Porsche Changes Tack

Yes, of course we have heard of shareholder value. But that does not change the fact that we put customers first, then workers, then business partners, suppliers and dealers, and then shareholders.
Dr. Wendelin Wiedeking, CEO, Porsche

Will Porsches new strategy actually create shareholder value?

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An Overview of Porsche AG, 2005

Porsche is a publicly traded family controlled company Porsche is a relatively simple company by product line, having three existing and one newly proposed products:
911 the only model produced and assembled completely by Porsche Boxster licensed manufacturing with Valmet of Finland Cayenne co-manufactured with Volkswagen of Germany Panamera to be completely Porsche (at least thats the plan)

Porsches profitability has been extremely impressive over the past decade particularly for an automaker Porsche has followed a strategy with both the Boxster and the Cayenne which uses a combination of licensing, out-sourcing, and in-sourcing to leverage other peoples money As a result of its strategy, Porsche has enjoyed an industry leading return on invested capital (ROIC) But two major announcements in the summer and fall of 2005 seemingly indicate that Porsche is changing directions:
The Panamera will be manufactured in-house, with Porsches own money Porsche has invested 3 billion in taking a 20% interest in Volkswagen (Germany), one of the worst performing automakers in the world

Copyright 2009 Pearson Prentice Hall. All rights reserved.

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Porsche Changes Tack: Case Questions

1. What strategic decisions made by Porsche over recent years had given rise to its extremely high return on invested capital? 2. Vesi wondered if her position on Porsche might have to distinguish between the companys ability to generate results for stockholders versus its willingness to do so. What do you think? 3. Is pursuing the interests of Porsches controlling families different from maximizing the returns to its public share owners?
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Exhibit 1 Porsches Growth in Sales, Profits and Margin

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Porsches Expanding Platforms and Growing Sales

The Cayenne was the single most successful new automobile launch in history.
Units
80,000 70,000 60,000 50,000 40,000 30,000 20,000 10,000 0 1994/95 1995/96 1996/97 1997/98 1998/99 1999/00 2000/01 2001/02 2002/03 2003/04

911

Boxster

Cayenne

Note: Excludes sales of the discontinued 928 and 944/968 models in 1994-1996. These models totaled 1005 in 1995 and 104 in 1006. Copyright 2009 Pearson Prentice Hall. All rights reserved.

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Corporate Governance at Porsche

Porsches focus is on stakeholder wealth
It has followed what is generically referred to as stakeholder wealth maximization over its history, rather than the increasingly common focus on stockholder wealth maximization common in the Anglo-American markets Stakeholder wealth maximization attempts to balance in theory the needs and returns to the multitude of corporate stakeholders stockholders, creditors, management, employees, suppliers, customers, community rather than focus solely on stockholders

Porsches focus may be one of self-interest

Porsche has frequently been accused of operating the company for the primary benefit of the Porsche and Pich families, and management, over all other stakeholder groups Rewards management in the company primarily on the basis of sales, profits, margins, and other financial measures of corporate performance rather than stock or stock options based on market performance

Porsche has continued to fight industry standards for reporting and disclosure
It has continued to report according to German accounting standards long after most other German companies, publicly traded companies, have moved to international standards It has continued to report only semi-annually, not quarterly, arguing that it does not see its business quarterly, and does not want to add to the short-term thinking common among equity investors in todays equity markets

Copyright 2009 Pearson Prentice Hall. All rights reserved.

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Managing to Metrics: ROIC

Return on invested capital is composed of two components calculated from the firms income statement and balance sheet, termed operating margin and velocity.

ROIC =

Operating Profits After-tax Sales

Sales

X
Invested Capital

Operating Margin

Velocity

In both cases, bigger is better. The larger the operating margin and the greater the velocity, the greater the return on invested capital. Traditionally, most companies focus on the operating margin, often concluding they have little capability to alter their basic velocity value. Velocity itself will change only with changes in corporate strategy including licensing and out-sourcing at Porsche, or the growing influence of in-sourcing in other industries.
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Exhibit 2 Return on Invested Capital (ROIC) for European Automakers, 2004

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Exhibit 3 Porsches Velocity, Margin, and ROIC

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What is Invested Capital?

Porsche's Managerial Balance Sheet, 2003 Assets Cash NWC Net fixed assets Liabilities & Net Worth Interest bearing debt 407 Other liabilities 3,816 Shareholders' equity 1,755 5,978 1,766 996 3,216 5,978

Porsches problem in recent years is that it has accumulated a very large cash balance. Cash is not free; it must be funded on the righthand-side of the balance sheet. If Porsche had dispensed the excess cash rather than retaining it, its invested capital base would not have grown, undermining its ROIC. Porsche has one other complicating factor: it possesses a large amount of non-interest bearing long-term liabilities, a feature of traditional German business practices.

Invested capital = Shareholders' equity + Interest bearing debt = 1,755 + 407 = 2,162 If netted for cash = 2,162 - 1,766 = 396

Porsche's Managerial Balance Sheet, 2004 Assets Cash NWC Net fixed assets Liabilities & Net Worth Interest bearing debt 2,106 Other liabilities 3,418 Shareholders' equity 2,323 7,847

2,791 1,259 3,797 7,847

Invested capital = Shareholders' equity + Interest bearing debt = 2,323 + 2,106 = 4,429 If netted for cash = 4,429 - 2,781 = 1,683

Copyright 2009 Pearson Prentice Hall. All rights reserved.

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Porsche and Volkswagen

Porsche says

The investment of 3 billion in VW is to secure its on-going and future strategic partnership with VW VW is currently responsible for roughly 30% of Porsches automotive manufacturing and assembly
See a significant conflict of interest between Porsche and VW, including prioritization of VWs and Porsches portfolio evolution, as well as the competitive conflicts between Porsche and Audi of VW A conflict of interest by Ferdinand Pich, non-executive chairman of VW, and the grandson of the founder of Porsche and a major family member of the current owners and leaders of Porsche VW is one of the two biggest underperformers in the European auto industry at present, and is in need of a strong wage reduction and cost reduction initiative which is not consistent with Porsches track record of accommodation of wage demands by auto industry workers That Porsche could have obtained the continuing services of VW and VWs technical resources in a variety of much more cost-effective (and shareholder friendly) methods That the expenditure/investment of more than 3 billion was an enormous use of corporate financial resources which would have generated better returns by simply being returned to shareholders (which had been the hope of much of the marketplace in recent years) That this decision is largely motivated by the personal ambitions and preferences and self-interests of Ferdinand Pich, rather than indicative of any significant return to German solutions or German cronyism

VW and major VW shareholders

Auto Analysts and Critics and Stockholders Argue

In the end may sustain Porsches growth and profitability success story at the expense to non-family shareholders

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Porsche Changes Tack: Case Questions

1. What strategic decisions made by Porsche over recent years had given rise to its extremely high return on invested capital?
Return on invested capital (ROIC) combines operating margins, found on the income statement, with greater capital utilization, which is derived from the balance sheet. All three Porsche product lines the 911, the Boxster, and most recently the Cayenne enjoyed high operating margins compared to nearly any other major European automobile manufacturer. The two newer product lines, the Boxster and Cayenne, had both been launched with the capital and technology embedded within other companies. The Porsche Boxster was manufactured by Valmet of Finland under a licensed manufacturing agreement allowed Porsche to effectively use other peoples money. Valmet owns its own factory and tools, and builds the Boxster for Porsche. This reduces the capital Porsche needs to support its own business significantly. The Porsche Cayenne was co-manufactured with Volkswagen. The Cayenne chassis was assembled on the same production line as the Volkswagen Touareg in Bratislava in the Slovak Republic, again greatly reducing the required capital to support Porsches business.

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Porsche Changes Tack: Case Questions

2. Vesi wondered if her position on Porsche might have to distinguish between the companys ability to generate results for stockholders versus its willingness to do so. What do you think?
This is a question which is growing in significance when investors examine the motivations and performance expectations of management in publicly traded companies. Porsche rewards management on business financial performance the numbers found on the three major financial statements and not on the markets opinion of the companys value (share price). This is considered as highly controversial because for the better part of the last 40 years academics have argued that management needs to share the same motivations, rewards, and risks as stockholders do the share price as core to investor and management returns. But Porsche has seemingly focused on executing the business with the highest of regard for the companys long-term performance and profitability (much like a family owned business), the result of which has been obviously appreciated by the market. One key point for class discussion here is whether the use of 3 billion euros to purchase a growing (and in the end controlling) position in VW was motivated by business needs to family bias? As the real results continue to roll out, it appears to be more and more of both.
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Porsche Changes Tack: Case Questions

3. Is pursuing the interests of Porsches controlling families different from maximizing the returns to its public share owners?
Yes, there is. Although the interests of family ownership and public shareholders are both based in growing and profitable and sustainable business, there is one key difference between families and markets: a focus on growth. The returns to a family from its ownership of a business are derived from distributed profits (dividends), salary and compensation (family members employed by the firm), and financial support (family members often enjoy company-owned assets and expenditures). The returns to a shareholder in a publicly traded firm are derived from dividends (dividend yield) and share price appreciation (capital gains). Although the dividend yield concept is similar, the capital gains concept of a market driving a share price upwards is much more complex and difficult to drive from a leadership perspective than what most family based businesses focus on. Clearly, in the end, one of the primary drivers of share prices is a company which promises and delivers profitable growth in both the top-line and bottom-line of the income statement. A family owned and managed business is as interested in sustainability and control as it is in rapid growth.

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Porsches announcement of its investment in VW was not well-received by the equity markets. As illustrated here, the downward spike just prior to 27.09.05 is the markets reaction to the announcement a one day loss of approximately 10% of its value which was then largely recovered, then lost again, in the following month.

Source: Porsche.com

Porsches share price performance over the 2004-2005 period, however, Recovered and was very good by all comparable measures.

Source: Porsche.com