Caveats up front:
1) Much of the value in VW is contingent on the correct evaluation of Porsche (this is where financial engineering in the form of a pair trade [it is not an arb, it is not an arb] might be of some value)
2) It can sometimes take a very long time for the market to come around to your way of thinking, you have to understand this going in or you are apt to get bored/lazy/scared and sell before the perceived value has manifested out of your head and into the price, to get a bit new-agey.
From Smead Capital Management:
Dial P911 for Value in Porsche and VW
Dear fellow investors,
If you were walking down the street and saw a $100 bill just sitting near the curb, would you pick it up? Academia would argue that the $100 bill isn’t there. If it were real, it would have already been picked up by someone else. It remains to be asked that should you be standing there over the crisp bill, would you take it?
Most stock market participants believe that markets are there to instruct you, not serve you. The investors of Smead Capital Management believe the contrary and are looking for ways to allow the market to serve us. If we believe the market is giving us $100, we attempt to grab it quickly from the street.
Starting back in September of 2018, we began looking at Porsche SE (PAH3 GY) as that $100 bill on the curb of the stock market. At the time, investors could see that they could buy Porsche SE and get a discount to their holdings of the Volkswagen ownership (VOW GY). There were dangers that held investors from piling in. For one, Porsche had tried to merge with Volkswagen unsuccessfully back in 2008. If you want to understand this, check out this link. Then in 2015, it came to light that Volkswagen was cheating on their diesel emissions. The question turned to whether their large owner, Porsche SE, and its leadership were culpable. This left an investor looking at a classic family-led holding company discount with contingent liabilities possibly in the future.
During that time, people talked about the value of the assets that Volkswagen owned like Porsche, Audi and others. The idea of these being spun out or sold were looked at as fantasy or only for deep-value dreamers. In our discussion with the investor relations person at Porsche SE, we asked if the Porsche and Piëch family would be interested in owning more of Volkswagen, as it looked attractive to us. The answer was no. They were interested in other projects, and they didn’t consider that to be a place to allocate capital.
Then in the first quarter of 2019 something very interesting happened. Porsche SE began buying Volkswagen. They acquired 2,006,610 shares during the quarter of the voting share (VOW GY). In the 2019 annual report, they stated:
Porsche SE supports Volkswagen AG with its “TOGETHER 2025+” strategy, which entails both the transformation into a digital technology group as well as increasing the company value. In the past fiscal year, we demonstrated by increasing our investment in Volkswagen Group that we at Porsche SE are convinced of the potential for increasing value added. Our 53.1 percent stake in the ordinary shares in Volkswagen guarantees a stable ownership structure.
Despite what we were told prior, the news of this purchase was also coming with a partial spin-off of the Volkswagen truck division, Traton Trucks. This whetted our appetite for the story that we already liked with Porsche SE, so we began buying Volkswagen voting shares as well.
The Traton division holds brands like Scania, Man, Volkswagen Trucks and Navistar. Traton spun out 10% of the company by selling 10% to institutional investors at €28. We love strong insider owners, preferably with recent purchases. It’s the bridge between the quality and value factors. It was even better to find out that they were beginning to think about showing the market the value of the underlying companies starting with Traton.
You are probably expecting us to tell you how well that worked out, but there’s no point in writing about success. You’ll know it when you see it. Opportunities must be fought for. Traton’s stock price fizzled during 2019 and the pandemic hit causing investors to not think much about the assets of Volkswagen yet again.
Despite the near-term setback of the pandemic and having to look like complete idiots in the spring of 2020, we gained more confidence in what we owned with Porsche SE and Volkswagen because Porsche SE began buying Volkswagen voting shares again in the second quarter of 2020. Those actions took intestinal fortitude with factories completely halted.....
....MUCH MORE
For fund managers, assuming the analysis is correct, it all comes down to "How long does it take to play our" or in the words of a very wealthy investor I was talking to as he laughed about the latest 89-page investment thesis he had been sent: "I don't want all this, I want the answers to three questions: What's the upside? What's the downside? What's the time frame?".
His points are: a) Is the trade convex? i.e. does the potential reward outweigh the potential risk for equal-and-opposite upmoves/downmoves and b) What is the rate of return on capital? i.e if it doubles in a year we've made 100% and I'm taking you out on the boat for a week or two (it's a big boat), if it takes five years my return is 14.4% per annum compounded; nice but not boat-worthy.
