Exposure Management Strategy

Porsche's Currency Hedging Strategy

Write 2-page, double-spaced, answering the questions in the file below. Your analysis for the case should be from all different angles but make it concise and straight to the point.Please type your answers immediately below each question.You may attach exhibits to support your arguments.

BMW says that its decisions on where it locates production are driven by market needs, not currency considerations. Yet it has created natural hedges for itself by producing cars in America and Britain. By incurring costs in these markets, it greatly reduces the currency translation problem. Rival Porsche makes most of its cars in Germany, so its costs are mostly in euros. Yet a large chunk of its revenues come from sales of its sports cars in America. Lacking BMW's natural hedge, Porsche uses financial hedging to minimise the short-term impact of currency swings. “Grappling with the Strong Euro,” The Economist, June 5, 2003, p. 53.

The USA represents approximately 50 percent of our total business. There are a few other countries that also use US dollars. This situation will not change much in [the] future. That is why we are hedged against currency fluctuation for the next three to four years. In our books the dollar and the yen are above the actual rates. That allows us time to react to any currency movement.

It was January 2004 and Porsche—the legendary manufacturer of performance sports cars—wished to reevaluate its exchange rate strategy. Porsche's management had always been unconcerned about the opinions of the equity markets, but its currency hedging strategy was becoming something of a lightning rod for criticism. Although the currency hedging results had been positive, many experts believed that Porsche had simply been “more lucky than good.”

There was growing concern among analysts that the company was actually speculating on currency movements. Analysts estimated that more than 40% of earnings were to come from currency hedging in the coming year. Porsche's President and Chief Executive Officer (CEO), Dr. Wendelin Wiedeking, now wished to revisit the company's exposure management strategy.

Porsche was a publicly traded, closely held, German-based auto manufacturer. Dr. Wiedeking had returned the company to both status and profitability since taking over the company in 1993. Porsche had closed the 2002/03 fiscal year with €5.582 billion in sales and €565 million in profit, after-tax (see Appendix 1). Wiedeking and his team were credited with the wholesale turnaround of the specialty manufacturer. Strategically, the leadership team had now expanded the company's business line to reduce its dependence on the luxury sports car market, historically an extremely cyclical business line.

Operational Superiority of Porsche

Although Porsche was traded on the Frankfurt Stock Exchange (and associated German exchanges), control of the company remained firmly in the hands of the founding families, the Porsche and Piéch families. Porsche had two classes of shares, ordinary and preference. The two families held all 8.75 million ordinary shares. Ordinary shares held all voting rights. The second class of share, preference shares, participated only in profits. All 8.75 million preference shares were publicly traded. Approximately 50% of all preference shares were held by large institutional investors in the United States, Germany,

Copyright © 2004 Thunderbird, The Garvin School of International Management. All rights reserved. This case was prepared by Professors Michael H. Moffett and Barbara S. Petitt for the purpose of classroom discussion only, and not to indicate either effective or ineffective management.

and the United Kingdom, 14% were held by the Porsche and Piéch families, and 36% were held by small private investors. As noted by the Chief Financial Officer, Holger Härter, “As long as the two families hold onto their stock portfolios, there won't be any external influence on company-related decisions. I have no doubt that the families will hang on to their shares.”

Porsche was somewhat infamous for its independent thought and occasional stubbornness when it came to disclosure and compliance with reporting requirements. In 2002 the company had chosen not to list on the New York Stock Exchange after the passage of the Sarbanes-Oxley Act. The company pointed to the specific requirement of Sarbanes-Oxley that senior management sign off on the financial results of the company personally as inconsistent with German law (which it largely was) and illogical for management to accept.

Management had also long been critical of the practice of quarterly reporting, and had, in fact, been removed from the Frankfurt exchange's stock index in September 2002 because of its refusal to report quarterly financial results (it still only reports operating and financial results semi-annually). Porsche's public response to its removal from the MDAX was unapologetic as usual: “Of far more importance, from the investors’ standpoint, than a continued presence in the internationally insignificant MDAX is the inclusion of Porsche's stock from the end of November 2001 in the Morgan Stanley Capital International index.” Porsche's management continued to argue that the company believed itself to be quite seasonal in its operations, and did not wish to report quarterly. It also believed that quarterly reporting only added to short-term investor perspectives, a fire which Porsche felt no need to fuel. Porsche's brief press release announcing its decision not to list in New York is shown in Appendix 4.

Porsche also continued to report only under German accounting standards. German standards were often criticized for their lack of transparency, and allowed companies like Porsche to mix operating results with financial results, including foreign exchange operations. Many of its rivals, even Germanbased companies, were now reporting in accordance with either International Accounting Standards (IAS) or U.S. Generally Accepted Accounting Principles (GAAP). The refusal to expand reporting was seen as one more indicator of the company's stubbornness, particularly since all EU-listed companies were required to report in accordance with IAS beginning in 2005.

But, after all was said and done, the company had just reported record profits for the ninth consecutive year. Returns were so good, and had grown so quickly in the past two years, that the company had paid out a special dividend of €14 per share in 2002. That was in addition to increasing the size of the common regular dividend. The company's critics, of course, had argued that this was simply another way in which the controlling families drained profits from the company.

1. Exhibit 3 of the case shows that Porsche has a substantially higher EBIT margin and ROIC compared to other European auto manufacturers. Can we conclude that Porsche is operationally a lot more superior? Why?

2. Do you think it is a good idea for Porsche to hedge 100% of its economic exposure? Why or why not?

3. In addition to using financial options, what do you think Porsche should do to manage its USD economic exposure?