Porsche vs Volkswagen

Can Porsche Handle Curves?

By VITO J. RACANELLI | MORE ARTICLES BY AUTHOR

DAY OR NIGHT, RAIN OR SHINE, Porsche sports cars usually get attention. Not so for the German company's shares, ignored by investors this year even as rival European car stocks have roared ahead 35%. (Porsche preference shares are listed, while the common is closely held.)

Two years ago little Porsche Automobil Holding SE (ticker: POAHY) famously tried to take over the much bigger Volkswagen(VLKAY), a spectacularly failed enterprise that went awry in the credit crunch. That led to a reverse merger and rescue of an overextended Porsche by VW. Last Dec. 7, VW acquired 49.9% of Porsche AG, the operating company, for €3.9 billion ($5.34 billion) from Porsche SE, which kept 50.1%. Porsche SE also holds 50.7% of VW common. The plan is for VW to buy the rest of Porsche AG by the end of 2011, and merge in stages with Porsche SE.

It's a complicated story, however, with the market worried the merger might be delayed or abandoned. But the billion-euro question is this: Why are Porsche's shares down this year, while VW's shares have taken off? Since its capital increase in March, the Frankfurt-traded common shares of Volkswagen (VOW.Germany) have surged 36% to €100, says Drew Dickson, a principal at Dickson Capital Management, which owns both Porsche and preferred shares of Volkswagen (VLKPY). Given Porsche SE's huge stake in VW, the latter's share rise should have translated into some €22 per share for Porsche, putting the Porsche home-traded stock (PAH3.Germany) at €68, not considering improvements in the valuation of Porsche AG, he adds. Instead, he points out, over that same period Porsche shares are actually down a bit, at €44.

The improvements were in the Porsche fourth quarter, ended July 31, when unit sales jumped about 30%, compared with flat sales in the first nine months. The maker of premium sports cars is benefiting from strong growth in emerging markets, China in particular, and that should help its industry-leading margins next year, too. Porsche posted a €454 million loss in fiscal 2010.

Why is Porsche stock unmoved? Investors are focused on three uncertainties, Dickson notes. First, the company is battling German tax authorities over liabilities from its VW options trades. Porsche has reserved €1.4 billion for it, but the final amount isn't known. Porsche is also readying an as-yet-undefined capital increase to improve its €6 billion debt position.

Legal issues could slow the merger timetable, as a number of U.S. hedge funds have sued Porsche here over alleged market manipulation when it tried to buy control of VW. A preliminary court ruling is expected in mid-January. Should the court throw out the suit, Porsche shares will leap. If the case moves forward, the merger could be delayed.

Investors fear, Dickson says, that setbacks could prompt VW to deploy a back-up provision to initially acquire just the operating company at a fixed price just as operations are looking up at Porsche, leaving Porsche SE a heavily indebted holding company, albeit one with a big VW stake. He says the worries, particularly the lawsuit, are overblown, and puts Porsche fair value at €94.

VW and Porsche want to close the deal, and given the powerful interests involved it's hard to believe it won't happen. Though Porsche shares look significantly undervalued, it's potentially volatile. Widows and orphans usually don't drive Porsches, and this stock, potentially cheap, isn't for them either.