Volkswagen's share price has soared 272% over the past two years, largely on a bet by investors that a German law protecting Europe's largest automaker from takeover would be toppled, clearing the way for German automaker Porsche to seize control. They were right. On Oct. 23 the European Union's top court ruled that the so-called VW law limiting the voting rights of Volkswagen's shareholders to 20% is illegal since it blocks the free movement of capital across borders.
The European Court of Justice decision is a major turning point for Volkswagen (VOWG.DE), long fettered by state ownership. It clears the way for Porsche (PSHG_P.DE), which already owns 31% of Volkswagen, to exercise full control as VW's largest shareholder. "This ruling will support management's drive to finally drag the company into the free market," says Garel Rhys, professor of automotive economics at the University of Cardiff in Wales.
VW's Slide Into Inefficiency
The 1960 VW law has long shielded Volkswagen from takeover, no matter how poorly it performed. It also ensured that the state of Lower Saxony, home to most of VW's 174,000 German workers, exerted maximum influence over management, protecting jobs at the expense of efficiency. The state, with its 20% share, has two seats on VW's supervisory board. State representatives typically have sided with labor over the years, reluctant to restructure VW's inefficient operations and eliminate jobs. Labor representatives have the right to 50% of the supervisory board seats at large companies in Germany.
The apparent victim of a meddling state that cared more for jobs than future growth, VW became increasingly inefficient and entered the 21st century with a bloated workforce, the highest manufacturing costs, and the shortest workweek (32 hours) in the global automotive industry. Even when crisis struck in 2004 and VW's German factories started posting losses, efforts to restructure were fraught with conflict and were tediously slow.
Evidence of just how unmanageable VW had become erupted in a 2005 scandal, when evidence was revealed of millions of dollars in slush funds granted by management to bribe union leaders for their support. The funds were used to pay for pleasure trips, parties, and even prostitutes. Several managers have pleaded guilty to paying off labor officials and have been fined.
Porsche Moves In
But as VW hit bottom, the European Commission was taking aim at the VW law, determined to obliterate the 20% limit on voting rights at VW. It didn't take long for Porsche family scion Ferdinand Piëch and Porsche Chief Executive Officer Wendelin Wiedeking to see a rare opportunity to grab control of a sharply undervalued automaker.
Porsche started snapping up VW's depressed shares in September, 2005, at €45 a share (then $55.24)—sending the stock price soaring. Today VW's shares cost €172 ($245.28). All told, the Piëch family, through its control of Porsche, has spent $7.2 billion to date for the 31% stake in VW, arguing that savings from joint research and development, technology, and production are strategically vital to Porsche's future growth.
Analysts agree that Porsche, with its $10.2 billion in sales, is too small to fund such huge investments independently, especially in electronics R&D. Porsche developed its hot-selling Cayenne sport-utility vehicle together with VW's Touareg. The bodies of the two SUVs are built at VW's Slovakia plant, further trimming manufacturing costs. The alliance between Porsche and Volkswagen (BusinessWeek, 8/17/0) could remain at arms length—like that of Renault (RENA.PA) and Nissan (NSANY)—or could be cemented by Porsche's raising its stake in VW and consolidating the larger automaker.
Removing Obstacles to Consolidation
Increasingly, it appears Wiedeking and Piëch, both of whom sit on the VW board of supervisors, aim to take full control of the much larger Volkswagen, which had revenues of $149 billion in 2006. The aim is to whip VW into a global challenger to Toyota (TM), with industry-beating quality and profits. Part of the strategy includes a new family of smaller, less expensive cars that will debut in 2010, a move to regain market leadership as the best-value-for-money automaker.
Challenging as that goal is, analysts say VW's real strengths have been masked for years by the infighting between its state owners and management. Now, with Piëch and Wiedeking backing Volkswagen CEO Martin Winterkorn, the German automaker finally has top management and owners pulling in the same direction (BusinessWeek, 5/2/07) after years of bitter infighting and boardroom drama.
"Porsche [has] some of the most skilled capitalists in the global auto sector, with an obsession for efficiency, product quality, and brand management—all skills which can help VW greatly," says Morgan Stanley (MS) analyst Adam Jonas.
Piëch, 70, has a strong personal ambition to see a resurgent VW. His engineer grandfather Ferdinand Porsche was the designer of the Volkswagen Beetle, and many see Piëch's drive to exert family control over VW as an industrial family saga come full circle. Piëch saved VW from decline in the early 1990s, but after his 10-year tenure as CEO, the automaker went into a second tailspin, increasingly hampered by labor opposition to change.
To speed change, Wiedeking has proposed the creation of a new Porsche holding incorporated as a European stock company under EU law. If Porsche is transformed from a German corporation to a so-called European SA (société anonyme), it will limit the number of Volkswagen labor representatives from any future merger on the Porsche board to 25%.
Labor Unlikely to Prevail
Outraged, VW union leaders have challenged the move in court. A ruling is expected on Oct. 25, and analysts say Wiedeking has the upper hand. "Labor doesn't have a chance to block the move. Porsche can decide what kind of organizational form it wants," says Jürgen Pieper, auto analyst at Metzler Bank in Frankfurt.
Under the management of ex-Audi boss and Piëch friend Winterkorn, VW already is picking up momentum. Car sales are up 8.4% this year—helping VW recapture lost market share in Europe and China. Morgan Stanley estimates the company's operating profit will jump 41% this year, to $8.8 billion, as revenues rise 8.5% to $163 billion. VW reports third-quarter earnings Oct. 26. Without the "VW law" as a shield, its future is bound to look different—and probably brighter.
For a look at VW's product line, click here.