Why is Abu Dhabi buying into Volkswagen? (page 1 of 3)

Where do automakers turn when they are in serious trouble? To governments, preferably their own.

That's what Chrysler did in the 1980s, when it successfully sought help from the US government. That's what Daimler Motors did, too, when it needed a major infusion of cash - although the state investor was Kuwait, rather than Germany. Now, it's the turn of another German carmaker to look to a Gulf state for an urgently needed capital infusion.

Volkswagen - which has recently seen both profits and its share price fall - has struck a deal with Abu Dhabi and Saudi Arabia's Olayan Group, which have agreed to pump in over $2 billion in a deal that involves the acquisition of FleetPlan, a leading fleet management company in Europe and Asia.

The timing of the deal could not have been better for VW. Despite sales of over 5 million vehicles, worth $105 billion, in 2003, the company is widely viewed as underperforming and proven perhaps vulnerable to a hostile takeover, which is why the $2 billion deal with Abu Dhabi is being met with great relief in Lower Saxony, where VW is headquartered.

Lower Saxony is currently the single largest shareholder in VW, and used its controlling stake to fend off takeover candidates. Germany's VW Act stipulates that no single shareholder is permitted to hold more than 20 percent of the voting rights in the group.

This shield has been the subject of controversy between the German government and the European Commission, which has been asking the government to disband its illegal protection of VW.

The European Commission believes this act impairs the free movement of capital and is now trying to launch legal proceedings. Lower Saxony fears that VW could become a potential takeover candidate if the act is overturned, endangering important manufacturing jobs.

'This is why efforts are being directed towards obtaining a stable capital structure and why Abu Dhabi is therefore a welcome investor,' explains Frederik Westin, an analyst at WestLB, a leading investment bank.

Together Abu Dhabi and Lower Saxony would have about 30 percent of the votes, constituting a blocking minority. The cash-rich emirate could also help finance future VW investments.

'Abu Dhabi would constitute a reliable and long-term-oriented investor who is familiar with and shares the stated goals of the Volkswagen Group, and who, we believe, would also be a stable partner,' argues Bernd Pischetsrieder, chairman of VW's management board.

Through this deal, Volkswagen is now taking the same road as American rivals General Motors and Ford, which have been turning to their financial divisions - including car loans, leasing and insurance - when sales have stagnated.

For VW, too, the financial division is the profit center, at least for now. Operating profits rose by 24 percent in 2003, to 894 million euros, while manufacturing profits were just 886 million euros, down from nearly 4 billion euros a year earlier.

It appears, then, that Volkswagen has killed two birds with one stone. Not only has the company managed to significantly expand its presence in the leasing business, but it has also found an outside investor to pay for the deal.

The acquisition of LeasePlan, Europe's largest fleet management business, has long been a strategic necessity, but VW did not have enough funds in its coffers to pay for the purchase. Neither could it have raised the money in the markets without seriously undermining its credit rating.