study: Mergers & Acquisitions of listed companies by Joachim Hcker

What is the macro view of this case study?

Small fish tries to eat big g fish ( (financial figures g are end of 2005 and rounded): )

VW: Market cap: 16 bn Book value: 24 bn Cash and cash equivalent: q 8 bn (+4 bn marketable securities)

Porsche: Market cap: 11 bn B k value: Book l 3 4 bn 3.4 b Cash and cash equivalent: 3.6 bn

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What is the macro view of the case study?

What is the agenda of this presentation?

1. Basic understanding: 1 How did the small fish try to eat the big fish - the takeover process! 2. Question 1: What does Porsche need to clarify in order to successfully attack the big fish? 3. Q Question 2: How can Porsche make sure that nobody realizes that the small fish is about to eat the big fish? 4. Question 3: How can Porsche finance the attack?

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1. Basic understanding of the takeover process: The situation of VW in 2005

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

bn

bn

VW: Lowest P/B ratio

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1. Basic understanding of the takeover process: The situation of VW in 2005

Porsche: Growth of turnover from 2000/2001 2004/2005

CAGR of f 10,2% ,
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1. Basic understanding of the takeover process: The situation of VW in 2005

Porsche: Growth of net p profit margin g from 2000/2001 2004/2005

Net p profit f margin g almost doubled f from 2001 to 2005

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1. Basic understanding of the takeover process: The situation of VW in 2005

Return on Equity q y Ratio, , Porsche and the competitors p (Status ( as of: 2004 or 2004/2005) )

Incredible high g p profitability f y of f Porsche

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1. Basic understanding of the takeover process

Porsche tries to acquire VW in 4 phases:

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Phase 1: Porsche entered in VW?

Before September 25th, 2005, Porsche held a 5% minority share in VW. Shortly thereafter, their h ldi holdings i increased dt to ca. 19%. 19% Additi Additionally, ll P Porsche h h had d options ti of f another th 3%. 3% VW shareholding structure after the entry of Porsche (status as of: autumn 2005):

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
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Phase 1: What was the Investor Reaction to Porsches entry into VW?
VW ordinary y share, ,p price movement from 12th Sep. p 2005 30th Sep. p 2005

Porsche announced having a blocking minority Basically y no effect ff on VW share price p

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Phase 1: What was the Investor Reaction to Porsches entry into VW?
Trading g volume of ordinary y VW shares, , 12th Sep. p 2005 30th Sep. p 2005

The trend line shows above average trading in VW securities from September 21st through g this period, p , Porsche seemed to have acquired q VW ordinary y shares, , thus 27th. During increasing demand .
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Phase 1: What was the Investor Reaction to Porsches entry into VW?
Price movement of Porsche from 12th Sep. p 2005 30th Sep. p 2005

Porsche shareholders were sceptical about the companys press release. In fact, after the ad h announcement, hoc t P Porsches h share h price i d dropped d 10 10.4%. 4%
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Phase 1: What was the Investor Reaction to Porsches entry into VW?
Traded volume of Porsche share from 12th Sep. p 2005 30th Sep. p 2005

The first trading day after Porsches announcement of its minority interest in VW, trade volume rose. Accordingly, the falling price of the shares indicate that many investors sold their Porsche stock soon after the companys announcement.
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Phase 1: Porsche might acquire VW: What are the threats and caveats
SWOT analysis, y , Porsche takes over VW

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Phase 2: Edging towards the 30% mark (November 2006)

Co c d g with Coinciding w the e announcement ou ce e of o its s 18.5% . % minority o y share s e (September (Sep e be 2005), ), Porsche o sc e 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, that very thing happened! To accomplish this, Porsche did not buy VW shares directly: Instead, it (again) acted through 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 totaling more than 25%. Two days later Porsches share increased to 27.4%.

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Phase 3: Crossing the 30% hurdle

According to the German Stock Corporation Act, Act when Porsche crossed the 30% 30%-threshold, 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. Porsche limited bidding to the legally prescribed minimum price of 100.92 euro per ordinary share, and 65.54 euro per preferred share. The acceptance p p period extended from April p 30th to May y 29th 2007. At the end of this p period, , an ordinary share listed at 111.39 euro and a preferred share at 74.54 euro.

The pronounced discrepancy between the going rate and the actual market value (offer below market k t value) l ) resulted lt d in i a 0.06% 0 06% acceptance t rate. t
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Phase 4: Approaching the 75% hurdle

Development p of VW common stock ( (monthly y key y rates) )

On October 28th 2008 short sellers reacted with panic buys when Porsches 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 (taking into account Lower Saxonys major share, the free float diminished to 5.9%).
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Phase 4: Approaching the 75% hurdle

Trading g volumes of VW common stock, , monthly y key y rates

Shortly before Porsches 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, p , further f driving g up p demand.
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Phase 4: Approaching the 75% hurdle

VW share structure as in 2009 (p (provided that Q Qatar Holding g LLC would exercise all options p held) )

The VW stock Th k - intrinsic i i i l lack k of f di diversification ifi i because b the h majority j i of f the h stock k is i in i the h hands of three major shareholders. Moreover, the stock is market-dependent, because the three major shareholders dont actively ti l trade t d in i the th market; k t and d have h instead i t d made d long-term l t investments. i t t
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Phase 4: Approaching the 75% hurdle

Trading g volume of VW common stock, , monthly y key y rates, , Nov. 08 Nov. 09

Decline D li in i trade d volume, l ongoing i since i November N b 2008 of f VW shares. h Th The tradability d bili of f the h stock has decreased. This puts the stock at risk of private shareholders, who favour shortterm investments. The risk remains that the stock will not immediately re-sell. The d decreasing i demand d d will ill lower l the th price i further. f th
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Phase 14 Summary: How and why did the VW share price increase?
November 2006 Porsche raised its VW share to 27 27.4%. 4% The price of VW common stock was at 82.25 euro, and had nearly doubled in a year. From October to November 2006, the trade volume increased by 206%. January March 2007 The tradng 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. published Accordingly, over the next months, share prices were driven even higher. October 2007 VW stock held at 197.90 euro, , corresponding p g with a 387% increase in three y years. In the following months, the rate slipped to 150 euro; possibly because of the ECJs 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.
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Phase 14 Summary: How and why did the VW share price increase?
October O b 2008 The Th financial fi i l crisis i i reached h d the h German G market, k VW stock k was resistant, i initially, i i i ll and on October 28th 2008, worth more than 1,000 Euro. Short sellers reacted with panic buys when Porsches stated that it held 42.6% VW common stock plus 31.5% cash-settled call options in b d and bonds; d as a result, lt drove d prices i up. And A d taking t ki into i t account t Lower L Saxonys S major j share, h diversified holdings diminished to 5.9%. November 2008 Porsche triggered 5% of its call options based on cash settlement settlement. The VW rate normalized, but the stock was still overvalued. January 2009 Porsche attained a 50.76% 50 76% majority share, share and the rate of VW VWs 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.

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2. Question 1: What does Porsche need to clarify in order to 2 successfully attack the big fish?

Answers to Question 1: 1: Constant improvement in terms of profitability and liquidity of business operations 2: The complete abolition of VW law 3: Financial assistance from the banks in the form of credits

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2. Answer 1: Constant improvement in terms of profitability and 2 liquidity of business operations?

Porsches P h car sales l d decline li (comparing the first half of 2007/2008 with the first half of 2008/2009)

The economic crisis hit all global automotive companies. Also Porsche could sell l cars. In less I response to t dwindling d i dli sales l figures, fi Porsche P h had h d to t curb b its it production. d ti
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2. Answer 1: Constant improvement in terms of profitability and 2 liquidity of business operations?

Porsches proceeds from share stock option 1st half-year 2008/2009

Porsche succeeded in quadrupling its profit, due to the 6.8 billion euro profit generated t d through th h VW option ti sharing h i
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2. Answer 1: Constant improvement in terms of profitability and 2 liquidity of business operations?

Despite the sales decline Porsche could increase its profitability. However:

1) Profitability: Profits from the cash-settled options depended upon an increasing VW share price. 2) Liquidity: 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%. As it turned out, Porsche was unable to fund the acquisition through its own means.

The operating p gp profitability f y and liquidity q y was not constant but declining g
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2. Answer 2: Complete abolition of VW law?

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 to 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.

The controlling stake remained at 20%, and Lower Saxony retained its right to veto. P Porsche h was prevented t d from f signing i i a domination d i ti agreement t and d a profit fit transfer t f agreement. t
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2. Answer 3: Financial assistance from the banks in the form of credits

1) Economic crisis changed lending: 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 (originally 30bn euro) refinance in spring, 2009. 2) Mr. M Hrter H t tried t i d to t outsmart t t the th banks: b k Porsches P h b behaviour h i d during i the th reorganization i ti of its credit terms factored in to the banks decision making. Porsche 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 loan, for a high return; effectively generating capital that Porsche would apply to its interest payments.

The relationship p Porsche and banks was cooling g down

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3. Question 2: How can Porsche make sure that nobody realizes that 3 the small fish is about to eat the big fish
Answers to Question 2: 1: Edging towards the 30% mark 2: Submitting a low tender offer 3: Using options (does not need to be reported to the BaFin)

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3. Answer 1: Edging towards the 30% mark

What are the thresholds and the rights of the shareholders?

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3. Answer 1: Edging towards the 30% mark

Co c d g with Coinciding w the e announcement ou ce e of o its s 18.5% . % minority o y share s e (September (Sep e be 2005), ), Porsche o sc e 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, 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 totaling more than 25%. Two days later Porsches share increased to 27.4%.

Porsche tried to p play y the good g guy g y as long g as they y were below the threshold of f 30%
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3. Answer 2: Submitting a very low tender offer

According to the German Stock Corporation Act, Act when Porsche crossed the 30% 30%-threshold, 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. Porsche limited bidding to the legally prescribed minimum price of 100.92 euro per ordinary share, and 65.54 euro per preferred share. The acceptance p p period extended from April p 30th to May y 29th 2007. At the end of this p period, , an ordinary share listed at 111.39 euro and a preferred share at 74.54 euro.

The pronounced discrepancy between the going rate and the actual market value (offer below market k t value) l ) resulted lt d in i a 0.06% 0 06% acceptance t rate. t
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3. Answer 3: Using options

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 investors holdings met or exceeded the registration threshold. threshold

Porsche f found a legal g loophole! p

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4. Question 3: How can Porsche finance the attack?

A Answers to Q Question i 3: 3 1 Liquidity from operating business 2 Instating Eurobonds and Hybrid Bonds 3 Borrowing from a syndicate of international banks 4 Profits from a smart options strategy

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4. Answer 1: Liquidity from operating business

Cash and cash equivalent q as well as marketable securities of Porsche 2003 2005 ( (in bn Euro) )

In 2003, 2004 and 2005 Porsches liquidity was excellent

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4. Answer 1: Liquidity from operating business

Porsches liquidity q y based on the financial year y 2004/2005

The current ratio shows that one quarter of Porsches then-current assets was enough to cover its it short-term h tt obligations. bli ti Moreover, M its it 3.77 3 77 billion billi euro debt d bt load l d was sufficiently ffi i tl 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.

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4. Answer 1: Liquidity from operating business

Ratio comparison, p , Porsche 2004/2005 and VW 2004

Profitability: Porsches Net Profit Margin was above-average 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%, VWs performance lagged at 0 8% 0.8%. Liquidity: Acquiring 18.5% of VW shares, plus 3.4% of its call options cost Porsche approximately 3 3.3 3 billion euro - the shares were basically financed with operating liquidity liquidity.
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4. Answer 2: Instating one Eurobond and two hybrid bonds

Porsche debt financing g was done via Eurobonds and hybrid y bonds Porsches Eurobond was split into the following two tranches:

Porsche issued a Eurobond of 1.9 bn at the beginning of 2006

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4. Answer 2: Instating one Eurobond and two hybrid bonds

Porsches issued the following two hybrid bonds:

Porsche issued two hybrid bonds totaling 1 bn as well as $ 1 bn.

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4. Answer 3: Borrowing from a syndicate of international banks

Increase in Porsches liabilities to banks:

In February 2008, Porsche completely exhausted its ten billion euro loan, taken out in early l 2007. 2007 Th The syndicate di t i included l d d 15 b banks k ( (earlier: li 30 b banks) k ) and d was h headed d db by th the financial institution Barclays. The credit line, granted with very favorable terms, was originally earmarked to cover the payment from the original mandatory offer for the remaining VW shares. shares
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4. Answer 4: Profits from a smart options strategy

Porsches earnings g from options: p

Porsches earnings from options: ca. 19bn in 2007/2008

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4. Answer 4: Profits from a smart options strategy

Porsches p profits from options: p

Porsches profit from options: ca. 7bn in 2007/2008

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4. Answer 4: Profits from a smart options strategy

Basic option p terms of technique q

Strike price

Strike

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4. Answer 4: Profits from a smart options strategy

Porsche held various options on VW shares (underlying) with a contractually determined strike price, divided into three types: yp Type 1 - Long Call 1 Porsche bought call options, which were designed for the delivery of shares, with a strike price that was in line with the shares current market price. Type 2 - Long Call 2 Porsche bought highly speculative call options, which were designed for cash compensation, with a strike price that significantly exceeded the shares current market price. Type 3 - Short S Put Porsche sold put options on VW shares to the banks. For the banks, these were protective put options used to safeguard against the effects of any decrease in VW share price.
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4. Answer 4: Profits from a smart options strategy

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

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4. Answer 4: Profits from a smart options strategy

How does the Porsche p position on Long g Call 1 look like?

Porsches profit per Long Call 1 = 0

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4. Answer 4: Profits from a smart options strategy

How does the Porsche p position on Long g Call 2 look like ( (Scenario 1-3)? )

Porsche starts making profit when the VW shares exceed 140. Especially, if the shares are listed at 1,000 level!

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4. Answer 4: Profits from a smart options strategy

Porsches long call strategy (Long call 1 and 2) in a nutshell:

-10 -15

85 (70 + 15)

140 (130 + 10)

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4. Answer 4: Profits from a smart options strategy

How does Porsches cash-settled strategy (Long call 2 and short put) look like? Porsche goes short on a put-contract with the banks. The strike price of the put option is 200 and the option is cash-settled. The received premium is 15 euro per Put. The Put and the 130-Call have the same exercise date.

Porsche starts making profit when the VW shares exceed 162,5 (+32,5- 37,5 + 5). Especially, if the shares are listed at 1,000 level!

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4. Answer 4: Profits from a smart options strategy

VW common stock price (closing prices) when Porsche announced to have access to 74.1% .

For a moment, VWs market capitalization reached 295 billion euro. VW was the worlds most valuable company even outperforming Exxon Mobil.

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