Open Wounds from Porsche and VW Merger

Volkswagen (VOWG.DE) CEO Martin Winterkorn and Michael Macht, the new Porsche (PSHG_P.DE) boss, intended to demonstrate how well they get along. After all, the battle for control of the two companies is over, with Porsche having failed in its attempt to take over giant automaker VW. Instead, VW is now absorbing the Porsche brand. And Winterkorn wanted to show that VW isn't bearing any grudges.

"Two of the most efficient companies in the automobile industry are coming together here," Winterkorn said on Wednesday of last week when he and Macht presented Porsche's annual financial statement. Posing for photos, Winterkorn even congenially placed his arm around Macht.

But the VW CEO was about to discover that certain people at Porsche haven't buried the hatchet quite yet.

Standing on the stage, Macht announced that Porsche had come in second place in a well-known US quality study. The other rankings were listed on a slide projected onto the wall behind him. Volkswagen was much farther down the list, in 16th place, while Audi was near the bottom, in 20th place. The three German carmakers were highlighted in red.

A Porsche employee had apparently smuggled the chart into Macht's presentation. It was the kind of diagram that could have come from the era of longtime Porsche CEO Wendelin Wiedeking. After Porsche bought a substantial stake in VW in 2005, Wiedeking began calling attention to the VW Group's weaknesses.

Winterkorn was sitting on the stage next to the new Porsche CEO. He saw the list, twisted to the side and, from then on, turned his shoulder to Macht.

Open Wounds

It will not be easy for VW and Porsche to come up with a sensible cooperation model. During the takeover battle, executives and works councils spent more than three years battling each other, and for many, the wounds have not healed yet. In the central German city of Wolfsburg, where VW is headquartered, some are out for revenge. And at Porsche headquarters in Stuttgart, there are those who are still unwilling to believe that they are the losers in this conflict.

For better or for worse, however, the two companies have no choice but to work together.

The Porsche holding company, which owns 51 percent of common stock in the VW Group, is still deeply in debt, and it continues to face the threat of bankruptcy.

Accountants put this in more refined terms, but their words are nevertheless clear: "Should the steps to merge Porsche Automobil Holding SE and Volkswagen AG, which include debt relief, not proceed as planned," the accounting firm Ernst & Young writes in its commentary on the Porsche financial statement, "a critical liquidity situation could emerge at Porsche Automobil Holding SE by the end of 2009, which would jeopardize the continued existence of the company and the group."

VW cannot simply look on as Porsche heads toward possible bankruptcy. If that happened, a bankruptcy administrator would take control at Porsche headquarters. His or her goal would be to sell off the assets, including Porsche's 51-percent stake in VW, to the highest bidder. They could end up in the hands of a Chinese sovereign wealth fund—a prospect that VW executives and the German state of Lower Saxony, where Wolfsburg is located, want to prevent at all costs.

For this reason, VW's chief financial officer, Hans Dieter Pötsch, and an army of consultants are developing a plan that would enable VW to rescue Porsche and then itself. The contracts and their appendices cover more than 1,200 pages, and notaries must read them out loud, word for word. Some have hired acting students to perform the job for them.

Seeking Approval

They will have to be finished by Thursday, because that's when the VW Group, at a special shareholders' meeting, expects to seek shareholder approval of its key resolutions.

The auto company will invest a total of more than €16 billion ($24 billion) in the Porsche deal. At the end of a series of complex transactions, Porsche will be the 10th brand in the VW Group, next to Audi, Bentley and others. VW also plans to acquire the Porsche Holding auto dealership in Salzburg, Austria from the Porsche and Piëch families. This would make the new VW Group the second-most powerful carmaker in the world, next to Toyota.

The most important shareholders are expected to be the state of Lower Saxony (20 percent, plus one share of common stock), the emirate of Qatar (20 percent, minus one share of common stock) and the Porsche and Piëch families (30 percent). Under this plan, the families will hold significantly fewer VW shares than the 40 percent originally planned.

Nevertheless, they can be satisfied with the outcome of the takeover battle. So can Lower Saxony Governor Christian Wulff, a member of Angela Merkel's conservative Christian Democratic Union (CDU). Wulff is the real winner of the corporate struggle. In the negotiations, he pulled off the feat of securing important special rights for Lower Saxony, rights that give the state's representatives a critical say in what happens in the VW Group in the future. This position of power is now safeguarded even more effectively than it was before.

Former Porsche CEO Wiedeking, in an effort to deprive the state of its power over VW, fought Germany's so-called "VW law," which guarantees the state of Lower Saxony a veto and two seats on the group's supervisory board. But now VW shareholders are expected to rule that these two provisions will continue to apply. When that happens, they will be permanently included in the company's articles of incorporation and will remain valid even if the European Union succeeds in overturning the VW law. The European Commission opposes the law because it violates EU rules on the free movement of capital.

Nagging Doubts about Merger

The plan has met with opposition. The Norwegian sovereign wealth fund Norges Bank Investment Management and the British Hermes pension fund have sent letters of protest to Ferdinand Piëch, chairman of VW's supervisory board. They feel poorly informed and suspect that Volkswagen is giving preference to the Porsche owner families and is sending too much money their way. They want to know why VW intends to pay €12.4 billion for Porsche AG and acquire the Porsche Holding car dealership in Salzburg from the families for €3.55 billion.

VW CFO Pötsch says that he had several appraisals performed to verify the price for Porsche and the car dealership. There is no doubt in Pötsch's mind that the sports car manufacturer is a real gem, and he also insists that the Salzburg dealership is very profitable. "They have excellent management and a great IT system," says Pötsch, "and they represent a substantial asset for the VW Group."

But not everyone is convinced, not even on the VW supervisory board. Board members Roland Oetker of the German private investors' association DSW and Jürgen Grossmann, the CEO of energy supplier RWE, voted against the planned €16 billion deal. But their objections failed to block the planned Porsche takeover within the supervisory board, and the Norwegian sovereign wealth fund and Hermes are unlikely to do so at the shareholders' meeting. Those in favor of a merger of Porsche and VW have a secure majority of votes.

Back to Business

VW CEO Winterkorn will be delighted when the event is over. In recent months, he has had far too little time to devote his attention to the new models on which the company's future hinges. Even though VW has weathered the economic crisis more effectively than competitors BMW (BMWG.DE) and Daimler (DAI), not everything is going well in Wolfsburg.

The VW subsidiary SEAT, for example, is in the red. The Spanish brand is only strong in South America, and it lacks a strategy for becoming profitable.

Audi is VW's most successful subsidiary. However, almost all of Audi's most profitable models were developed by Winterkorn, who was CEO of the company until 2007. VW executives are now critical of Audi for not developing enough new products.

And now Porsche is also part of the mix. VW executives question whether the new subsidiary is well equipped for the future. They criticize the Panamera, a four-door coupe that has been on the market for a few months now, and the new Cayenne SUV, which it is hoped will boost sales next year, for being potentially too big and too heavy and having poor fuel efficiency.

VW would like to see Porsche's product line expanded to include two models: a roadster and a smaller SUV. Porsche developers are already hoping that they will be permitted to spend more money on innovation in the future. In the past, the engineers were forced to look on as their former boss, Wiedeking, cancelled some of their projects because he felt that the expected returns were insufficient.

Continuing Paralysis

Nevertheless, most Porsche executives are not yet willing to commit themselves to the company's new owners in Wolfsburg, preferring to take a wait-and-see approach. "Almost nothing is being decided," says one Porsche executive, "but we can't afford to let this paralysis continue for very long."

Wiedeking's successor, Macht, has been busy negotiating contracts with VW, but now he plans to pay more attention to the actual business side of things. He will no longer tolerate the kind of sabotage he experienced at last Wednesday's event.

Two hours after Macht had presented the financial statement to journalists last Wednesday, he presented it to the analysts. Once again, VW CEO Winterkorn was sitting next to him. And, once again, Macht was discussing his brand's quality ratings. This time, however, no one displayed the chart that shows Porsche's future sister companies, Audi and VW, bringing up the rear.

Translated from the German by Christopher Sultan

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