One Hand On Two Steering Wheels

Porsche's bid to control VW -- both its rival and its partner -- opens a Pandora's box of governance issues

When Porsche family scion Ferdinand K. Piëch stepped down as chief executive at Volkswagen in 2002, he was already dreaming of cruising around the world with his family on a new $15 million, 102-foot sailboat. But the 68-year old engineer, now VW's non-executive chairman, has changed tack. Since launching Porsche's bid on Sept. 25 to become the largest shareholder at Volkswagen with a target 20% stake, Piëch has put sailing plans on hold and become chief protagonist in a bitter power struggle at VW.

Porsche's move to control VW has triggered a crisis in German corporate governance. Piëch and the Porsche family own 100% of the voting shares of Porsche. So the sports car maker's $4 billion investment in October to raise its VW stake to 18.5% (with the intention of reaching 20%), gives Piëch strong influence at VW, which is both partner and competitor to Porsche. The sports car maker has already announced it wants several VW board seats.

Investors, analysts, and members of the VW supervisory board are crying foul over Piëch's conflict of interest, since he juggles ownership in Porsche with his role as VW chairman. VW board member Christian Wulff, representing the state of Lower Saxony where VW is based, quickly commissioned a report by JPMorgan Chase & Co., which recommended that neither Piëch nor Porsche managers sit on VW's board. "The [German governance] code recommends a chairman step down if he holds a position with a competitor," says Theodor Baums, a former member of the German government commission on corporate governance. Both Piëch and VW declined to comment.

Complicating the situation is the joint venture that already exists between Porsche and VW and the fact that VW's luxury-car unit, Audi, competes with Porsche. Buyers of the highly successful Porsche Cayenne sport-utility vehicle, which starts at $41,000, are probably unaware that VW workers produce more than 85% of the wholesale value of every Cayenne, and that the Cayenne shares 65% of its parts and modules with VW's Touareg. The Cayenne's body is built at VW's plant in Bratislava, where workers earn $250 a month.

Porsche's investment in VW is likely to secure similar cooperation to build its new 4-door sports coupe, the Panamera, expected to hit the market in 2009. Analysts and auto industry experts figure that without the VW investment, Porsche risked trouble finding allies that would offer the same generous terms as in the past, since the benefits of such agreements seemed to have flowed disproportionately to Porsche. "The Cayenne is making huge profits. But for the next-generation model, Porsche risked suddenly standing there without a partner," says Arndt Ellinghorst, analyst at Dresdner Kleinwort Wasserstein in Frankfurt.

Porsche, for example, invested $420 million in the development of the highly profitable Cayenne. "That's very, very little for a new car," says Ferdinand Dudenhöffer, director of the German Center for Automotive Research at the University of Gelsenkirchen. If Porsche had done it by itself, he notes, it would have needed to invest between $1.2 billion and $1.8 billion. "There's no question, VW had all the risks and Porsche earned the greatest profits," says Dudenhoffer.

VW Chief Executive Bernd Pischetsrieder insists the Touareg-Cayenne cooperation was a win-win project, saying Volkswagen couldn't have turned a profit on the Touareg without its collaboration with Porsche. That may be true, but it doesn't rule out that Porsche gained the lion's share of benefits from the alliance. VW investors and analysts now worry that Porsche's new influence could undercut management's ability to fairly represent the interests of VW's shareholders. The mass-market auto maker could be coaxed into working on joint projects with Porsche, like the Panamera, under conditions that it might otherwise have refused.

Pischetsrieder says VW's management decisions will remain independent of Porsche's influence. He has also assured financial analysts and investors that the company will set up a subcommittee to monitor potential conflicts of interest and will hammer out a cooperation agreement that will govern future joint ventures. "It is absolutely clear that...our model planning...must remain completely untouched," he told analysts and journalists in a conference call on Oct. 11.


By snapping up a big stake in VW, Piëch has effectively blocked any chance that a rival might woo Volkswagen away from Porsche's side. Analysts say Porsche feared a possible tie-up between VW and DaimlerChrysler (DCX ), which could have imperiled Porsche's partnership with VW.

Porsche's urgency to link up with Volkswagen also exposed surprising cracks in its own business model, analysts say. Porsche boasts engineering savvy, powerful engines, and high margins, but its stance as a boutique auto maker outsourcing much of development and production now appears unsustainable.

True, Chief Executive Wendelin Wiedeking engineered a decade of impressive growth by investing Porsche's capital sparingly -- mainly in the core 911 model -- and outsourcing most other manufacturing to third parties. But Porsche lacks depth in electronics, an increasingly vital element in luxury cars that requires billions in investments. Going it alone would have been increasingly difficult, since Porsche doesn't produce the volume of cars needed to amortize hefty investments in electronics, development, and manufacturing. Porsche's future growth is increasingly dependent on collaboration with a larger auto maker that can provide leverage and scale.

That larger partner is now Volkswagen. Besides worrying that VW may get the raw end of the deal in future projects, analysts also worry VW premium brand Audi might be forced to delay or cancel certain models that challenge Porsche, such as the LeMans sport coupe. Audi insiders complain that the VW cooperation with Porsche on the Cayenne delayed by three years its introduction of the Q7 SUV, which will be launched in 2006, costing it profits and market share. Audi CEO Martin Winterkorn denies Piëch delayed the Q7 to benefit Porsche.

Despite the investor concern, Piëch is likely to prevail in the battle for the board seats. All 10 labor representatives on Volkswagen's supervisory board support his bid to get two seats for Porsche managers. Labor controls 50% of the board and Piëch's vote makes a majority. Meanwhile, Wolfgang Bernhard, former Chrysler turnaround ace and now head of the VW brand, is struggling to restructure the carmaker, whose profits have plunged over the last three years. VW needs to slash 20,000 workers and spin off unprofitable components units, analysts say. Already skeptical that VW can meet its targets, they fear that Piëch, to get labor's backing for the board seats, could cut a deal with labor that ties Bernhard's hands.

Indeed, over the past 10 years, labor reps on the board backed Piëch's unprofitable investments in luxury brands such as Bugatti, Bentley, and Lamborghini, as well as VW's unsuccessful Phaeton sedan.

VW has other labor issues as well. This summer, VW's Personnel Chief Peter Hartz, a union member, and Klaus Volkert, a union leader and head of VW's works council, resigned after the company notified prosecutors of a fraud and sex scandal involving the misuse of company funds for pleasure trips and prostitutes. Hartz and Volkert have been placed under investigation. Both deny wrongdoing.

Could the Porsche-VW alliance see both partners prosper? Porsche certainly wants to make a decent return on the $4 billion investment. If Piëch and Wiedeking don't slow Bernhard down, they could help forge a vibrant new legacy out of the two companies founded by Piëch's legendary grandfather. But first investors' concerns about this deal must be laid to rest.

By Gail Edmondson in Frankfurt

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