Taking the concept of excellent cornering to a new level, Porsche casually announced at the weekend that it had amassed a holding of 74.1 per cent in that other piece of German financial engineering, Volkswagen.
Held in the form of a 42.6 per cent holding in shares and then a further 31.5 per cent in so-called “cash settled options,” Porsche said it was making the disclosure “due to the dramatic distortions on the financial markets.” According to official records - last updated on August 5 - Porsche’s previous holding amounted to just 30.29 per cent.
Net result on Monday? The most dramatic market distortion of a leading European company we have seen in some time as shares in Volkswagen were catapulted 85 per cent higher to €391.
This has nothing to do with the fundamental value attached to Porsche seemingly being close to its stated goal of achieving of “domination of the Volkswagen group by Porsche.”
It is about squeezing the hedge funds that had sold VW short in the understandable belief that the shares were comically over-priced. Note this sneering paragraph in the Porsche release:
Porsche has decided to make this announcement after it became clear that there are by far more short positions in the market than expected. The disclosure should give so called short sellers — meaning financial institutions which have betted or are still betting on a falling share price in Volkswagen — the opportunity to settle their relevant positions without rush and without facing major risks.
Max Warburton, the Sanford Bernstein analyst who undoubtedly hurried the Porsche disclosure, points out that in shorting VW stock over recently months, hedge funds must have been borrowing shares (indirectly and unknowingly) from Porsche itself. After all, aside from the Porsche holding, almost 20 per cent of VW is held by the Lower Saxony state, leaving a “free float” of less than 6 per cent.
Here’s the summary of a new Bernstein note sent to clients on Monday:
• So was it more than a “fairytale”? Porsche announced on Sunday 26th that it controls 74.1% of VW’s Ord shares — 42.6% directly and 31.5% via cash-settled options. This announcement is overdue in our view and appears to support many of the ideas we put forward in our recent report, “Porsche: The Fruit Machine? A Possible Explanation for VW’s Inexorable Rise” — that Porsche was near 75%, that the daily volume seen in VW could likely only be short selling, that only Porsche or its banks could be providing the supply of stock and that Porsche was likely profiting from these transactions. Last week, Porsche described our report as a “fairytale” to the press.
• Shutting down the Fruit Machine. Porsche’s disclosure effectively shuts down The Fruit Machine — a potentially money making situation that only worked when Porsche owned more of VW than the market realised, and when there was a ready supply of hedge funds willing to put money into the slot, in the hope of a payout if the freefloat eventually traded on fundamentals. Now it is confirmed that there is no significant freefloat, and no payout, there will be no more players willing to feed the Fruit Machine.
• Disclosure at last. Porsche states that it “has decided to make this announcement after it became clear that there are by far more short positions in the market than expected”. We find it surprising that Porsche can claim there were more shorts than expected given Porsche and its counterparties own nearly all the stock, so only they can have supplied stock for lending (aside from Lower Saxony), so they should have been reasonably aware of short positions. Information on short interest is also available publicly.
• Short squeeze to infinity? Porsche also states that “the disclosure should give the so called short sellers…the opportunity to settle their relevant positions without rush”. This is surely an ironic statement: we think it is likely there will be a stampede to close shorts. From whom will the hedge funds repurchase stock if Porsche and its counterparties own all but 5.9% of the freefloat? Do other funds (temporarily) hold VW shares that are ultimately already owned by Porsche? Did Porsche buy the shares from the short sellers for a second time? At what price will these other funds — or Porsche and its counterparties — sell VW shares back to the hedge funds? At a “nice” price to defuse the situation? Or at €300? €400? €500? Infinity?
• One last jackpot for Porsche? The consequences of this disclosure are complex for the share prices of VW Ords, VW Prefs and Porsche. We discuss potential outcomes in this note but in simple terms we believe we will see a massive short squeeze on VW Ords, a further fall in VW Prefs (short term — but not long-term — might Porsche now eventually have to bid?) and probably some upside in Porsche. In theory, we believe that Porsche (if it so chooses) can make one last big profit from VW as the shorts are settled. Porsche also clearly believes it can soon get its hands on VW’s cash pile.
Porsche appears to have made many billions of euros employing this fruit machine.
On one level, the hedge funds playing VW deserve everything they have got. The market was clearly “false” - if only in the sense that VW’s valuation and daily price moves did not in any way tally with economic reality. And the dim-witted nature of Germany’s financial regulators has been known for some time.
But such activity, had it had occurred in the UK, would have caused investors to reach for their lawyers and/or call the financial police. In Germany, the relevant legislation does not come into force until next Spring.
In the meantime, Porsche has brought the German equity market into disrepute - albeit in spirit rather than the letter of outdated laws.
Related links
Porsche LLC? - the VW fruit machine explained - FT Alphaville
