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Learning to fly

5 May 2015 By Olaf Storbeck

Volkswagen needs a corporate governance do-over. The recent tussle with former Chairman Ferdinand Piech is a reminder of the drawbacks of the carmaker’s convoluted ownership and board structure. This setup has paralysed decision-making and been a drag on the stock. The revamp of Airbus offers a template for reform.

The European aircraft manufacturer, previously known as EADS, was a governance nightmare. Several governments owned stakes. Paris and Berlin exercised their influence mainly through proxies Lagardere and Daimler, both of which had veto power over big decisions. As a result, the stock traded at a discount to peers.

Then came a shake-up in 2013. That was sparked in part by the failed merger with British defence group BAE Systems, which fuelled the need to regain investor trust. Daimler and Lagardere sold their stakes. The German, French and Spanish governments each remain minority shareholders but waived the right to name a board member and now have far less clout. These days, sober business rationale drives the business far more than potentially conflicting national interests.

The effect of these changes on the stock price was dramatic. Airbus shares have soared by 54 percent over the past two years, compared with a one-third rise for the broader market. The company now trades at 18 times expected earnings for this year. That’s 25 percent higher than its 10-year average and a fifth better than the wider European aerospace and defence sector, Thomson Reuters data shows.

That’s the kind of outperformance Volkswagen Chief Executive Martin Winterkorn should be gunning for. The company does, after all, have scale – only Toyota produced more cars last year. And the group is particularly strong in high-margin premium brands like Audi, Porsche and Bentley.

Yet Volkswagen trades at 10 times the next 12 months’ expected earnings. Rivals Daimler and BMW command multiples of around 12 times forward earnings. It’s not hard to find reasons why. One of the company’s core brands – its VW passenger car marque – is a mess. High costs have pushed margins down to 2 percent, and the brand has fallen behind in the U.S. market. The integration of expensively acquired truckmakers MAN and Scania will be an epic task.

The group also runs a conservative balance sheet, hoarding most of the 6 billion euros of free cash it generates each year. By the end of March the company had almost 21 billion euros of net cash. It hiked the dividend by a fifth a couple of months ago. But at 21 percent of last year’s earnings per share, Volkswagen’s payout ratio remains way below its 30 percent target. That raised the fear that it might be preparing for value-destroying acquisitions.

These issues ultimately lead back to the governance structure. Volkswagen has two tiers of stock that allow the Piech-Porsche family – currently feuding – to control just over 50 percent of the votes with 32.2 percent of total outstanding shares.

The State of Lower Saxony has a lock on another fifth of voting rights, with just 12.7 percent of stock – and has a veto right over important decisions. The Qatar Investment Authority controls 17 percent of the voting rights.

That leaves private investors with less than a 10 percent say in how the company is run despite owning around 38 percent, because most of their stake is held in non-voting preference shares.

And that’s before considering the role played by trade unions. These appoint half of Volkswagen’s supervisory board members – a right they have at every publicly traded German company. That gives them a lot of sway. Last year, for example, unions stopped Winterkorn appointing McKinsey to hammer out a cost-cutting programme.

Abandoning its dual-class share structure would make for a far more straightforward entity. It would not solve everything, of course: the Piech-Porsche family would still control a third of the company and Lower Saxony would surely defend its veto. But private shareholders, though still a minority, would have a louder voice.

They might, for example, be able to act as a more effective check against the kind of empire-building that Piech was famous for. They could lobby for a more speedy turnaround at VW. Or they could have greater power to push the board to return more uninvested capital to shareholders. Any concomitant increase in the stock price as the company’s earnings multiple shifts higher would benefit its biggest owners the most. Airbus showed the way. Volkswagen would do well to follow.


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