Over the past two days, we’ve spent quite a bit of time documenting the emissions scandal that’s rocked Volkswagen, sending its shares down more than 30% (see here [13], here [14], and here [15] for instance).
Far from representing an isolated, “contained” event, revelations that the company used software to game diesel emissions tests have the very real potential to reverberate throughout the German economy.
As we explained on Tuesday, Volkswagen Group is the largest automaker in Germany and it is also the largest German company by revenue. In case the implications of that for Germany’s export machine are in any way unclear, allow us to elaborate:
While banking may be the most important sector to the hyper-financialized US economy, for the export-driven German economy - whose exports account for over 40% of GDP - it is all about the car companies and their massive supply chains.
So what happened over the past 48 hours to Volkswagen, which has lost over a third of its market cap, or more than the market cap of Tesla, is nothing short of an earthshattering cataclysm to an economy where all the cogs and gears and running in a smooth, undisturbed ensemble... until everything changed overnight.
Throw in the fact that the industry is already threatened by the deceleration in China’s economy, and you have a veritable nightmare scenario in the making and for anyone who thinks we may be going overboard with the hyperbole, we present the following from Deutsche Bank (another German company that’s quite adept at gaming regulators), out Wednesday:
An investor's nightmare: uncertainty on all levels.
After VW lost c. €30bn of its market value in 2 days, it might strike as a buying opportunity. However, we stress that the full magnitude of the emission scandal is likely to remain uncertain for much longer. So far we conclude that1) the legal fines will be painful, impossible to quantify and potentially remain a topic for years & that 2) the impact on the operational business poses even higher risks for future cash flows. We cut our EPS ests materially over 2015- 2017 accounting for a €5bn legal fine, recall costs, lower growth and pricing pressure from brand damage (2%). Any €1bn additional fine would take away €2.02 per share.
Last Friday VW came under attack for having deliberately misled regulators by equipping their engines with ‘hidden’ software. Initially the US regulator spoke about 500k vehicles with a maximum fine of $18bn or $37.5k per car. Today VW stated that they see globally some 11 million cars impacted. History has shown that with recalls the first ‘confessions’ are rarely the end of it. Our current base case is that VW will face about €5bn in legal fees/ residual impairment.
We think the impact on the operational business – namely volumes, residual values, pricing and costs - is even harder to estimate and is the key concern here. A main element of our buy case had been significant cost cuts. We now believe that rising costs for diesel cars will offset most of the effects. Most importantly, we have taken a more cautious stance on the growth outlook for VW and Audi and believe pricing will come under pressure due to the reputational damage. Consequently, we cut our 2015-2017 earnings by up to 35%. We further include the €6.5bn provision already announced. We note several countries have already indicated consequences VW cars if cheating is discovered and in Germany for example all relevant cars will now be tested.
Risks: what we cannot put in numbers (yet)...
...1) further law suits; 2) a need for further disposals or even equity measures; 3) management changes where we expect a decision over the next days
Of course this is the sellside we're talking about here which means that somehow, Deutsche Bank managed to get a "Hold" rating out of all that (apparently even companies the bank thinks represent "an investor's nightmare" don't deserve to be sold), but you get the idea.
Meanwhile, the scandal looks as though it may end up ensnaring Germany's transport ministry. Here's FT [16]:
In a written response to a question from the Green party, the German transport ministry said: “The federal government is aware of [defeat devices], which have the goal of [test] cycle detection.”
The Greens asked if the ministry was aware of the deployment of defeat device software in new vehicles, and it replied: “We have no knowledge of this.”
There was no specific question about VW and defeat device software from the Greens and the ministry did not refer to the company.
However, the ministry answered the question on July 28, prompting accusations that Berlin had been aware of the potential for cheating in the industry for months.
Oliver Krischer, a German Green party lawmaker, said: “The federal government admitted in July, to an inquiry from the Greens, that the [emissions] measurement practice had shortcomings. Nothing happened.
“The VW emissions scandal is the result of a politics in which environmental and consumer protection plays no role and every trick and means of cheating is accepted with a wink.”
Now obviously, being aware of the potential for cheating and having knowledge of actual cheating are two entirely different things. That is, cheating is always theoretically possible in any industry that's subject to regulatory oversight so in one sense, the German transport ministry really didn't say anything at all. On the other hand, recall that, as Theo Vermaelen, a finance professor at INSEAD put it earlier this week, "if it looks like it's more companies, not just Volkswagen, it would be a major problem for the German car industry, and the German economy overall." When viewed through the lens of the potential effect on the German economy, it seems at least possible that someone in Berlin had instructions to protect the country's economic interests at the possible expense of the environment.
In a testament to just how critical the company is in Germany, residents of Wolfsburg (where VW funds everything from the university to the soccer club) fear their town may be headed for a Detroit-like death spiral. Here's more from Bloomberg [17]:
Nowhere is Volkswagen AG’s widening emissions scandal being felt more acutely than in Wolfsburg, the ultimate company town in Germany.
Here, a hundred miles west of Berlin, VW funds the university, runs the biggest museum and owns the local soccer club, which is competing against some of the best teams in the world in the Champions League.
"If you’d visualize traffic in and out of the city, it would look like a pulse and the heart is the VW plant," cab driver Karsten Raabe says as he steers his Skoda by the sprawling complex, where hundreds of gleaming cars sit in parking lots and on the back of freight trains. “Without VW, this city and the entire region would die. We’d become a European Detroit,”
More than seven decades after the Nazis built Wolfsburg from scratch to make the original ‘people’s car,’ VW employs about 72,000 people in the city of 125,000. The company’s annual sales have quadrupled over the past two decades to 202 billion euros ($225 billion). The boom has helped drive unemployment down to 4.9 percent, well below the national average.
Even the main tourist attraction is a tribute to VW: Autostadt, a 28-hectare theme park with road-safety tracks and vintage cars that was completed in 2000 for about 400 million euros. And then there are the 7.8 million VW-branded sausages that are made in Wolfsburg and sold nationwide each year.
‘Black Monday’
On Tuesday at Saloniki, a wood-paneled tavern near the central station, six men heatedly debated VW’s admission that it cheated on U.S. emissions tests, sparking an investigation that has wiped about 25 billion euros off the company’s market value.
“Black Monday for VW” read the front-page headline of the local newspaper sprawled on the bar in front of them.
And as we explained on Tuesday, it's not just VW and it's not just the German auto industry that are at risk - it's the entire supply chain.
Finally, because no scandal at a publicly traded company would be complete without a healthy dose of market manipulation and/or insider trading, BaFin has now launched a "routine" probe into trading activity in VW shares (just seven years, we might add, after the regulator looked into how it happened that Volkswagen briefly became the most valuable company on the face of the planet after its shares surged to €1,000 one Tuesday during the depths of the financial crisis).
The "watchdog" (and we use that term very loosely in light of BaFin's half-hearted investigation of Anshu Jain) is also looking into the timing of the company's disclosures. Via WSJ [18]:
Germany’s financial watchdog BaFin on Wednesday said it is investigating possible trading irregularities in Volkswagen AG shares, and whether the car maker was obliged to disclose information regarding its emissions scandal sooner than it did after its shares dropped sharply over the past two days.
BaFin, the German securities supervisor based in Frankfurt, is examining market developments for indications of potential insider trading or other manipulation. A BaFin spokeswoman said this is a “routine” probe with no foregone conclusions. As part of the investigation, Volkswagen will be asked to what extent the executive board knew about the emissions issue, and when individuals knew, she said.
The watchdog is also probing the timing of news disclosure, since market-relevant information is supposed to be disclosed immediately.
So there you have it: an unadulterated disaster that threatens to engulf everyone from assembly line workers in Wolfsburg to officials in Berlin and which has the potential cripple Europe's economic engine just as the German auto industry is marking an extremely difficult transition towards a world where double-digit growth in China is no longer realistic.
We shall see, going forward, if this is just the excuse the ECB needs to expand PSPP or whether perhaps - just perhaps - air pollution ends up being the proximate cause for Mario Draghi to drag the depo rate further into NIRPdom, triggering retaliatory cuts in Sweden and ultimately in Switzerland where, we might add, the air is famously clean.
