Porsche: Holding Discount May Narrow If Legal Risk Is Resolved – Porsche Automobile Holding SE ADR (OTCMKTS:POAHY)


Porsche (OTCPK:POAHY) is currently undervalued as the holding discount seems to be too big. This happens because the company still has some legal claims against it; when this risk is resolved a lower holding discount will be warranted.

Porsche Automobil Holding SE (Porsche) is a holding company established in 2007, based in Germany. Its main investment is its long-term stake in Volkswagen AG (OTCPK:VWAGY), which is one of the leading automakers in the world. Porsche has a market capitalization of about $20.5 billion and trades in the U.S. on the over-the-counter market.

Portfolio Overview

The most important asset of Porsche is the 52.2% stake of the ordinary shares of Volkswagen AG, representing a stake of subscribed capital of 30.8% as Volkswagen has both ordinary and preference shares. This stake has a weight above 90% of Porsche’s assets, being by far the most important investment.

Porsche is the largest single shareholder of Volkswagen and considers itself as a long-term strategic shareholder of the company. Volkswagen AG includes several car brands, including Volkswagen, Audi, Bentley or Porsche, the motorcycles manufacturer Ducati, commercial vehicles and trucks.

Since mid-2012, Porsche has been a pure holding company with its investments concentrated in Volkswagen. However, this strategy changed last year with the acquisition of three equity investments, extending its portfolio into venture capital investments.

Porsche has now other smaller investments across the automotive value chain, given that it holds almost 100% in PTV AG, a provider of software for traffic planning and management, plus minority stakes in the U.S.-technology company INRUX and in two 3D printing specialists (Markforged Inc. and Seurat Technologies).

Porsche’s investment strategy is to continue to acquire further strategic investments in companies connected to the automotive industry, with above-average growth potential over the long term. This is expected to be mainly about industry-specific trends like electrification and mobility-related services, with the goal of maintaining the company at the forefront of technological innovation in the industry.

Financial Overview

Regarding its financial performance, given that Porsche operates as a holding company, it does not have any activities beyond the stakes in other companies.

Therefore, its profits are directly influenced by the profit from investments accounted for at the equity method. Furthermore, given that Porsche has a small number of employees at the holding level (around 30), its earnings are practically explained by profits from its investments.

This explains why over the past three years its earnings have been in line with Volkswagen’s earnings, recovering from reported losses in 2015 due to the Dieselgate to a good level in the past year.

In 2017, Porsche’s profit amounted to €3.33 billion ($3.86 billion), representing an increase of 142% from the previous year. This is fully explained by higher profits of the Volkswagen group, leading to Porsche’s profit from investments of €3.4 billion ($3.94 billion).

Porsche’s cash flow mainly comprises of dividends received from Volkswagen, which are sustainable over the long term due to VW’s relatively low payout ratio and strong balance sheet as I’ve analyzed previously here.

In the past year, Porsche’s cash flow from operations amounted to €250 million ($290 million) and its net liquidity was €937 million ($1.08 billion) at the end of 2017. This net financial position was lower in about €350 million ($406 million) than at the end of 2016 due to the investments performed by Porsche during the year.

Due to higher earnings and a solid balance sheet measured by its net liquidity, Porsche’s dividend was raised to €1.76 ($2.04) per share related to 2017 earnings, up by 75% from the previous year. Despite this big increase, the dividend payout ratio was only 16%, which is a very conservative level of earnings distribution to shareholders.

During the first six months of 2018, Porsche’s earnings amounted to €1.9 billion ($2.2 billion), up by 2% year on year, supported by the positive operating momentum at Volkswagen, which reported unit sales up by 5.8% year on year and higher profit. Porsche’s cash flow remained good and its net liquidity increased to €972 million ($1.12 billion).

Going forward, Porsche’s profit should remain directly linked to the performance of its main investment in Volkswagen, even though Porsche is expected to continue its diversification strategy in the coming years and reduce its reliance on a single asset.

Valuation

Given that Porsche is a holding company and that its main asset is its equity stake in Volkswagen ordinary shares, it is quite easy to value the company using a sum-of-the-parts methodology.

Volkswagen is valued at its current share price (I have used the close price on September 21, 2018), while other investments in unlisted companies are valued at an amortized cost. The value of smaller stakes in the 3D printing companies is not disclosed, but the value should be quite small and is not material for valuation purposes.

Beyond its portfolio value, it is necessary to add net liquidity and subtract its pension liabilities. Considering its 306 million shares outstanding, Porsche’s net asset value per share is close to €81 per share. However, taking into account that Porsche is a holding company, there is also the holding company discount, which means that usually the share price trades below the Net Asset Value (NAV) per share.

Using a holding discount of 10%, Porsche’s fair value per share is near around €73 per share, implying an upside potential of more than 23%, as shown in the sum-of-the-parts model below.

Given that Volkswagen represents close to 95% of Porsche’s NAV, the holding discount should be quite small. Usually, investors demand a discount because if Porsche would sell Volkswagen’s shares, it most likely would use an Accelerated Book Building (ABB) offering to institutional investors. This normally is done with a discount of 2-5% compared to the market price to attract enough buyers for the block sale.

Higher holding discounts are usually demanded for companies with a significant exposure to unlisted assets, which can go to a holding discount between 10-20%, which is not Porsche’s investment profile.

However, Porsche has some litigation risk due to claims against Porsche SE related to its abortive attempt to take over Volkswagen in 2008-09 and the Dieselgate scandal more recently. It is quite difficult to quantify the potential direct cost (if any) for Porsche due to these legal issues, so I added another 5% holding discount to account for this.

Even though this 10% holding discount seems to be appropriate, considering a more conservative discount of 20% (the level for holding companies with significant exposure to unlisted assets), Porsche would still be undervalued by about 8%, which doesn’t seem to be justified.

To reach the current Porsche’s share price, the holding discount should be about 26%, a level that seems to be too high for a company that has close to 95% of its NAV invested in one of the largest and most liquid companies in Europe.

Conclusion

As a holding company that is heavily exposed to a single listed asset, Porsche’s valuation is quite straightforward and the only metric that can be discussable is the holding company discount. Its current market price reflects a discount of 26% to its NAV, which seems to be excessive.

The pending legal issues against the company is the main reason why Porsche trades much lower than its NAV, and a settlement of these cases would be a major catalyst for a lower holding discount. It is practically impossible to forecast how long this could take, but over the long term, Porsche seems to have value because its current share price does not reflect the value of its assets.

Disclosure: I am/we are long VWAGY.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.





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