Page last updated at 07:46 GMT, Thursday, 22 January 2009

Fast bucks: how Porsche made billions

By Emily Hughes
BBC Money Programme

Porsche dealership
Making and selling cars is just one part of Porsche's business

Porsche is world famous for its iconic sports cars.

But car manufacturing isn't the only thing the company is good at.

Last year it made six times as much on the stock market as it did making cars.

Industry insiders are only half joking when they call it a hedge fund with a carmaker attached.

Porsche says its stock market trades are only for one reason: to take it towards its long term goal, the takeover of car making giant, Volkswagen.

In October 2008, Porsche's takeover moves triggered an unprecedented stock market squeeze when it suddenly revealed it owned or had positions on more than 74% of Volkswagen shares.

The value of Volkswagen stock rocketed to more than 1,000 euros, briefly making it the most valuable company in the world.

Hedge funds, who had gambled that the value of Volkswagen shares would fall are said to have lost between 10bn and 40bn euros.

Porsche denies any wrongdoing and says that it made no profit from the squeeze, but some hedge funds are crying foul.

Now the German financial regulator, BaFin, is conducting an investigation into what it calls "suspected market abuse."

The back story

The stories of Porsche and Volkswagen have long been intertwined.

Wendelin Wiedeking
Wiedeking took the decisions, the risky decisions, to come up with new models
Arndt Ellinghorst, head of European automotive research at Credit Suisse

Ferdinand Porsche designed the iconic Volkswagen Beetle in the 1930s, a car that became an emblem of Germany's economic success throughout the world.

He then founded his own company, which became famous for making superfast sports cars.

The Porsche family still owns the company their grandfather founded and now wants to own Volkswagen itself, a company 14 times the size of Porsche.

Volkswagen owns some of the biggest names in European motoring; Seat, Audi, Lamborghini, Bugatti and Bentley.

The personalities

The recession of the early 1990s hit Porsche hard and some questioned if the company would survive.

Then, in 1993, Wendelin Wiedeking was appointed chief executive.

Together with chief financial officer Holger Haerter they are credited with turning the company around.

"Wiedeking took the decisions, the risky decisions, to come up with new models," says Arndt Ellinghorst, head of European automotive research at Credit Suisse.

They also slashed production costs, but most importantly, Mr Haerter used Porsche's cash to enter the financial markets.

He had little experience of car making, but he did bring expertise in investment management.

Through currency hedging he developed a mastery of the markets that he eventually turned towards Porsche's end goal; the take over of Volkswagen.

"Porsche does not have the research and development budget to come up with really the key innovations of the industry," says Mr Ellinghorst.

A takeover of Volkswagen would mean access to its huge production facilities, its technology and,most importantly, its cash.

VW Law

In 2005, Porsche quietly started to increase its stake in Volkswagen.

Volkswagen shares
Porsche has been accused of speculating in Volkswagen shares

By September 2008 it had acquired 35.14% of Volkswagen shares.

Whilst Porsche stated publicly its long term goal was a takeover, insiders knew this goal was stymied by a peculiar anomaly: the VW Law.

The VW Law essentially protects Volkswagen from hostile take over.

It means that an 80% majority is needed to make "significant decisions" at annual meetings.

This gives the local state government of Lower Saxony, owning 20.1% of the shares, a blocking majority.

Porsche needs to overturn this law before it can reach its ambitious goal.

It is applying the pressure on both the EU and the German government to do this.

While the VW Law is still in place there is consensus among market insiders that there is little point in Porsche increasing its stake in Volkswagen, but sometimes things are not quite what they seem.

Short selling

By July 2008 the credit crunch was hitting the car industry hard and car company share values were plummeting around the world.

But Volkswagen's were remaining stubbornly high.

Porsche Panamera
Porsche would gain from Volkswagen's expertise and finances

Hedge fund managers calculated that Volkswagen shares could not remain so high indefinitely and believed there was an opportunity to make some cash by short selling the shares - borrowing Volkswagen shares off a third party in the expectation that the price would fall so they would be able to buy them back cheaper, later and pocketing the difference.

Volkswagen shares became some of the most "shorted" stocks in Europe.

But despite the downturn, by the end of the summer it was clear there was something peculiar about Volkswagen shares.

The price was not dropping and the reason was about to be revealed.

The bombshell

On Sunday 26 October 2008, Porsche dropped a bombshell.

It announced it had increased its stake in Volkswagen to 42.6% and held cash settled options on a further 31.5% - meaning it had positions on up to 74.1% of all Volkswagen shares.

It seemed it had effectively cornered the market and short sellers who needed to buy back shares to close their positions were forced to fight over the remaining available stock.

How did it happen?

Porsche was able to build its secret holding by using financial instruments called cash settled call options.

Call options essentially give the buyer the option to buy shares at a competitive price at a future fixed date.

A cash settled call option enables the buyer to either take delivery of the share, or the difference between the strike price agreed when the option was bought and the market price when deal is settled.

The buyer can then use this money to purchase the share on the open market.

Porsche proved to be masters at this type of transaction, which, as long as it got the bets right and Volkswagen prices continued to rise, let it buy Volkswagen shares at favourable prices.

In the UK, any increase in share holdings to more than a 30% stake in a company has to be disclosed, whether you do it through cash settled call options or not.

This is not the case in Germany and this enabled Porsche to build up its position in secret.

Winners and Losers

Investors who were caught short have questioned Porsche's behaviour and the timing of its announcement of its secret positions in Volkswagen shares.

This is now being investigated by the German regulator, BaFin.

Porsche denies all wrongdoing and says its strategy was driven by its goal of taking over Volkswagen, not the wish to make profits from financial speculation.

It says it has invested the profits it made from the squeeze into purchasing more Volkswagen shares outright.

Fast Bucks: How Porsche made Billions, 19.30 Thursday 22 January 2009.

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