Porsche is an automaker holding that controls 100% of Porsche AG and officially 31% of Volkswagen ordinary shares (BBG: VOW GY), or 23% of total capital. 

We believe that Porsche offers a unique opportunity of buying a premium, niche company (Porsche AG) that resembles a “luxury goods company” and a successful turnaround story (Volkswagen) at a very attractive valuation.

We built our conviction on an extensive due-diligence over the past 18 months, including meetings with the company’s top management, industry experts and investors.

Porsche has already secured a larger stake at VW through cash-settled options. Our finding is that Porsche has at least an additional 20% of VOW through options at a strike price of € 80-100/share, well below current market prices of €150. This assumption is based on the recently reported €3.6 bn extraordinary profit booked for VW options gain as explained by Porsche’s management. Our back-of-the-envelope calculation is depicted below:

 

 

 

 

Source: Pollux Capital

 

 

With the stock down 38% since its recent high in Nov/07, the opportunity exists because of (i) over-blown market fears of the impact of a recessionary environment, (ii) Porsche’s lack of disclosure on its exact stake in VW, leading to an under-valuation of that stake, and (iii) the fact that the market is not appropriately valuing Porsche’s new product cycle based on the Panamera Project, a 4-door premium sports sedan. As happened in the past with the Cayenne SUV, this product can increase Porsche’s unit volume by more than 50% from the current 100k cars/year level.

Porsche used to be a “one product company” relying on the legendary 911 model, and focused on Western Europe (mainly Germany and UK) and the US. However, in the mid 90’s under the current management Porsche started to implement a growth strategy increasing the product line (Boxter in 1997 and the Cayenne SUV in 2002), and also expanding geographically into Emerging Markets (Asia, Russia and Eastern Europe). The result of that is that the company almost doubled the number of cars sold from FY02 to FY07 to 98k from 20/30k units in early 90’s, while at the same time posting the highest operating margins in the industry. 

Source: Company Reports; Pollux Capital

 

 

 

We value its core business (ex-Panamera) at € 650/share assuming 13x unlevered 08 earnings based on an assumption of 18% Ebit margin, which compared to historical standards is very conservative. We are also assuming that revenue growth for this FY will be only 3% despite clear indications  that could be much more (revenue for the 1H08 is up 16% on a YoY basis).

 

 

 

Source: Company Reports; Pollux Capital

 

 

We think that the Panamera will be positioned as Premium Sedan and only the top version (Turbo) will compete with Maseratti Quattroporte, Bentley and Mercedes CLS. The entry level version (V6) will be able to compete with more “regular” cars such as BMW 5 series, similar to what happened to the Cayenne. We assume price range between € 50k and € 100 k and 45k units/year (15% market share). For gross margins we adopted margins between the 911 and Cayenne (range: 33% - 48%). We arrive at an NPV of € 350/ share for this project.

 

 

As we mention at the beginning our analysis indicates that Porsche has already secured at least 51% of VW’s ordinary shares. At current market value of € 150/share of VOW, Porsche’s stake is worth € 1,020/share VOW at an acquisition price of €80/share for the undisclosed stake. Alternatively, the Porsche stub is trading at € 200/share or 4x our core business EPS of € 50 for 08 (and that does not include any volume for Panamera).

 

However the full upside can be much higher, as we believe that there is also upside for Volkswagen. Quite interesting, we suspect the Porsche opportunity exists in part because many players do not fully understand how VOW has even further upside potential – stock is up 72%  over the last 12 months vs -5% for the DJ Euro Stoxx Automobile Index. Some investors do not realize that the VOW investment case is no longer dependent on further market share gains in the zero-sum-game European market, but rather on the emerging and U.S. markets. Our target price for VOW (€ 200/share) is based on a DCF valuation, and the key assumption is the achievement of low double digit ROIC by 2010, as guided by the management which implies an EBIT of € 8.5 bn. We think this is feasible given the current operational momentum, the new management initiatives under Porsche administration, the Emerging Markets (Eastern Europe and BRICs) potential and a breakeven US operation. Under Porsche leadership, VOW management seems to have finally understood that its product offering in the U.S. must be adjusted to the American taste, potentially leading the company to get back closer to its 5% market share achieved back in the mid 90`s vs the current 2%.

 

VW’s returns are already improving due to cost cut programs and also sales growth, as evidenced in the following charts:

 

 

Source: Company 3Q07 Reports

 

 

 

Source: Company 3Q07 Reports

	Criteria	Value/Share
Porsche Core Business	13x Unl. Core EPS 08	650
VW Stake	Market Price => EUR 150/Share	1240
Net Debt (Pos VW Stake Acq.)	Price of Acq. of EUR 80/Share	-220
Value Pre-Panamera		1670
Panamera	DCF => 45k units/year	345
Value Pre-Discount		2015
Discount Pref	Assuming Pref = 0.7 x Ord	-350
Target Price		1665
Mkt Price		1180
Upside		41%

	Criteria	Value/Share
Porsche Core Business	13x Unl. Core EPS 08	650
VW Stake	DCF Based => EUR 200/Share	1640
Net Debt (Pos VW Stake Acq.)	Price of Acq. of EUR 80/Share	-220
Value Pre-Panamera		2070
Panamera	DCF => 45k units/year	345
Value Pre-Discount		2415
Discount Pref	Assuming Pref = 0.7 x Ord	-430
Target Price		1985
Mkt Price		1180
Upside		68%