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The second para. below confirms that "Porsche's takeover demand would target the latter [ordinaries] rather than the former [preference]." Then why did investors like Albert Bridge Capital "short the ords and long the prefs"?

Perhaps I will ask this as a separate question...I also don't grasp why VW's "share price would fall as soon as Porsche got control and stopped buying".

Kindly explain in most simple English. I don't know German law. I don't want to know all the history behind Porsche and Volkswagen's rivalry.

The day Volkswagen briefly conquered the world | Financial Times

In Germany, this tactic gained traction thanks to the Teutonic tradition of dual-share classes. According to a paper by Katie Bentel and Gabriel Walter, the practice dates back to the 1980s, where preference shares — which carry no voting rights but a fixed dividend — became popular as to protect German companies from both hostile takeovers and foreign influence. The outside investors got their dividends, and local owners kept control through the ordinary shares. Everyone was happy.

I don't quote four paragraphs in between.

Attention quickly turned to Volkswagen, where the preference shares traded at a significant discount to the ordinaries, in part because Porsche's takeover demand would target the latter rather than the former.

I don't quote many paragraphs in between.

Funds like Albert Bridge Capital piled in. Here's how they described the trade:

By late August, the prefs [preference shares] were trading at €100 per share, but the ords [ordinary shares] were twice the price at €200. Consequently, nearly everyone and their brother were short the ords and long the prefs, in what some viewed as a riskless trade. We, however, were not short. It felt like such a consensus trade and we knew that Porsche were suspiciously adept at playing the markets (and playing market participants).

But then, just three weeks later, the premium was over 3x (the prefs were at €90 and the ords at €270). That was enough for us to eliminate our “be anti-consensus” requirement, and we threw in the towel and got short in late September in two tranches at €261 and €278 — with the underlying value (represented by the prefs) nearly 70 per cent lower.

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The family politics of the Porsche dynasty (one of whom was VW's CEO at the time) were obviously a factor in the background of all of this; but the story doesn't need any warring cousins. They just add a bit of journalistic "human interest" spice.

So the cashflows from VW's Ords and Prefs were identical. The difference between the two was thus a reflection of the value of control over the company (as opposed to its economics). If Ord = 2 * Pref, that's the market effectively saying that the vote was worth as much as the company itself. Selling 1 Ord to buy 2 Prefs gave you a full set of dividends at a net zero price. That's why the funds did it.

The funds were not naive. They knew Porsche was buying up VW stock; and this is exactly why the two securities (with identical cashflows) were so differently priced. Porsche was at something like 35% before the drama happened. But Porsche's holding on VW's shareholder's register had massively slowed down, as very weak liquidity in the Ords presented few opportunities to grow their holding at a decent pace at decent prices.

If Porsche had paused/slowed thus, then the spread should converge (in the Pref's favour). And even if Porsche did find other external shareholders to support their bid and get them >50.01%, then their need to buy Ords in the first place would then disappear, causing the entire reason for the wide spread between Ords and Prefs to disappear.

To repeat, the funds were not naive. They knew it was odd that the Ord-Pref spread should remain so wide if Porsche had paused; but yet it did. And they knew that the real source of the demand for those Ords probably had to remain Porsche. So there were explicit suggestions in the market that Porsche could be hoovering up stock out of sight, via options. Only when these expired, would the stock actually become Porsche's. But here lies the rub. Porsche explicitly and publicly denied this. But they were lying to the market; while they were doing exactly this in massive size. They were sitting on another 30% of the VW's Ords acquired off balance sheet!

And that's the really important detail. Porsche actively deceived the market about covertly cornering the market in VW Ords. In many investors and regulators' eyes, that easily constituted market abuse. The Porsche CEO certainly lost his job over this a few months later. He then spent most of the next 8 years of his life in facetime with his lawyers, before being finally acquitted of criminal wrongdoing in 2016.

So the moment the news broke, all hell broke loose. Once you took Porsche's existing plus their new undercover holdings, you got to >70%. Lower Saxony held a 20% stake; and they were long-term public-sector, ie they held and never sold. So that left <10% of the Ords publicly tradable for all the shorts to cover. Horde of people cramming through small door. Hence VW briefly became the most valuable company in the world!

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  • $\begingroup$ i remember this at the time, this is v good summary of behind the scenes market activity. $\endgroup$
    – Attack68
    Jan 28 at 12:12
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Supply and demand is your answer.

Porshce wanted to acquire influence over the company, therefore they had significant demand for ordinary shares (with voting rights), and drove their price up significantly.

Other investors recognised the distortion between these and placed a medium term bet on mean reversion, i.e. that the value of voting rights versus non-voting right would return to normal levels once the unusual level of demand for voting rights had dissipated.

By shorting one class and buying the other class the hedge funds are placing that specific bet and are not impacted by idiosyncratic risks such as the wider stock market and porshce earnings etc.

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