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Porsche and Volkswagen
In a time when many odd economic events are taking place, this saga nonetheless deserves comment:
Volkswagen's shares more than doubled on Monday after Porsche moved to cement its control of Europe’s biggest carmaker and hedge funds, rushing to cover short positions, were forced to buy stock from a shrinking pool of shares in free float.
VW shares rose 147 per cent after Porsche unexpectedly disclosed that through the use of derivatives it had increased its stake in VW from 35 to 74.1 per cent, sparking outcry among investors, analysts and corporate governance experts.
This seesaw has been going on for some time and German regulators haven't done much about it, despite complaints from hedge funds. Today the share price rose by a factor of nearly five (!). So for a brief while Volkswagen became the world's largest company in terms of capitalization. Who needs Exxon and WalMart?
I thank Ben, a loyal MR reader, for the pointer to this episode.
Posted by Tyler Cowen on October 28, 2008 at 09:24 AM in Economics | Permalink
Comments
Why should German regulators do anything about it? I know many hedge funds involved in what's called the Porsche stub trade, and truthfully, it was flawed from the start. Essentially what happened is that earlier this year Porsche disclosed a sizeable stake in VW. Hedge funds figured out that the value of Porsche's stake in VW exceeded the enterprise value of Porsche, meaning in effect you were getting paid to own the operating business of Porsche. So to capture that spread, you go long Porsche and short VW. I know a number of funds that put this trade on and pitched it to me. The glaring flaw in their analysis though was that they assumed that Porsche, who had announced its intention to take a "majority" stake in VW, was going to stop accumulating at 50.1% because Lower Saxony controls 20% of VW and it was thought they would never acquiesce to a takeover by Porsche. Porsche never committed to stopping at 50.1%, and as this weekend's announcement shows, they didn't.
So what ended up happening was that the hedge funds were shorting VW as Porsche was acquiring it. It's akin to a reverse risk arb; in risk arb you buy the target and short the acquiror, here the funds were shorting the target and buying the acquiror. As would be expected, this is a recipe for disaster. Once Porsche announced they controlled 74.1% of the stock through owned shares and cash settled options (where their banks effectively control the shares), it became obvious that with only 5.9% of shares now in the free float (remember Saxony controls 20%) that the 13% of shares sold short were in a, shall we say, precarious position. Thus the single greatest short squeeze I have ever seen. VW is now valued at over 2x Toyota Motor despite being smaller and less profitable.
Posted by: joe at Oct 28, 2008 9:38:24 AM
Can someone explain why Porsche's owning of cash-settled options would decrease the free-float % of VW shares?
Posted by: Chad at Oct 28, 2008 9:52:07 AM
Seems to me that having the shorts squeezed in such a manner is a far better object lesson about the possible dangers of naked puts than government regulation could ever be. (And naked puts are sometimes quite useful and healthy things.)
Posted by: John Thacker at Oct 28, 2008 9:53:37 AM
Porsche raised its stake to 42.6% buying shares plus another 31.5% through options - thus the direct+indirect 74.1% stake. Free float is reduced because until sunday everyone thought Porsche's cash share to be just 35%.
Posted by: CRP at Oct 28, 2008 10:04:59 AM
BTW, I agree that shorters are paying for a mistake. On the other hand, Porsche has been less than transparent, stating repeatedly that they are not actively buying on the market, have no intention of reaching 75%, are not lending VW stock etc. So one might say that there has been market manipulation, and many HF fell for it.
Posted by: CRP at Oct 28, 2008 10:07:33 AM
To CRP: I thought these were cash-settled options though. Am I wrong that cash settled means that when you exercise them you don't actually get the stock and merely get the price of the stock?
Posted by: chad at Oct 28, 2008 10:17:54 AM
A possible reason for regulatory action could be that, at least in the United States, a holder of a certain amount of stock in a company must disclose its purchases to provide greater transparency in the market. If Germany has similar requirements and Porsche failed to appropriately comply, then the securities regulators would have grounds to take enforcement action. The point is not to protect naked option takers, but to enhance confidence in the the market and provide information and greater transparency.
Posted by: DWG at Oct 28, 2008 10:18:38 AM
Boy, I could lose money on this deal and not even learn anything useful.
Posted by: Andrew at Oct 28, 2008 10:32:01 AM
DWG,
According to FT Alphaville, the "relevant legislation" that would curtail Porsche's activity does not come into effect in Germany until the spring, so they would seem to be in the clear.
Posted by: at Oct 28, 2008 10:43:43 AM
chad, correct, but Porsche's goal is raise its control of VW, so they would use cash proceeds from cash settlement of options to buy VW. I think what will happen in practice is that Porsche will just go to its option writers and agree on some options-for-VW-shares scheme
Posted by: CRP at Oct 28, 2008 11:21:34 AM
And now GS and MS are down -10% to -26% on rumors that they lost bundles on VOW!
It serves them right for taking on the Largest Company in the World!
They've come out with statements refuting this (and we heard it from other sources), but rumors have a life of their own.
Posted by: Nick at Oct 28, 2008 12:18:15 PM
Porsche's stake in VW was worth 105b Euros while it entire market cap is something like 9.05 billion Euros talk about dislocation...
Posted by: hank at Oct 28, 2008 1:07:34 PM
And now GS and MS are down -10% to -26% on rumors that they lost bundles on VOW!
No problem, Paulson's got tens of billions lying around to help them out. It'll be good for main street. Good for America.
Posted by: guy in the veal calf office at Oct 28, 2008 1:09:06 PM
The free float is actually around 15%. Lower Saxony owns about 20% of VW.
Wolfgang Porsche has always wanted to bring Porsche and VW together even though he doesn't like the Piech side of the family tree. Porsche has been building this stake for years and doing it in this exact manner. Although, I suspect Porsche may been using derivatives to hedge the exposure (or take outright bets) on their VW options and shares.
While the short position on VW's fundamentals makes perfect sense, everyone knew they were going to eventually take over VW. While I'm sympathetic to complaints that the whole thing is shady, that was the side any shorts had to play against, and a hedge fund "in the know" should have known that was a risk.
Posted by: Nate at Oct 28, 2008 2:21:08 PM
I can barely understand it, but it sounds hilarious.
Posted by: Phil at Oct 28, 2008 2:38:12 PM
I've no idea what you're all talking about.
Posted by: Sune at Oct 28, 2008 2:45:56 PM
Phil and Sune: hedge funds noticed Volkswagen shares were way overpriced, and shorted them. However, Porsche had secretly cornered the market in Volkswagen shares, and publicly revealed this fact a couple of days ago. Short-sellers were forced to buy back VW shares at ruinously ever-higher prices.
Shorting shares means you try to sell high and buy low, in that order. If the price spikes in the meantime, you lose. Just like panic selling can drive the price of shares down (a familiar scenario lately), panic buying by short-sellers can spike the price upward, which is known as a "short squeeze". This was the mother of short squeezes.
The money quote:
“I have hedge fund managers literally in tears on the phone,” said one London-based auto analyst.
P.S. when Porsche casually revealed that they controlled far more VW shares than they had previously been thought to own, they disingenuously stated:
The disclosure should give so called short sellers [...] the opportunity to settle their relevant positions without rush and without facing major risks.
Which only goes to show that sadistic Teutonic humor is alive and well.
Posted by: at Oct 28, 2008 3:44:25 PM
By the way, the Dow Jones and S&P 500 were both up more than 10% today. Coincidence? Although Volkswagen was a unique situation and Porsche's maneuver would probably run afoul of the regulatory authorities in most jurisdictions (but not Germany), still, I can't help but wonder if short sellers across the board suddenly decided to rethink their positions and get a lot more cautious. After all, if they didn't see that one coming, what other surprises might be in store?
Nevertheless I wouldn't count on this marking the bottom. As Nouriel Roubini has pointed out, the worst is yet to come.
Posted by: at Oct 28, 2008 4:15:15 PM
It's amazing that hedge funds are so despised that people don't seem to mind that porsche lied (yes lied) about their intentions and blatantly manipulated the market. But hey, if the counterparties are american and english "locusts", then i guess it's okay to let them suffer. I am not short VW shares, but I continue to follow this story and I think it has several more interesting turns to take. What Joe did not mention in his good summary of the situation is that Porsche had stated publicly earlier in the year that it would not seek to go to 75% and only very recently (3 weeks ago) did they mention that going to 75% was a "theoretical possibility". I guess "theoretical possibility" actually meant they were buying boatloads of options to take them to 75%. I have heard that privately porsche was telling investors the share price was too high and thus egging on short sellers. So hedge funds that were caught short were a little naive, but the "flaw" Joe points out is really that they took Porsche management at their word. And that turned out to be a huge mistake.
Other tidbits:
1) Porsche has disclosed they own options to take porsche to 75%. . but these could be way out of the money call options that as of last week (pre announcement and squeeze) had fallen tremendously in value as VW fell 50%.
2) Porsche has also sold puts in the market (perhaps to fund buying all these calls), so last week's sharp decline also was probably killing them on put liability.
3) So whatever options they own, Porsche has clearly levered up to buy them (Porsche is a tiny company compared to VW). When VW stock fell last week, all of a sudden Porsche could have found itself in a terrible liquidity crunch. Thus the press release about owning options to go to 74% and the very weird statement about allowing shorts to exit their positions in an orderly fashion (hahaha).
the whole thing is totally bizarre. and Sunday's announcement smelled more like panic than triumph to me. it is too bad there aren't more financial journalists looking at this situation from the correct angles. . .i feel like it's another fantastic story from 2008 featuring games with derivatives which have gone bad. if porsche does not get away with cornering the market here, they could be totally screwed. given their bad behaviour, they deserve it.
Posted by: jeff at Oct 28, 2008 5:16:24 PM
I guess hedge funds are in part to blame for some of the mess we've been seeing in the past few months. Financial markets are very much disconnected from underlying fundamentals these days, and that's both dangerous and unhealthy.
Not much pity for those beaten hedgies. That may also be why the German regulators didn't bother to intervene.
Posted by: Pete at Oct 28, 2008 6:16:55 PM
porsche lied (yes lied) about their intentions and blatantly manipulated the market
Welcome to the poker game.
Posted by: Anderson at Oct 28, 2008 6:17:53 PM
Okay I think I get it now. What made people short VW in the first place?
Posted by: Sune at Oct 28, 2008 6:29:47 PM
"Okay I think I get it now. What made people short VW in the first place?"
Fundamental overvaluation. A stupid reason in this case.
Posted by: IWantCookieNow at Oct 28, 2008 8:13:12 PM
Now does anyone here think that Porsche did all this themselves?
As one of the recent posters points out, Porsche may have have themselves gone out on a limb selling puts, buying Way OOT calls, etc. Perhaps, perhaps not.
Others imply that there was manipulative intent in all this as well.
This sounds to me like there was some good advice (especially with regards to current disclosure law in Germany) by financial engineers.
Does anyone know which bank/i-bank is advising Porsche?
They will be the real culprits screwing the hedgefunds.
Would be interesting to find out!
Posted by: murray teynnensw. at Oct 28, 2008 8:50:41 PM
Everyone of those traders is whining, but are not options volumes available? Wouldn't due diligence be to know what those are?
And Jeff, selling naked shorts should be dangerous; traders should bare the risk.
And why is it so damn different if Porsche buys those options or Warren Buffet?
Why should one have to disclose and the other not?
The point that everyone seems to have forgotten is that being a trader involves risk. Risk is a part of the reason you get paid the large sums you do. If you don't like the blow-up, don't pick up pennies in front of the steamroller. You guys got your bailout now stop whining that its too damn risky.
Posted by: R. Pointer at Oct 28, 2008 9:08:15 PM
