Porsche Changes Tack

Porsche Changes interchange Yes, of course, we pick up heard of sh beh aged(prenominal)er value. But that does non change the fact that we put customers first, thence workers, then business partners, providers and dealers, and then pctholders. Dr. Wendelin Wiedeking, chief operating officer, Porsche, Die Zeit, April 17, 2005. Porsche had always been different. Statements by Porsche leadership, cable cable care the one above, always made Veselina (Vesi) Dinova noisome about the telephoners attitude about creating shareholder value. The order was a paradox.Porsches attitudes and activities were like that of a family- k in a flash takegeed firm, but it had succeeded in creating substantial shareholder value for to a greater extent than a decade. Porsches chief operating officer, Dr. Wendelin Wiedeking, had been impute with clarity of purpose and sureness of execution. As one colleague described him He grew up PSD poor, smart, and driven. Porsches management of ii minds had created confusion in the foodstuffplace as to which value proposition Porsche presented. Was Porsche continuing to contrive an organizational focus on shareholder value, or was it cave ining to its more traditional German grow of s obtainholder chapiterism?Simply put, was Porsches leadership building value for every last(predicate) shareholders, including the exacting families, or was it pursue family objectives at the expense of the shareholder? Vesi had to make a recommendation to her investing committee tomorrow, and the evidence was mistake at best. Shareholder Wealth or Stakeholder peachyism? Vesis dilemma was whether PorschePorsches leadershipwas more and more pursuing shareholder wealth maximization or the more traditional Continental European present of stakeholder jacketism.Shareholder Wealth Maximization. The Anglo-Ameri evict marketsthe United States and United Kingdom primarilyhave followed the philosophy that a firms objective should be shareholder wealth maximization. More specifically, the firm should strive to maximize the return to shareholders, as paced by the sum of bully gains and dividends. This philosophy is based on the assumption that strain markets are efficient that is, the share price is always correct, and quickly incorporates all new in descriptoration about expectations of return and risk.Share prices, in turn, are deemed the best allocators of bully in the macro economy. Agency theory is the subject of how shareholders can motivate management to accept the prescriptions of shareholder wealth. For extype Ale, liberal use of stock picks should encourage management to remember like shareholders. If, however, management deviates too far from shareholder objectives, the social clubs board of directors is responsible for refilling them. In cases where the board is too weak or ingr hold to take this action, the discipline of the uprightness markets could do it through a takeover.This discipline is made possible by the one-share-one-vote rule that exists in well-nigh Anglo-American markets. right of first publication 2007 Thunderbird School of Global Management. every(prenominal)(prenominal) rights reserved. This case was prepared by Professor Michael H. Moffett for the purpose of classroom sermon whole, and not to indicate either effective or ineffective management. Special thanks to Wesley Edens and Pilar Garcia-Heras, MBA 06, for case-writing assistance. Stakeholder crownism. In the non-Anglo-American markets, particularly continental Europe, projectling shareholders similarly strive to maximize long-term returns to equity.However, they are more throttle by powerful different stakeholders like creditors, labor unions, governments, and regional entities. In particular, labor unions are a lot much more powerful than in the Anglo-American markets. Governments often intervene more in the marketplace to encourage important stakeholder interests in local communities, such as environm ental protection and employment needs. Banks and new(prenominal) mo bring inary institutions often have cross-memberships on corporate boards, and as a result are frequently kinda influential. This model has been labeled stakeholder ceilingism.Stakeholder capitalism does not assume that equity markets are either efficient or inefficient. Efficiency is not really precise because the firms monetary goals are not whole shareholder-oriented since they are constrained by the other stakeholders. In any case, stakeholder capitalism assumes that long-term loyal shareholderstypically, controlling shareholdersrather than the transient portfolio investor should influence corporate strategy. Although both philosophies have their strengths and weaknesses, twain trends in novel long time have led to an increasing focus on shareholder wealth.First, as more of the non-Anglo-American markets have progressively privatized their industries, the shareholder wealth focus is seemingly needed to attract supranational capital from outside investors, legion(predicate) of whom are from other countries. Second, and still quite controversial, many analysts think that shareholder-based multinationals are more and more dominating their worldwide sedulousness segments. Porsche AG I kat once exactly what I want and what must happen. I am the real one. You can be sure. Dr. Wendelin Wiedeking Porsche AG was a publicly traded, closely held, German-based auto compensater.Porsches chair and Chief Executive Officer, Dr. Wendelin Wiedeking, had returned the company to both status and favorableness since winning over the company in 1993. Wiedekings background was in fruition, and many had questioned whether he was the right man for the job. Immediately later taking over Porsche, he had killed the 928 and 968 model plat social classs to reduce complexity and cost, although at the time this left the company with totally one platform, the 911. Wiedeking had then brought in a gro up of Japanese manufacturing consultants, in the Toyota tradition, who led the complete slip away of the companys manufacturing processes. Wiedeking himself made news when he walked down the production line with a invoice motto, cutting off the shelving which held parts. Porsche had closed the 2004/05 fiscal year (ending July 2005) with 6. 7 billion in gross gross gross gross sales and 721 million in profit after-tax. Wiedeking and his team were credited with the wholesale turnaround of the specialty fabricater. Strategically, the leadership team had now expanded the companys business line to reduce its dependence on the luxury sports car market, historically an extremely cyclical business line.Although Porsche was traded on the Frankfurt Stock modify (and associated German exchanges), control of the company remained firmly in the hands of the founding families, the Porsche and Piech families. Porsche had two classes of shares, ordinary and preference. The two families he ld all 8. 75 million ordinary sharesthe shares which held all voting rights. The second class of share, preference shares, participated only in profits. All 8. 75 million preference shares were publicly traded. Approximately 50% of all preference shares were held by amperelegish institutional investors in the United States, Germany, and the United Kingdom 14% were eld by the Porsche and Piech families and 36% were held by small private investors. As noted by the Chief Financial Officer, Holger Harter, As long as the two families hold on to their stock portfolios, there wont be any immaterial influence on company-related decisions. I have no doubt that the families impart hang on to their shares. iodine of the consultants, focused on lean manufacturing techniques and Porsches overwhelming levels of subcomponent assemblies and various automotive parts and inventory, was quoted as saying, Where is the car factory? This looks like a movers warehouse. 1 2 TB0067 Porsche was somew hat infamous for its breakaway thought and occasional stubbornness when it came to disclosure and compliance with reporting requirementsthe prerequisites of universe publicly traded. In 2002, the company had chosen not to list on the New York Stock Exchange after the passage of the Sarbanes-Oxley Act. The company pointed to the specific requirement of Sarbanes-Oxley that senior management sign off on the pecuniary results of the company personally as inconsistent with German righteousness (which it largely was) and illogical for management to accept.Management had alike long been critical of the practice of quarterly reporting, and had in fact been removed from the Frankfurt exchanges stock power in September 2002 because of its refusal to report quarterly financial results (Porsche still reports operating and financial results only semi-annually). Porsches management continued to argue that the company believed itself to be quite seasonal in its operations, and did not cove ting to report quarterly. It also believed that quarterly reporting only added to short-term investor perspectives, a fire which Porsche felt no need to fuel (see addendum 4). troop 1 7,000 Porsches Growth in Sales, Income and boundary line Operating Margin 28% Millions of euros () Sales 6,000 20. 8% 5,000 18. 0% 18. 2% 17. 9% 20% 24% 4,000 13. 6% 3,000 11. 6% 12. 0% 16% Operating Margin (EBIT / Sales) 12% 2,000 7. 0% Operating Income (EBIT) 8% 4. 2% 1,000 2. 0% 0 1996 1997 1998 1999 2000 2001 2002 2003 4% 0% 2004 2005 Note EBIT = earnings onwards interest and tax. But, after all was express and done, the company had just reported record profits for the tenth consecutive year (see reveal 1).Returns were so good and had grown so steadily that the company had paid out a special dividend of 14 per share in 2002, in addition to increasing the size of the regular dividend. The companys critics had argued that this was plainly another way in which the controlling families drained pr ofits from the company. in that respect was a continuing refer that management came first. In the words of one analyst, we think there is the potential risk that management may not rate shareholders interests very highly. The motivations of Porsches leadership team had long been the subject of deal.The compensation packages of Porsches senior management team were well-nigh soaply focused on current year profit efficacy (83% of executive board compensation was based on performance-related pay), with no management incentives or stock option awards related to the companys share price. Porsche clearly focused on the companys own operational and financial results, not the markets valuationor opinionof the company. Leadership, however, had clearly construct value for all stakeholders in recent years, TB0067 3 nd had shared many of the fruits of the business, in the form of bonuses, with both management and labor alike. We are aware that our lofty ambitions for products, processes , and customer satisfaction can only be achieved with the support of a high- feel and well-motivated team. Here at Porsche, we have such a teamand we believe that they should share in the success of the company by means of special bonus payments. 2 Porsches Growing Portfolio Porsches product portfolio had undergone significant change as CEO Wiedeking pursued his promise to shareholders that he would grow the firm.The company had deuce-ace study vehicle platforms the premier luxury sports car, the 911 the competitively priced Boxster roadster and the of late introduced off-road sport utility vehicle, the Cayenne. Porsche had also recently announced that it would be adding a fourth platform, the Panamera, which would be a high-end sedan to compete with Jaguar, Mercedes, and Bentley. 911. The 911 series was still the focal point of the Porsche smirch, but many believed that it was growing old and due for replacement. Sales had seemingly peaked in 2001/02, and fallen back more than 15% in 2002/03.The 911 was a highly developed series with more than 14 current models carrying the 911 tag. The 911 had always enjoyed nearly exclusive self-will of its market segment. Prices continued to be high, and margins some of the very highest in the global auto industry for production models. Although its sales had been historically cyclical, 911 demand was not priceelastic. The 911 was the only Porsche model which was fabricate and assembled in-house. Boxster. The Boxster roadster had been introduced in 1996 as Porsches entry into the lower-price end of the sports car market, and had been by all measures a very big success.The Boxster was also considered an anticyclical move, because the traditional 911 was so high priced that its sales were heavily dependent on the disposable income of buyers in its study markets (Europe, the United States, and the United Kingdom). The Boxsters lower price made it affordable and slight polished to the business cycle. It did, however, compete in an increasingly competitive market segment. Although the Boxster had competed head-to-head with the BMW Z3 since its establishment in 1996, the introduction of the Z4 in 2003 had drastically cut into Boxster sales. Boxster sales volumes had peaked in 2000/01.Volume sales in 2003/04 were down to 12,988, less than half what they had been at peak. Cayenne. The third major platform innovation was Porsches entry into the sports utility vehicle (SUV) segment, the Cayenne. Clearly at the top end of the market (2002/03 Cayenne sales comed more than $70,000 each), the Cayenne had been a very quick success, especially in the SUVcrazed American market. The Cayenne introduction was considered by many as one of the most successful new product launches in history, and had single-handedly floated Porsche sales mos in recent years.The Cayennes success had been even more dramatic given much pre-launch reproach that the market would not support such a high-priced SUV, particularly one which shared a strong blood-line with the Volkswagen (VW) Touareg. The Porsche Cayenne and VW Touareg had been adjunctionly developed by the two companies. The two vehicles shared a commonalty chassis, and in fact were both manufactured at the same factory in Bratislava, Slovakia. To preserve its rum identity, however, Porsche shipped the Cayenne chassis 17 hours by rail to its facility in Leipzig, Germany, where the engine, drive Porsche Stays on Course, Dr.Wendelin Wiedeking, President and Chief Executive Officer, Porsche Annual Report 2003/04, p. 5. 2 4 TB0067 train, and interior were combined in final assembly. 3 A new six-cylinder version was introduced in 2004 to buoy Cayenne sales after the initial boom of the introduction year, by offering a significantly cheaper model choice. 4 As illustrated by certify 2, Porsches platform innovations had successfully grown sales volumes over the past decade. Exhibit 2 Units 0,000 80,000 70,000 60,000 50,000 40,000 30,000 20,000 10,00 0 0 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 Note Excludes sales of the discontinued 928 and 944/968 models in 1994-1996. These models totaled 1005 in 1995 and 104 in 1006. 911 sales in 2004 and 2005 include 222 and 660 Carrera GTs, respectively. Porsches Expanding Platforms and Growing Sales 911 Boxster Cayenne Panamera. On July 27, 2005, Porsche announced that it would proceed with the nurture and production of a fourth major modelthe Panamera. The name was derived from the legendary Carrera Panamericana long-distance road play held for many years in Mexico.The Panamera would be a premium class, four-door, four- situation sports coupe, and would compete with the premium sedan models produced by Mercedes Benz and Bentley. Pricing was judge to begin at $125,000, rising to $175,000. Production was scheduled to begin in 2009 at a scale of 20,000 units per year. This new model would give Porsche a competitive element in every major premium-product market segment. The M ost Profitable Automobile gild in the World Porsches financial performance and health, by auto manufacturer standards, European or elsewhere, was excellent.It was clearly the smallest of the major European-based manufacturers with total sales of 6. 4 billion in 2004. 5 This was in comparison to DaimlerChryslers 142 billion in sales, and Volkswagens The engine was, in fact, the only part of the Cayenne which was actually manufactured by Porsche itself. All other components of the vehicle were either outsourced or built in conjunction with other manufacturers. 4 The six-cylinder engine, however, was actually a Volkswagen engine which had been reconfigured. This had led to significant debate, as Porsche was criticized for degrading the Porsche brand. Comparing Porsches financial results with other major automakers is problematic. First, Porsches fiscal year ends July 31. Hence Porsches financial results for 2004 reported in Exhibit 3 are those for the August 1, 2003, through July 31, 2004, period. Secondly, Porsche announced that beginning with the 2004/05 period, which ended July 31, 2005, it would move to InternationalFinancial Reporting Standards (IFRS), rather than the German Commercial Code and special accounting requirements of the German Stock Corporation Law (German Generally true Accounting Principles) which it has followed since it went public in 1984.These results will not be comparable to previous reporting years, and will require both Porsche and its analysts to reconstruct its financial history following IFRS. 3 TB0067 5 89 billion. But, as illustrated in Exhibit 3, Porsche was outstanding by all metrics of profitability and return on invested capital. Porsches EBITDA, EBIT, and net income margins were the highest among all European automakers in 2004. 6 What also always stood out about Porsche was the average revenue per vehicle. At 83,671, only DaimlerChrysler was even close. Exhibit 3 European Automaker BMW DaimlerChrysler Fiat Peugeot Porsche Renault VolkswagenPorshes Competitive Positioning, 2004 Earnings Measures Sales (millions) 44,335 142,059 46,703 56,797 6,359 40,715 88,963 Revenue per vehicle 39,622 78,056 28,844 19,354 83,671 19,291 18,369 EBITDA 5,780 10,280 2,190 4,502 1,665 4,414 7,140 EBIT 3,745 4,612 22 1,916 1,141 2,148 1,620 Net Income 2,222 2,466 - 1,586 1,357 616 3,551 677 EBITDA Margin 13. 0% 7. 2% 4. 7% 7. 9% 26. 2% 10. 8% 8. 0% Margin Measures EBIT Net Income Margin Margin 8. 4% 5. 0% 3. 2% 1. 7% 0. 0% -3. 4% 3. 4% 2. 4% 17. 9% 9. 7% 5. 3% 8. 7% 1. % 0. 8% Source European Autos, Deutsche Bank, July 20, 2005 Porsche, Deutsche Bank, September 26, 2005 Thomson Analytics compose estimates. Renaults results included 343 million in extraordinary income in 2004, accounting for net income exceeding EBIT. Porsches financial results, however, had been the subject of substantial debate in recent years as upwards of 40% of operating earnings were thought to be derived from curre ncy hedging. Porsches cost-base was sublimately European euro it produced in only two countries, Germany and Finland, and both were euro area members.Porsche believed that the quality of its engineering and manufacturing were at the core of its brand, and it was not willing to move production beyond Europe (BMW, Mercedes, and VW had all been manufacturing in both the United States and Mexico for years). Porsches sales by currency in 2004 were roughly 45% European euro, 40% U. S. dollar, 10% British pound sterling, and 5% other (primarily the Japanese yen and Swiss franc). Porsches leadership had undertaken a very aggressive currency hedging strategy beginning in 2001 when the euro was at a record low against the U.S. dollar. In the following years, these financial hedges (currency derivatives) proved extremely profitable. For example, nearly 43% of operating earnings in 2003 were thought to have been derived from hedging activities. Although profitable, many analysts argued the com pany was increasingly an investment banking firm rather than an automaker, and was heavily exposed to the unpredictable fluctuations between the worlds two most powerful currencies, the dollar and the euro. Exhibit 4 European Automaker BMW DaimlerChrysler Fiat Peugeot Porsche Renault VolkswagenReturn on Invested jacket crown (ROIC) for European Automakers, 2004 Operating Margin Sales (millions) 44,335 142,059 46,703 56,797 6,359 40,715 88,963 EBIT 3,745 4,612 22 1,916 1,141 2,148 1,620 Taxes 1,332 1,177 - 29 676 470 634 383 EBIT After-tax 2,413 3,435 51 1,240 671 1,514 1,237 Interest Bearing debt 1,555 9,455 24,813 6,445 2,105 7,220 14,971 Invested great Stockholders equity 17,517 33,541 5,946 13,356 2,323 16,444 23,957 Invested Capital 19,072 42,996 30,759 19,801 4,428 23,664 38,928 Capital Turnover 2. 2 3. 30 1. 52 2. 87 1. 44 1. 72 2. 29 ROIC 12. 65% 7. 99% 0. 17% 6. 26% 15. 15% 6. 40% 3. 18% Source European Autos, Deutsche Bank, July 20, 2005 Porsche, Deutsche Bank, September 26, 2005 Thomson Analytics author estimates. Invested Capital = total stockholders equity + gross interest-bearing debt. Capital employee turnover = sales/invested capital. ROIC (return on invested capital) = EBIT taxes/invested capital. ROIC. It was Porsches return on invested capital (ROIC), however, which had been truly exceptional over time.The companys ROIC in 2004following Deutsche Banks analysis presented in Exhibit 4was 15. 15%. This was clearly superior to all other European automakers BMWs ROIC was second highest at 12. 65%. Other major European automakers struggled to reach 6% to 7%. EBITDA (earnings before interest, taxes, depreciation, and amortization) is frequently used as the income measure of pure business profitability. EBIT (earnings before interest and taxes) is similar but is reduced by depreciation and amortization charges associated with capital asset and goodwill write-offs. 6 6 TB0067This ROIC reflected Porsc hes two-pronged financial strategy 1) superior margins on the designate but selective product portfolio and 2) leveraging the capital and capabilities of manufacturing partners in the maturation and production of two of its three products. The company had successfully exploited the two primary drivers of the ROIC formula ROIC = EBIT after-tax Sales x Sales Invested Capital The first component, operating profits (EBIT, earnings before interest and taxes) after-tax as a percent of salesoperating marginwas exceptional at Porsche due to the premium value pricing derived from its global brand of quality and excellence.This allowed Porsche to charge premium prices and achieve some of the largest of margins in the auto industry. As illustrated in Exhibit 4, Porsches operating profits after-tax of 671 million produced an operating margin after-tax of 10. 55% (671 divided by 6,359 in sales), the highest in the industry in 2004. The second component of ROIC, the capital turnover ratio (sale s divided by invested capital) velocityreflected Porsches manufacturing and assembly strategy.By leveraging the Valmet and VW partnerships in the design, production, and assembly of both the Boxster (with Valmet of Finland) and the Cayenne (with Volkswagen of Germany), Porsche had achieved capital turnover ratios which dwarfed those achieved by any other European automaker. Porsches capital turnover ratio had surpassed all other European automakers consistently over the past decade. As illustrated by Exhibit 5, Porsches growing margins and relatively high velocity had sustained a very impressive ROIC for many years. In recent years, however, invested capital had risen faster than sales.But Porsche was not adding rigid assets to its invested capital basis, but cash. The rising cash reliefs were the result of bear profits (undistributed to shareholders) and new debt issuances (raising more than 600 million in 2004 alone). As a result, fiscal 2003/04 had proven to be one of Porsche s poorest years in ROIC. Exhibit 5 2. 5 Porsches Velocity, Margin, and ROIC Margin amp ROIC 20% Velocity = Sales/Invested Capital 2. 15 2. 0 2. 12 Velocity 1. 97 1. 99 1. 81 18% 1. 91 ROIC (Operating Margin X Velocity) 14. 2% 12. 5% 11. 7% 11. 6% 10. 5% 1. 19 10. 5% 1. 21 9. % 11. 6% 13. 8% 16% 12. 9% 1. 5 14% 12. 6% 11. 9% 12% 10% 1. 0 8. 0% 6. 1% Operating Margin 6. 4% 6. 0% 6. 4% 8% 0. 91 0. 84 6% 0. 5 3. 8% 2. 0% 3. 7% 4% 2% 0. 0 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 0% Operating margin = ( EBIT Taxes ) / Sales. Invested capital = cash + net working capital + net fixed assets. Porsches minimum levels of invested capital resulted from some rather unique characteristics. Invested capital is delimitate a number of ways, but Vesi used her employers standardized definition of cash plus net working capital plus net fixed assets. As illustrated in Exhibit 6, Porsches invested capital base TB0067 7 had been growing rapidly in recent years, but not because of additional fi xed asset investments. Porsches invested capital was growing primarily because of its accumulation of cash. 8 Vesi was concerned that using this measure of invested capital led to a distorted view of the companys actual performance. Porsches minimal fixed-asset capital base resulted from the explicit strategy of the company as executed over the past decade.The developing and manufacturing and assembly of the Cayenne was a clear example Porsche had spent only $420 million in the development of the Cayenne. Auto analysts estimated that any other major automaker would have spent between $1. 2 and $1. 8 billion. Porsche had effectively avoided these be and investments by co-producing the Cayenne with Volkswagen. The Cayenne shared some 65% of its parts and modules with the VW Touareg, with only 13% of the Cayennes actual wholesale value being derived from parts developed and manufactured by Porsche itself. The production agreement between Porsche and VW made VW responsible for all c osts associated with quality problems arising at VWs manufacturing facilities. Porsche paid VW a unit price for each Cayenne body produced in VWs assembly facility in Bratislava, Slovakia. Porsche had successfully off-loaded both cost and risk. Exhibit 6 Asset social organization funds Net working capital Net fixed assets Invested capital Liability Structure short debt Long-term debt centre debt Equity Invested capital Porsches Managerial correspondence Sheet (millions of euros) 996 227 38 487 753 1997 281 116 578 975 1998 466 132 590 1,188 1999 730 225 649 1,604 2000 823 258 755 1,835 2001 1,121 369 960 2,449 2002 1,683 (355) 2,746 4,073 2003 1,766 (382) 3,215 4,599 2004 2,791 403 3,797 6,992 2005 4,325 (131) 3,641 7,834 8 19 27 726 753 7 124 131 844 975 10 114 124 1,064 1,188 52 107 159 1,445 1,604 20 82 102 1,733 1,835 158 (49) 108 2,341 2,449 137 850 987 3,086 4,073 70 859 929 3,670 4,599 649 1,641 2,290 4,702 6,992 1,107 2,026 3,133 4,701 7,834Net working capital = accounts receivable, inventories, and prepaid expenses, less accounts payable and accured expenses. This assumes provisions for risk and charges as equity. Porsche Changes Tack The summer and fall of 2005 saw a series of surprising moves by Porsche. First, Porsche announced that the 1 billion investment to design and manufacture the new Panamera would be largely funded by the company itself. Although the introduction of the Panamera had been anticipated for quite some time, the market was surprisald that Porsche intended to design and build the carand its manufacturing facilitynearly totally in-house.The new sports coupe was to be produced in Leipzig, Germany, at the existing Porsche facility, although a substantial expansion of the rig would be required. As contend to the previous new product introductions, the Boxster and the Cayenne, there would be no major production partner involved. Porsche CEO Wendelin Wiedeking specifically noted t his in his press release There are no plans for a joint venture with another car maker. But to ensure the profitability of this new model series, we will support more closely than so far with selected system suppliers. 9 The German share of the value of the Panamera would be roughly 70%. Like the 911, Boxster, and Cayenne, the Panamera would bear the Made in Germany stamp. This methodology defines invested capital by assets, the left side of the managerial symmetricalness sheet. Alternative definitions of invested capital focus on the right-hand side of the balance sheet for example, as stockholder equity plus interest-bearing debt. Either version can also be netted for cash holdings under different methods. 8 Porsches cash and marketable securities grew from 2. billion in 2004 to over 4. 3 billion at the end of 2005 (July 31, 2005). Credit Suisse First Boston had in fact noted on September 21, 2005, just days before the VW announcement, that, In our view, the only dashing hopes is that management indicated that the company would not look into returning cash to shareholders in the next 18 months. 9 Go Ahead for Porsches Fourth Model Series, Porsche Press Release, July 27, 2005. 7 8 TB0067 The second surprise occurred on September 25, 2005, with the announcement to invest 3 billion in VW.Porsche AG, Stuttgart, seeks to acquire a share of approximately 20 percent in the stock capital of Volkswagen AG, Wolfsburg, entitled to vote. Porsche is taking this decision because Volkswagen is now not only an important development partner for Porsche, but also a significant supplier of approximately 30 percent of Porsches sales volume. In the words of Porsches President and CEO Making this investment, we seek to secure our business relations with Volkswagen and make a significant contribution to our own prospective plans on a lasting, long-term basis. Porsche is in a position to finance the acquisition of the plotted share in Volkswagen through its own, existing liqui dity. After careful examination of this business case, Porsche is confident that the investment will prove profitable for both parties. The planned acquisition is to ensure that there will not be a hostile takeover of Volkswagen by investors not committed to Volkswagens long-term interests. In the words of Porsches President and CEO Our planned investment is the strategic answer to this risk.We wish in this way to ensure the independence of the Volkswagen Group in our own interest. This German solution we are pursuance is an essential prerequisite for stable development of the Volkswagen Group and, accordingly, for continuing our cooperation in the interest of both Companies. scholarship of Stock to Secure Porsches Business, Porsche AG (press release), September 25, 2005. Porsche would spend approximately 3 billion to take a 20% monomania position in VW. This would make Porsche VWs single largest investor, slightly larger than the government of Lower Saxony. 0 It clearly elimi nated any possible hostile acquisitions which may have been on the horizon (DaimlerChrysler was rumored to have been interested in raiding VW. ) The announcement was met by near-universal opposition The family linkages between the two companies were well known. Ferdinand K. Piech, one of the most prominent members of the Piech family which, along with the Porsche family, controlled Porsche, was the former CEO (he retired in 2002) and still prexy of Volkswagen. He was the grandson of Ferdinand Porsche, the founder of Porsche.Accusations of conflict of interest were immediate, as were calls for his resignation, and the denial of Porsches request for a seat on VWs board. Although VW officially welcomed the investment by Porsche, Christian Wulff, VWs board member representing the accede of Lower Saxony where VW was headquartered, publicly opposed the investment by Porsche. In the eyes of many, the move by Porsche was a return to German corporate cronyism. For years, Deutschland AG was emblematic of the cosy network of cross-shareholdings and shared non-executive directorships that insulated Germany from international capitalism.Wendelin Wiedeking, Porsches chief executive, himself invoked the national angle, saying this German solution was essential to secure VW, Europes largest carmaker, against a possible hostile takeover by short-term investors. Shield for Corporate Germany or a Family Affair? VW and Porsche Close Ranks, Financial Times, Tuesday, September 27, 2005, p. 17. Germany, although long known for complex networks of cross-shareholdings, had effectively unwound most of these in the 1990s.The German government had successfully accelerated the unwinding by making most cross-shareholding liquidations tax-free in recent years, and both the financial and nonfinancial sectors had sold literally billions of euros in shares. This move by Porsche and VW was seen as more of a personal issueFerdinand Piechrather than a national issue of German alliances. Many P orsche investors had agreed, rivalry that if they had wanted to invest in VW, they would have done it themselves. The resulting ownership structure of Volkswagen in October 2005 was 18. 3% Porsche 18. 2% State of Lower Saxony 13. 0% Volkswagen 8. 58% Brandes Investment Partners 3. 5% Capital Group and 38. 19% widely distributed. Porsche still possess the option to purchase another 3. 4%. 10 TB0067 9 There were also potential strategic conflicts between the two companies. Volkswagens premium segment company, Audi, was a evident competitor to Porsche, particularly in light of the new Panamera project. VW itself had fallen on poorly times (see Exhibit 3), and many VW watchers believed that the company needed activist shareholders.VW and its Audi unit were both suffering from high wage costs in German factories, and VW had been seeking wage concessions from many of its unions to regain competitiveness and profitability. Porsche had a reputation of being soft on German unions, and wit h the growing presence of both Porsche and Ferdinand Piech, critics feared VW would back away from its wage-reduction push. Porsche was not expected to be as cost-conscious or to push VW to make drastic strategic changes.Instead, Porsche was expected to push VW to ensure a number of the new models and platforms Porsche was in the process of introducing. There were, in fact, lingering allegations that a number of VWs new product introductions had been delayed by the Cayennes production in 2003 and 2004. Shareholders in Porschethe nonfamily-member shareholderswere both surprised and confused by this dramatic turn of events. Although the arguments for solidifying and securing the Porsche/ VW partnership were rational, the cost was not.At 3 billion, this was seemingly an enormous investment in a nonperforming asset. Analysts concluded that the potential returns to shareholders, even in the form of a special dividend, were now postponed indefinitely shareholders would not see the money for years to come. The move was also seen by some as an acknowledgment by Porsche that it could no longer expand into new product categories without significantly larger capital and technical resources. Automotive electrical systems, for example, were increasingly complex and beyond capabilities possessed in-house by Porsche.The interest in VW, Europes second largest automaker to DaimlerChrysler, would surely provide the company with access to key resources. But why werent these resources accessible through partnerships and alliances, without the acquisition of one-fifth ownership in Europes largest moneyloser? The announcement of Porsches intention to take a 20% equity interest in Volkswagen in September 2005 was greeted with outright opposition on the part of many shareholders in both Volkswagen and Porsche. Major investment banks like Deutsche Bank immediately downgraded Porsche from a buy to a sell, argue that the returns on the massive investment, ome 3 billion, would likely n ever accrue to shareholders. 11 Although Porsche and VW were currently co-producing the Porsche Cayenne and Volkswagen Touareg, this ownership interest would take the two companies far down a path of cooperation way beyond the manufacture of a sport utility vehicle. Although Porsche had explained its investment decision to be one which would assure the stability of its future cooperation with VW, many critics saw it as a choice of preserving the stakes of the Porsche and Piech families at the expense of nonfamily shareholders.The question remained as to whether this was indeed a good or bad investment by Porsche, and good or bad for whom? Vesi wondered if her position on Porsche might have to, in the end, distinguish between the companys ability to generate results for stockholders versus its willingness to do so. Why should a small and highly profitable maker of sports cars suddenly full stop its fortunes to a lumbering and struggling mass-producer? That was the question that some alarmed shareholders asked this week when Porsche, the worlds most profitable carmaker, announced plans to buy 20% stake in Volkswagen (VW), Europes biggest carmaker.To some critics of the deal, Porsches move looked like a return to cosy, German corporatism at its worst. Since January 2002, when a change in the uprightness encouraged German companies to sell their cross-shareholdings in each other, free of capital gains tax, new foreign shareholders have often shaken up fossilised German management. A deal with friendly compatriots from Porsche might saving VW from this distasteful fate, particularly since foreign hedge funds and corporate raiders have been rumored to be circling VW. Business guardianship It in the Family, The Economist, October 1, 2005. 1 Porsche We may never see the cash downgrade to sell, Deutsche Bank, September 26, 2005. TB0067 10 Appendix 1 (Millions of euros) Sales Cost of goods sold Gross profits Porsches Statement of Income, 1996-2005 (period ending Jul y 31) 1996 1,438 1,177 261 243 15 64 97 6. 8% 68 29 2. 0% 3 26 1 0 25 1. 7% -1997 2,093 1,648 446 339 21 67 195 9. 3% 108 87 4. 2% 7 81 9 1 70 3. 4% 45. 6% 40. 0% 1998 2,519 1,853 667 439 17 88 334 13. 2% 157 176 7. 0% 13 164 22 142 5. 6% 20. 4% 12. 4% 1999 3,161 2,154 1,007 571 29 84 550 17. % 184 366 11. 6% 12 354 164 191 6. 0% 25. 5% 16. 3% 2000 3,648 2,527 1,121 625 26 114 636 17. 4% 197 439 12. 0% 12 427 220 207 5. 7% 15. 4% 17. 3% 2001 4,441 3,062 1,380 793 61 87 735 16. 5% 133 602 13. 6% 14 588 318 270 6. 1% 21. 8% 21. 2% 2002 4,857 2,981 1,877 914 79 110 1,152 23. 7% 279 873 18. 0% 48 825 363 (0) 462 9. 5% 9. 4% -2. 6% 2003 5,582 3,250 2,332 1,187 116 147 1,409 25. 2% 392 1,017 18. 2% 88 928 363 0 565 10. 1% 14. 9% 9. 0% 2004 6,359 3,787 2,572 1,254 99 248 1,665 26. % 525 1,141 17. 9% 58 1,082 470 (4) 616 9. 7% 13. 9% 16. 5% 2005 6,574 3,501 3,073 1,539 172 169 1,875 28. 5% 510 1,365 20. 8% 127 1,238 459 (4) 783 11. 9% 3. 4% -7. 6% Selling, general & admin expenses Non-operating income Other income/expense, net EBITDA EBITDA/sales Depreciation & amortization Earnings before interest and tax EBIT/sales Interest expense on debt Earnings before taxes (EBT) Income taxes Minority interest Net income availabe to common Net income/sales (ROS) Sales growth Earnings growthSource Thomson Analytics, June 2006, and author calculations. Appendix 2 (Millions of euros) Assets Cash amp equivalents Receivables, net Inventories Prepaid expenses Total current assets Porsches Balance Sheet, 1996-2005 (period ending July 31) 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 227 91 199 23 540 0 60 1,324 917 407 21 1,027 281 170 297 47 795 12 5 1,536 994 541 20 1,374 466 196 328 37 1,027 10 5 1,623 1,062 561 14 1,617 730 202 357 42 1,332 30 9 1,683 1,183 501 110 1,981 823 321 396 45 1,585 177 14 1,797 1,310 487 76 2,340 1,121 439 468 29 2,056 253 38 1,960 1,399 561 108 3,016 1,683 638 487 50 2,858 539 39 3,607 1,652 1,955 214 5,604 1,766 823 539 42 3,170 552 42 4,122 1,847 2,276 346 6,385 2,791 939 726 23 4,479 733 21 4,724 2,116 2,607 436 8,276 4,325 971 572 17 5,885 1,211 27 4,486 2,378 2,108 295 9,525Long term receivables Investments in unconsol subsidiaries Property, plant amp equipment, gross Accumulated depreciation Property, plant amp equipment, net Other assets Total Assets Liabilities Accounts payable ST debt amp current portion due LT debt Income taxes payable Other current liabilities Current liabilities, total Long term debt Provision for risks amp charges Deferred taxes Other liabilities Total liabilities Shareholders Equity Non-equity reserves & minority interest Common Equity Shareholders equity, total Total liabilities amp shareholders equity Common shares outstanding (millions) 117 8 3 156 283 17 481 1 1 782 148 7 10 241 406 116 541 4 4 1,071 159 10 8 262 439 114 648 n/a 0 1,202 193 52 10 174 429 102 856 n/a 5 1,392 240 20 17 248 525 102 951 (22) 2 1,558 236 158 28 303 725 0 1,312 (52) 2 1,987 305 137 200 1,027 1,668 317 1,619 97 437 4,138 337 70 71 1,378 1,856 337 1,916 173 350 4,631 368 649 61 855 1,933 1,457 2,378 182 2 5,953 440 1,107 187 1,064 2,798 1,985 1,281 36 5 6,105 10 235 245 1,027 17. 5 298 303 1,374 17. 5 0 416 416 1,617 17. 5 2 587 589 1,981 17. 5 0 782 782 2,340 17. 5 0 1,028 1,028 3,016 17. 5 1 1,466 1,467 5,604 17. 5 ( 0) 1,755 1,755 6,385 17. 5 6 2,317 2,323 8,276 17. 5 8 3,412 3,420 9,525 17. 5 Source Thomson Analytics, June 2006, and author calculations. TB0067 11 Appendix 3 (Millions of euros) Porsches Statement of Cash Flow, 1996-2005 (period ending July 31) 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005Operating Activities Income before extraordinary items Depreciation & amortization Other Cash Flow Funds From/For Other Operating Activities Net Cash Flow From Operating Activities Investing Activities Capital Expenditures Additions To Other Assets Increase In Investments Disposal of Fixed Assets Net Cash Flow From Investing Activities financial backing Activities Net Proceeds From Sales/Issue of Com/Prf Stock Com/Prf Purchased,Retired,Converted,Redeemed Long Term Borrowings Inc(Dec) In ST Borrowings Reduction In Long Term Debt Cash Dividends Paid Total Net Cash Flow From Financing Activities Exchange Rate Effect Cash & Cash Equivalents Inc(Dec) 25 74 47 26 171 71 127 (0) 22 220 142 157 (7) 72 363 191 184 23 (5) 392 210 197 11 (22) 396 270 133 16 151 570 462 279 26 611 1,377 565 392 423 77 1,456 612 525 515 (349) 1,303 779 510 42 (157) 1,175 ( 184) (15) (14) ( 214) ( 230) n/a n/a ( 230) ( 174) (2) (0) 10 ( 166) ( 145) (12) (7) 27 ( 136) ( 257) n/a n/a 8 ( 249) ( 306) n/a (1) 23 ( 285) ( 1,833) 831 ( 1,002) ( 1,338) n/a 309 ( 1,028) ( 1,265) n/a 478 ( 787) ( 851) (63) (243) 226 ( 932) 0 6 1 8 (30) 0 102 (33) (5) 64 54 0 (13) ( 13) 185 0 49 (21) (22) 6 1 2 63 0 (36) (22) ( 58) 4 93 0 37 (26) 11 2 298 0 339 (102) (45) 192 (5) 562 0 (39) (297) ( 336) (8) 84 0 639 n/a (0) (59) 580 5 1,025 6 147 (69) 84 (32) 296 Source Thomson Analytics, November 2005, and author calculations. Appendix 4 Porsche Dispenses with Listing in New York Stuttgart. The preferred stock of Dr. Ing. h. c. F. Porsche AG, Stuttgart, will continue to be listed exclusively on German stock exchanges. All considerations about gaining an additional list in the U. S. A. have been laid aside by the Porsche visiting card of Management. The sports car manufacturer had been invited to join the New York Stock Exchange at the beginning of the year. The Chairman of the age of Management at Porsche, Dr.Wendelin Wiedeking explained the decision The idea was certainly attractive for us. But we came to the conclusion that a listing in New York would hardly have brought any benefits for us and our shareholders and, on the other hand, would have led to considerable extra costs for the company. The crucial factor in Porsches decision was ultimately the law passed by the U. S. government this summer (the Sarbanes-Oxley Act), whereby the CEO and the Director of Finance of a public hold company listed on a stock exchange in the U. S. A. have to swear that every balance sheet is correct and, in the case of incorrect specifications, are personally liable for high financial penalties and even up to 20 years in prison.In Porsches view, this new American ruling does not match the legal position in Germany. In Germany, the annual financial statement is passed by the entire Board of Management and is then presented to the Supervisory Board, after being audited and certified by undertake accountants. The chartered accountants are commissioned by the general meeting of shareholders and they are obliged both to report and to demo the annual financial statement to the Supervisory Board. The annual financial statement is only passed after it is approve by the Superviso ry Board. Therefore there is an overall responsibility covering several different committees and, as a rule, involving over 20 persons, including the chartered accountants.The Porsche Director of Finance, Holger P. Harter, made the following comments Nowadays in Germany, the see falsification of balance sheets is already punished according to the relevant regulations in the Commercial Code (HGB) and the Company Act (Aktiengesetz). Any special treatment of the Chairman of the Board of Management of the Director of Finance would be illogical because of the intricate network within the decision-making process it would also be irreconcilable with current German law. Source Porsche, News Release of October 16, 2002. 12 TB0067 Appendix 5 Porsches Share Price, 2004-2006 Source www. porsche. com. TB0067 13