Cornering Tracks and Markets

A couple of weeks ago, a court in Stuttgart acquitted Porsche’s (Xetra:PSHG_p) former CEO Wendelin Wiedeking and ex-CFO Holger Härter on the charges of attempted market manipulation regarding the unsuccessful takeover of Volkswagn AG (Xetra:VOWG_p).

This story made me remember the remarkable short squeeze Porsche managed to pull, and what is even more amazing, is that nobody has decided to make a movie out of it.

Let’s go back in time to relive one of the most amazing short squeezes ever.  But first, let’s check out a few concepts (for the folk whose lost practice on doing short trades after a rather long bull market).

Short Selling

Short selling or selling a stock short, means you get to sell a stock you don’t own hoping to repurchase it at a lower price, and making money in the process.  Unlike long positions, where you can lose all your investment, in short position your potential loss is unlimited, since the stock may rise way above the price you paid for it.  Long positions are always limited to zero.

Short squeeze

A short squeeze takes place when liquidity for a stock dries up in the market, and short investor can’t buy stock to cover his position.  In that case the owners of the stock can literally ask whatever price they want for it and the short seller will be forced to buy.

Having said that, let’s go back to 2008, at the height of the market crisis, stocks were dropping like flies, and short sellers were making a fortune in the process.  Just like they took turns shorting the banks: Bear, Lehman, AIG, Morgan, Goldman, Citi, Bank of America (in that order), hedge funds were conducting a similar strategy with auto makers, taking out General Motors, then Ford, and later turned their sights to Volkswagen.

Besides sharing a history (remember it was Ferdinand Porsche who designed the famous VW Beetle), Porsche had a financial interest in VW.  In 2005 Porsche was a minority shareholder in VW with 20% of the shares, while the state of Lower Saxony held a similar amount.  Between 2005 and mid-2008, Porsche slowly increases its stake in VW to 42.6%.  At this moment 2 things had happened:

  1. Porsche had driven the price of VW’s stock so high, that many considered it had passed its economical value.
  2. The financial crisis was at its peak, and while many car manufacturers were in the ropes or going bust, VW’s stock price remained hovering around the €200 mark.

With this in mind, it was a no-brainer for the hedge funds to start shorting the stock, assuming that at some point either Porsche would divest, or VW’s stock would catch up with its peers putting downward pressure on the price of the stock.  What they didn’t know is that while Porsche owned 42.6% of the shares, they had options to purchase a extra 31.5%, which meant that they had control of about 74.1% of the total outstanding shares.  Add to this the 20% owned by the state of Lower Saxony, and you end up with a float of less than 6%.  And what is worse, they had in many cases been the counterpart to the short trade (i.e. the borrowed shares belonged to Porsche).

On October 26, 2008, Porsche dropped the bomb, announcing that they owned nearly 43% and had options to purchase a further 32%.  At this point panic struck among short sellers running for cover, except there weren’t enough shares in the market to purchase in order to cover the short positions.  The price of VW stock quadrupled from around €200 to €1,005 in 2 days, making it the most valuable company in the world – albeit for a few hours.

It is estimated that Porsche cleared anywhere between €6 to €12 billion, the realized profits seem paltry by comparison to €30- €40 billion they had at one point.  A few days later they released 5% of their shares to the market to allow the likes of Greenlight Capital, SAC Capital, Glenview Capital, Marshall Wace, Tiger Asia, Perry Capital, and Highside Capital to cover themselves.  Being derivatives trading a zero-sum-game, it is likely that the Porsche’s profits were the hedge funds’ losses.

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