VW to close deal with Abu Dhabi; a $2bn-plus deal that will see Gulf interests take a substantial stake in Europe's largest car manufacturer is close to completion

Middle East, The, August-Sept, 2004 by Stephen Williams

ABU DHABI'S STATE-OWNED Mubadala Development Company looks certain to formally sign a deal to take an undisclosed but significant stake in Europe's largest car-maker, Volkswagen (VW). Under the agreement, VW will sell Mubadala around 10% of its own shares in order to finance a 50% stake in a new company to be formed between itself with a 50% majority stake, and Mubadala and the Saudi-owned Olayen Group each holding a 25% stake.

This new joint venture company will then buy Europe's largest car-fleet management company. LeasePlan, from Dutch bank ABN in a deal worth over $2.4bn. Having completed the purchase, VW intends to merge its own vehicle leasing business into the new entity. Despite sales of over five million cars in 2003, worth some $105bn, Volkswagen and its chief executive, Bernd Pischetsrieder, are coming under increasing pressure. Many auto-industry analysts believe VW is under-performing--VW's first quarter results this year were poor. The launch of the new Golf, the fifth version of VW's core model, has been disappointing, and the company has been forced to reduce its sales targets and bundle in 'free' air-conditioning to European customers (previously an option) to add value to what is seen as a competent bur unexciting and overpriced new car.

And it is not just VW's core volume-car business that has been suffering. The upmarket VW Phaeton saloon has also failed to meet sales expectations, and the launch of the Veyron supercar-a 1,000bhp 250mph vehicle from VW's luxury sportscar subsidiary Bugatti-has been delayed by well over a year. It has been reported that Veyron engineers are struggling to develop a handling package to keep the world's fastest production car on the road at top speeds.

But aside from VW's business performance, the proposed sell-off of VW shares to the Abu Dhabi company does provide a solution to the pressure the German carmaker is under from the European Commission (EC). The EC disapproves of VW's historical share structure, set up after WWII when the company was rescued from bankruptcy. The victorious allied occupation forces oversaw the manufacture of VW Beetles for both its own military and key civilian personnel, such as doctors and police, in post-war Germany.

The share-structure set up in 1946 included a 20% stake held by the state of Lower Saxony, where VW has its headquarters in Wolfsburg. Lower Saxony's stake is virtually a controlling one as, under this share-holding structure, no party can own more than 20% of the company's voting equity. The EC now interprets this arrangement as tantamount to protectionism and a form of state subsidy. Lower Saxony's prime minister, Christian Wulff, welcomes Abu Dhabi's interest in VW, describing both Mubadala and the Olayen Group as "highly respectable partners for long-term cooperation".

The deal's business rationale for VW also appears convincing. It has long been recognised that only about 10% of the value of the automotive sector comes from pure auto-manufacturing. The rest comes from leasing, finance, servicing, parts, second-hand sales and insurance. That argument has persuaded Pischetsrieder to embark on a strategy of moving VW towards being a 'global mobility group'--offering all these services alongside manufacturing cars.

While VW insists the deal comes with 'no strings attached', it is probable that the company will invest in a production facility in, and source components from, Abu Dhabi itself. These might include plastic, rubber, and in particular aluminium components that require large amounts of energy to produce--energy that is a lot cheaper in the Gulf than in many other places in the world.

VW would also gain mi important foothold in the Gulf region, an area that is seeing a burgeoning growth in auto ownership yet one in which VW has only a negligible presence compared to, say, BMW or Mercedes-Benz.

The LeasePlan deal's business plan also envisages VW conducting a feasibility study on a truck assembly plant for the Middle East region. If that study proves viable, it could bring VW's long rumoured acquisition of Scandinavian truck and bus maker Scania a step closer to reality.

The purchase of LeasePlan is also viewed as attractive to VW because there are obvious synergies with its own leasing business. Although the proposed new company, which would become the world's second largest car-leasing company, would offer little or nothing in the way of extra car sales for VW, it would provide valuable information regarding the maintenance costs of its rivals' various models. Furthermore, both LeasePlan and VW's own finance division are profitable. The former made profits of over $200m last year.

But no matter how encouraging are Pischetsrieder's arguments for the LeasePlan deal, few have forgotten that he was the man responsible, as chairman of BMW, for the Rover Group debacle. Back in 1994, BMW was persuaded that its very survival depended on attaining the critical mass of a volume car manufacturer, and Pischetsrieder led the BMW board in the purchase of the British Rover Group. By the time, six years later; that BMW had rid itself of this white elephant, BMW had been forced to take a $3.2bn charge against its earnings, and Pischetsrieder resigned.