These days, liquidity is in short supply for all hedge funds, and it comes as no surprise the hedge fund wannabe Porsche (POAHF) suffers from the same liquidity squeeze symptoms as many of its hedge fund brethren. The liquidity situation for Porsche will be critical over the next three weeks.
Recall that Porsche engineered a massive short squeeze of Volkswagen common stock (VLKAF) just a few months ago. Volkswagen’s common had been shorted by arbitrageurs who went long the undervalued preferred (VLKPF) at the same time. When Porsche announced that it had acquired 75% of Volkswagen through options and intended to take over the firm, the common stock soared while the preferred didn’t budge. This led to large losses for the hedge funds when they had to cover their short positions in the common.
The flipside of Porsche’s large position in VW option is that their exercise is coming up on June 19th. Options on 23% of outstanding VW shares will expire that day, representing almost half the free float. Currently, Porsche owns 50.8% of the common. Most of the outstanding options are likely to be held by Porsche, which has announced that it controls some 75% of VW shares through direct ownership and OTC options. Many of the options are cash settled. The banks that sold Porsche the options are likely to have hedged themselves through exchange-traded options and also by acquiring underlying shares and hedging them with puts. This would explain the large number of outstanding puts with strike prices between Eur 100 and 800.
The risk is that the unwinding of the hedges on cash settled options will lead to massive selling of the VW shares. This would depress the value of Porsche’s holdings of VW, and flow through the income statement. Much of last year’s gains by Porsche were realized through the appreciation of VW shares during the short squeeze. Upon the expiration of the options, the opposite effect may happen, and Porsche will face losses of billions of Euros.
Porsche has debt of Eur 10bn, much of it incurred in the acquisition of VW shares. Porsche needs an additional Eur 2.5 billion in working capital to keep its business going. So far, only Bank of Tokyo has committed Eur 750 million.
It has now been made public that Porsche was already skirting insolvency in late March, when Eur 10bn of debt came due. Porsche was saved only when government-owned banks agreed to extend credit, and Volkswagen chipped in an Eur 700 million bridge loan that will mature in September. The Porsche/Piëch families owns large stakes in both VW and Porsche. The Porsche family hypothecated parts of its Austrian dealership network for some of the loans. Although the seriousness of Porsche’s situation was not known at the time, the market did see an increased default risk for Porsche.
The question is whether Porsche will be able to raise sufficient capital in the next three weeks, and how large its cash needs will be upon the expiration of the options. Not all VW options are cash settled, so that Porsche will have to buy some VW shares at the strike price. There have been rumors that a middle Eastern investor might acquire a stake in Porsche. No names have been mentioned, but with Dubai having troubles of its own, we think it could be the KIA (Kuwait Investment Authority), which has owned a large stake in Daimler(DAI) since 1970.
VW’s CEO Piëch talked about a potential “insolvency” of Porsche as a result of its trading in VW shares. It is ironic that the engineers of one of the largest short squeezes now find themselves begging for liquidity only months after squeezing hedge funds by removing liquidity from VW’s common stock. Porsche is unlikely to find much sympathy for its plight.
Disclosure: Thomas Kirchner manages the Pennsylvania Avenue Event-Driven Fund (PAEDX), which holds long and short positions in different Volkswagen securities. He is the author of an e-book about alternative strategies as well as the forthcoming book Merger Arbitrage: How to Profit from Event-Driven Arbitrage (Wiley Finance, 2009).