The Raider And The Behemoth

Mergers and acquisitions are all over the news. Companies buy each others using every imaginable method in a plethora of deals. Some go through and some fail for reasons as diverse as price, lack of synergy, appearance of an outbidder, anti-trust regulation etc.

Corporations are thirsty for this kind of deals because they have so much to offer. From gobbling up a competitor to increase market share, buying a startup to snap it out of a competitor's reach or acquiring a promising piece of technology many strategic reasons stand as a basis of such spectacular events.

While a number of buyouts are a fruit of collaboration between two companies there are many cases when it looks more like a scene from a battlefield. This is when companies are raided and taken over against the will of the management.

An example of this corporate behaviour involved the car company Volkswagen. These days its reputation is tainted by the carbon emissions manipulation scandal but a few years earlier it made the news for another reason.

Thanks to the involvement of luxury car company Porsche, Volkswagen briefly became the most valuable company it the world by market capitalisation.

Porsche tried its hand at a gargantuan task akin to the operations frequently executed by investment funds. Taking over Volkswagen which is many times larger in every possible way. VW produces and sells more cars, employs more people and is more valuable.

This operation involved extensive use of options on VW stock in a concealed takeover attempt shielding the acquirer's plans until the last moment.

After falling into economic difficulties during the early nineties Porsche was able to redress the situation under new management. The latter was able to put it in the black which was a first for a company mared by losses for many years.

The company launched new models that propped it in the car market notably the more affordable boxter which opened a new segment of clients and another model which surfed on the new and profitable SUV trend. Porsche became more and more dependent on Volkswagen since it used it technology and chassis to build its own models.

Bolstered by its success, it's profits and promising potential it set its eye on VW. The latter's shares were trading at low levels for a total market capitalisation of $17 billion. Porsche started buying VW shares in 2005 to acquire a complete control of the company. It announced at first the purchase of a 20% stake for $4.2 billion which constituted two thirds of its $6 billion cash reserves.

Publicly the company was taking a strategic stake in its partner to insure its access the VW car platforms. Behind the scene it was actively buying shares and lobying regulators for changing the rules in its favor. Notably regarding the restrictive 20% stake of Lower Saxony government which was seen as conflicting with EU laws.

Porsche holdings went from 20% initially to 25% in 2006, 31% in 2007 and 43% in 2008 with options on the equivalent of 31%. Porsche virtually controlled 74% of VW stock. These announcements sent its stock price higher each time. As the company was in poor state and its case started getting noticed more and more traders began shorting its shares. but they realised that almost all of VW stocks were in the hands of porsche (74%) and lower saxony government (20%) leaving only 6% on the market as a whole. As the share price rose, short sellers started to close their positions adding more demand for the stock that was already in short supply. VW shares went from less than 60€ to an all-time high of 1005€ on October 28th 2008.

Meanwhile the financial crisis of 2008 was showing its teeth. Foreclosures were on the rise and the number of default was roaring. Some were spectacular like the collapse of bear stern. Bankruptcies brought defaults and defaults enticed liquidity provider -- investors and banks -- to be more cautious. it wouldn't take long for the crisis to cross the Atlantic and set foot in Europe.

Due to the worsening crisis in America and europe and the subsequent rarification of liquidity, banks started cutting loose ends and putting restrictions on loans they were giving to their customers. This policy impacted Porsche directly. buying a larger competitor is a huge bet which require significant financial power. The rising price of VW stock dried up porsche's cash reserves which had to fold its strategy because of the lack of funds to purchase further call options on the VW stocks whose price were still rising.

Nevertheless the company needed funds to execute the options it had bought if it wanted its plan to be effective. Porsche management started looking for an alternative funding source contacting potential investors who might give it the means to achieve what it had started.

With political backing on VW's side and economic conditions worsening the opposite finally happened. Porsche collapsed under the weight of its financial undertakings and VW acquired Porsche and included it in its impressive gamut of brands alongside Seat, Audi and Skoda among others.

While options offer an interesting tool to execute a takeover as tge Porsche experiment shows it requires a well funded acquirer to be able to exercise his options when the right moment comes. In this light it can be a risky strategy even when taking into account liquidity crunches and other unforseen elements and might lead to the complete bankruptcy of the raider as was the case with Porsche.

An additional risk resides in the potential of total bankruptcy and liquidation of the company if it doesn't find an acquirer. Again Porsche was lucky due to the fact that VW was ready to buy it out since it was valuable to them. But this might not be the case for everyone.