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Trouble at Volkswagen

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Monday, December 19, 2005 Print this Comment on this E-mail this Neil Winton Board rifts threaten VW's profits It's not just General Motors, Ford and Delphi that are sailing through troubled waters. Volkswagen, Europe"s biggest car manufacturer, is also being buffeted on many fronts. VW always had to hurdle obstacles of almost Byzantine confusion because of the German system of corporate governance. Now its finances will be coming under pressure as profits in Europe crumble next year, losses mount in the U.S. and China, and its Latin American operation is crippled by an unexpected exchange rate problem. VW has too many workers who are paid too much money, using factories which aren’t producing enough cars. "Restructuring” is required. Sounds familiar, doesn’t it? Well try this. VW has problems of such mind-numbing complexity, such arcane opacity, they must make GM’s Rick Wagoner and Bill Ford feel they’re home free. At least everybody understands what Detroit’s problems are. Lift up the rock covering VW’s shenanigans and brace yourself. There’s the much publicized scandal that VW funds were used to pay for prostitutes to entertain union members. German authorities are investigating. Power Struggle The company is also reeling because of a power struggle in the boardroom where the chairman of the supervisory board, Ferdinand Piech, has used the German system of power sharing with unions to fill a crucial salary and conditions negotiating executive with a candidate who was anathema to CEO Bernd Pischetsrieder. Horst Neumann, former Audi personnel chief, was with the IG Metall trade union for 16 years and got the job after Piech lined up support with the unions on the board. According to the Financial Times of London’s Lex column, Neumann is also in a relationship with Andrea Nahles, one of Germany’s best-known socialist politicians. “Top managers and conservative politicians close to VW suggest that this is the last thing VW needs - a union man who is big friends with a young leftie firebrand politician,” Lex said. Pischetsrieder’s Contract Pischetsrieder, who is responsible for the day-to-day running of the giant corporation, was said to be seething and toying with resignation. His contract is up for renewal next April. Pischetsrieder’s contract runs until 2007, but VW traditionally renews these contracts a year before they expire. Piech stands accused of conflict of interest because Porsche, which he controls with other Porsche family members, recently took an almost 20 per cent stake in VW. The German state of Lower Saxony, where VW is based, was the biggest shareholder with 18.2 per cent until Porsche bought its stake. Because of a law designed to stop a hostile takeover of VW, the Lower Saxony shares were deemed to outvote all the other shares Cozy for VW Shareholders were shocked when Porsche announced it was splurging its $3.5 billion cash pile on buying 20 percent of VW back in October. Many critics saw the move as a cozy way to protect VW from any hostile takeover, which might now be possible because the rules which had protected VW were about to be changed as the European Union acted to make markets freer. Any hostile takeover might seek to divert VW from the “German Way” and make it into an efficient, slim-line, global competitor which put the customers and product first, and employees, well, not first. The “German Way”, or Mitbestimmung, encourages ownership of big business by large groups of banks who tend to be happy with an arm’s length relationship, and who are not overly concerned about shareholder value. This also is linked to a close - critics say corrupting - relationship with trade unions which often have equal voting power at board level. This is a recipe for guaranteeing jobs and communities, or bloated inefficiency, depending on your point of view. Mitbestimmung supporters describe the German Way as rigorous, not ruinous, competition. This was in contrast to the so-called Anglo-Saxon method, where shareholder value was supreme. The Financial Times Lex column was in the Anglo-Saxon camp. Ominous “Family, not good governance, is at the heart of the deal (with Porsche),” said Lex, “Ferdinand Piech ... is also VW’s chairman. This cozy 'German solution’ does not bode well for the prospects of accelerated restructuring at VW.” Investment bankers have now had time to delve more deeply into the ramifications of the Porsche deal. J.P. Morgan reckoned that Porsche sought the tie-up with VW, not because it was a great investment, but because it feared its future was in jeopardy. Crucial projects - the new Panamera 4-seater, and ongoing production of its Cayenne SUV and Boxster roadster - were threatened. A linkup with VW might be the answer. Porsche developed the Cayenne jointly with VW and it is produced on the same production line as the VW Touareg, and new Audi Q7. J.P. Morgan believed VW was taking more than its share of the costs of Cayenne production. Porsche was unable to agree a Cayenne-type deal for the upcoming Panamera, and wanted VW input to help pay for the $1.2 billion development budget. J.P. Morgan also thinks that production of the Boxster, made by Finnish firm Valmet for Porsche, could be taken over by VW if the current arrangement failed. Real World Problems That’s enough of the can of worms. VW has other problems which are less opaque and more readily understood out there in the real world. VW, under its ForMotion programme, plans to increase pre-tax income to 5.1 billion euros in 2008 as part of its restructuring plan of cutting the workforce and manufacturing costs. VW’s pre-tax income in 2004 was 1.1 billion euros, or $1.3 billion. According to Morgan Stanley, this plan is unlikely to come close to succeeding. In Europe, VW has been making more money than Toyota while Ford Europe and GM Europe have been losing money. The trouble is, because of an aging model line-up and increasing competition, sales growth will end and profits in Europe will come under pressure. Unfortunately for VW, other parts of its global empire aren’t likely to fill the gap. Morgan Stanley says: North America - VW lost $1.1 billion in 2004 and will lose a bit more in 2005, as the Passat, Jetta and Touareg failed to excite U.S. buyers. In 2006 red ink will still be about $895 million. Latin America - Brazil’s car market is under pressure, and an appreciation of the currency - the real - has sabotaged the economics of the little VW Fox city-car which was being shipped to Europe from Brazil. China - this had been a license to print money for VW but Morgan Stanley expects a $118 million loss in 2005, doubling in 2006. SEAT, the Spanish based VW brand, is expected to lose $118 million in 2005, twice as much in 2006, and $590 million by 2008. Professor Ferdinand Dudenhoeffer, managing director of Bochum, Germany-based automotive analysts B&D Forecast, doesn’t underestimate VW’s problems, but expects the possibility of financial disaster will force even the unions to fall into line and make the needed concessions over wages and headcount. “We estimate that there is an excess of 15,000 too many jobs (in Germany, Spain and Belgium) and that Bernhard will take the tough decisions necessary to restructure the brand and make black numbers in the future,” Dudenhoeffer said. Bernhard Plan Wolfgang Bernhard, hired by VW after being fired by DaimlerChrysler last year, heads the VW brand group that includes Bentley, Skoda and Bugatti. Bernhard is working on a restructuring plan details of which he is expected to reveal in January or February 2006. “Even the unions have a strong interest for VW to be successful,” Dudenhoeffer said. “Without tough restructuring the future of VW will not be safe. Despite the factions on the board, they will let Bernhard do his job. They know that without this there will be huge problems in two or three years which will threaten the survival of VW.” Paul Melville, European Restructuring Specialist at British-based management consultants Grant Thornton, isn’t so sure. Melville, who advises automotive retail and manufacturing businesses, said VW will find it difficult to come to more sensible arrangements with the unions on the board. Citicorp summed up VW’s problems like this recently. Overpaid “VW should be the most fertile field for auto restructuring, with capacity utilization of 72-73 percent in Europe, and in our view a labor force 15,000 to 20,000 too high being paid 20 percent above engineering norms.” Melville, who will transfer to Detroit early in 2006, said VW’s range of brands is causing problems. “VW’s got the very strong Audi brand, but Skoda and SEAT, it’s not sure what to do with them,” he said. “There’s a mix of brands which even compete against each other. Look at GM with seven or eight brands. VW is not a mini GM but it has the same sort of competing brands like the VW Golf and Audi A3.” VW Discounts “VW is going through a period of change, with a difficult home market, and high labor costs to address,” said Melville. “The German retail market is very difficult, probably the most difficult in Europe now. It’s very competitive like in the U.S., and VW is having to discount products which it never did in the past.” Investment banker Merrill Lynch finds it hard to believe that German unions will come up with the sort of concessions needed to turn VW around, particularly after board chairman Piech undermined CEO Pischetsrieder by appointing Neumann with the support of the unions. “This may speak volumes for what can now be expected on the job reduction front at VW,” Merrill Lynch said in a recent report. Edited by HarleyEarl

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