Wednesday, October 29, 2008

The only responsible trade...

Warning – I strongly recommend against trading in any security mentioned in this post. The volatility is enormous and the situation fluid. The stocks are not being driven by fundamentals… The recommendations in this post are made in a somewhat humorous manner. They might even be reckless...

I am horrified - despite this warning at least one person has thought that the trade should be placed. Please take this warning seriously. I have no position.

The Stutz Motor Car Company

There was once a fine American sports car company called Stutz. It made beautiful – even legendary cars. The cars had a reputation for dependability, reliability and punishing speed. I know they look antique – but these were really quick for their day – and they won big races like Indianapolis and the Le Mans 24 hour race. Le Mans (at least) is an event that Porsche likes to win. Here is their 1913 Stutz Bearcat – a car that was modified, overpowered etc and won races into the mid 1920s.

Anyway Stutz was controlled by Alan Aloysius Ryan through family holdings. For reasons mostly to do with improved mass production by competitors the company found itself under pressure. Short sellers could smell blood. And they shorted the stock. And shorted some more.

Through this Alan Aloysius Ryan stood firm, buying stock when he could (possibly through options and hidden holding companies so the shorts could not see what he had done). He did this until he declared one day in 1920 that he owned 105 percent of the company and the shorts could settle with him on his terms.

His terms were a price so high that it would bankrupt broker dealers who had stood as intermediaries between the stock exchange and shorts.

Well to put it bluntly the financial market and regulators defended their own. The story is told here and here and here and here in the New York Times – and the amounts of money involved were monstrous for the time. Eventually the New York Stock Exchange –with the threat of criminal proceedings – arbitrarily determined a price to settle the short positions. The shorts even got an officially sanctioned “protective committee”.

That price was way below the top price that Ryan paid – but far more than intrinsic value. The shorts – well – except those that shorted right at the end – lost money. Ryan wound up paying too much for a motor car company which was slowly declining anyway. As he now owned 100 percent of Stutz his debts got intertwined with the car company and both he and the car company went bust. Some family members got a little out but only by suing other family members. The only winners were ordinary longs of Stutz who sold along the way – or even at the final settlement price.

As you might have guessed this looks horribly familiar. Porsche is now firmly in control of Volkswagen – and they did it with non-standard cash settled options and other things they argue that they did not need to disclose. It looks and smells like market manipulation – and Volkswagen – General Motors for Europe – may be - depending on the time of day - the biggest company in the world by market cap. [Yes – its market cap is higher than Microsoft, Exxon or PetroChina.] This is the short-squeeze from hell – the first short-squeeze to infinity since the Stutz corner…

Now I think Porsche is one of the great businesses of the world. They have convinced middle aged richer Americans that they are more attractive – or at least more fun – if they drive that particular fast car. (Viagra is for poorer guys…)

And unlike Ferrari (which spends all of its profits on Formula One) Porsche – like Stutz before it – managed to make its mark with near-production cars in events like Le Mans. In the automobile world there are only two car companies with margins near 10 percent – Porsche and Toyota. And they got there different ways.

Porsche (the business) is having a rough time at the moment because if you haven’t noticed the willingness of middle aged American men to drop 100K on a car is somewhat reduced of late. But that might be temporary.

Porsche is a company I want to love – a very fine consumer brands company masquerading as an automobile company. And it is not expensive at the moment – especially if you back out their holding of Volkswagen. Indeed its holding of Volkswagen is worth many times Porsche’s market cap – making Porsche one of the cheapest stocks in the world.

But if history is a guide the Porsche and its controlling family are going to go the way of the Ryans. Their behaviour doesn’t look any more criminal than Alan Aloysius Ryan – and that wound up with him – and his company bankrupt. The system has a knack of defending itself – and the family that controls Porsche and indeed the Porsche company itself is every bit as expendable as Alan A Ryan.

I started this post with a warning – which was that nobody should play any security involved in this story – and I want to stick with this warning. But if you want to play – and it pains me to say this – the only responsible trade is to short Porsche. Porsche – the company – and possibly the car – like Stutz before it – will likely get confined to the dustbin of history.

This is a sad thing – because Porsche – as I have noted – is a nicely run and profitable company. But the appearance of criminal market manipulation will have consequences – and Porsche will pay the piper. My guess – some hapless European investment bank (say Fortis or UBS) is at risk in this – the greatest squeeze since Stutz – and the European court when forced to decide between a mid-ranking German car company and a bank that is integrated with a European government they will chose the bank at Porsche’s expense.

Porsche lovers can however console themselves if they are going to live another 40 years. Someone made some pug-ugly cars under the name of the “New Stutz Company” in the 1960s. Elvis Presley loved his. A small consolation – but the name lives on well after any family legacy is gone.

John Hempton

PS. Having spent some time the other day slamming the New York Times I would thank them for making available – for free no less – the original newspaper articles about the Stutz Corner.


Anonymous said...

One crucial difference between Porsche and Stutz:

Stutz screwed powerful people in his own country who could manipulate the stock exchange against him. Porsche screwed a bunch of mostly foreign hedgies and investment banks who are deeply hated. My bet is that Porsche will become folk hero's for this little stunt and they will be allowed to let the shorts settle at very favorable terms to Porsche. A price of E 911,-/share of VW sounds exactly right to me.

An indication of who is winning the popularity/power contest here is that the German authorities have announced that they will look into the events and investigate any wrongdoing -by the shorts-. Porsche is absolved in advance.

Oh, and thanks for the excellent story!

Charles Butler said...

Not to mention yesterday morning's sideshow on the DAX as the hedge failed. Ex-VOW, the index was down 10%.

John Hempton said...

I agree with anon that Porsche's actions will play OK in Germany.

But they might play a little less well in the European court when its another European country's bank being nationalised.

I really have NO IDEA how this will work out. None at all...

I do know that if I owned a Dax index fund I would sell it and buy every stock in the index except VW. But that is also a trade. VW might go to infinity... its down as I write this...

Jonathan said...

I'd like to say thanks too for an excellent story and a continued excellent blog. Regards, Jonathan.

Anonymous said...

Thanks for the interesting story. Regarding past New York Times articles, why don't you try the Google Archive Search -- it looks like there is a plenty from NYT from that time. Here is a link:

Greetings from Germany!

Anonymous said...

This is purely a matter of national law, not European and that means German courts rule on it, not European. Good luck if you're an evil hedgie short going up against an upstanding member of the community not to mention an icon of German industry...

The European commission might ordinarily try to intervene if shorts from other EU members get abused to badly. Not now though. The commission will be glad if the union can get through this mess without collapsing. Pissing of the Germans would be just the thing to make the latter happen.

On an anecdotal level, investors here, even those themselves caught short, seem to think Porsche played hard but smart and deserve their laurels. Continental Europe just never had the liking for bankers and speculators/investors that the US has and it tells.

Anonymous said...

I agree with John on this. The smart trade may be to buy the large DAX stocks - ie go the other way to all the index guys out there who are having to sell large cap DAX to re-weight VW. There is some precedence here ... I am told (by somebody much older than me) that a similar thing happened with the Northern Railroad Co in 1907 in the US, when 2 investors (Hill vs Harriman) got over 50% of the equity and created a huge short-squeeze which led to margin calls everywhere and consequent selling of the rest of the market - the lesson was, apparently, to buy those other stocks.

Anonymous said...

If some EU judge finds it in his interest to get political on Porsche, maybe ordinary people (as in everyone who isn't a member of the banks and hedge funds) needs to get out their pitch forks and torches and tar and be a little political with that judge..... X-C

OK. Breathe. Maybe I'm getting a little too "internet" here. But the fact remains that Porsche has, as far as I know, not done anything illegal; the shorts are well aware that they risk losses of potentially infinite amounts for a potential gain of 100%. This is what happened here. As for manipulating stock prices, Porsche bought stock (nothing wrong in that). If anyone was manipulating the price of stock; it was other sellers putting on the squeeze (and this does set this apart from the example you used as Porsche still does not own more stock than exists), who in turn manipulated no more than short sellers usually do. I any case; the EU and its institutions have a reputation for being bureaucratic, corrupt and always siding with the biggest dog, but I think this is greatly exaggerated and I think they will not get far with a lawsuit. Or so I hope.....

Anonymous said...

Anonymous October 30, 2008 4:15: "This is purely a matter of national law, not European and that means German courts rule on it, not European."

Porsche's actions in relation to its VW stockholding potentially raise questions of interpretation concerning several EU legal acts, especially the transparency directive, the take-over bids directive and the market abuse directive.

Remember that there are several ways for cases to reach the European Court of Justice (ECJ), inter alia:

- the Commission may bring a case against a Member State pursuant to Article 226 of the EC Treaty;

- a Member State may, subject to certain preliminary procedural requirements, bring a case against another Member State before the ECJ pursuant to Article 227;

- a national court may, and in some cases must, refer questions relating to the interpretation of EU law to the ECJ pursuant to Article 234.

The latter may be the most likely route through which Porsche could find itself pleading before the ECJ.

Anonymous said...

Hi John,

We had our own little corner down here in oz in the 80's.
A guy called Ian Murray ? from memory.
When he announced he had 95 % of the stock the brokers who ran the bourse declared "a disorderly market".
They turned the tables on him and he lost a fortune.
It seems the brokers do not liked to be beaten at their own game.

Anonymous said...


You are correct that the commission or a member state (forgot to mention that one! thanks for the reminder) can bring a case against Germany. However, they would have to establish that Germany violated EC-treaty obligations. I really don't see how Germany violated any obligations under the treaty. And Porsche, not being an EU member state, cannot be sued on this basis, only Germany.

There is also the political angle to consider. Trying to kill Porsche or annoy Germany in an effort to help evil hedgie shorts is going to be extremely unpopular so I really don't think any member state government or the commission is going to burn its fingers on that.

Last but not least, these proceedings would take many years and by then Porsche will have been sitting on the cash for a long time and the hedgies will be bust or have moved on.

Only the highest ranking national court is obligated to refer a case to the ECJ if there are questions concerning EU law. It would take years for a case to get that far and until then the national courts are in charge.

Also, EU directives have no "horizontal effect". Even if there were a blatant failure to implement them by Germany (I doubt it, the directives you mention leave plenty of leeway to the national authorities and as far as I can tell Germany did pass implementation legislation) this would have no effect on Porsche in it's relation with the hedgies. The hedgies would have to go for damages from the German government for its failure to implement the directives properly, but that seems an extreme long shot to me.

Last but not least, Deutsche Borse and its broker dealers might move against Porsche. Like anon. at oct. 31 mentions happened in an Ozzie case.

(anon. could you tell us more about what happened?)

Germany is a federal state and Porsche and VW are local champions. The prosecutor and courts in Stuttgart would probably have a blast having Deutsche Borse and broker-dealer directors arrested and their assets frozen at the slightest whiff of manipulation against Porsche.

John, I disagree on the trade here. If anyone insists on trading this, and I strongly recomment against it, this is insane speculation, I say go long Porsche. They will make a fortune and end up controlling VW for free making them a major carmaker at once. The stock price may not reflect that. But, as noted trading this kind of snake pit is just nuts.

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