VW Deal Impresses Some Investors But Big Threats Remain

VW Deal Impresses Some Investors But Big Threats Remain.

“Ugly as this episode is, we think Volkswagen is making progress to change for the better”

    Some investors believe Volkswagen’s agreement to pay compensation of up to $14.7 billion to U.S. “dieselgate” customers is a solid step towards ending its woes, but the danger of the bill ballooning to an existential threat level still remains.

    The deal includes up to just over $10 billion for U.S. owners of 475,000 VW Jettas, Passats, Beetles, Golfs and Audi A3s with 2-litre engines found to use software that wilfully defeated U.S. environmental regulations. VW will also pay $2.7 billion to an environmental remediation fund and $2 billion to promote electric cars. The deal doesn’t include problems with 85,000 vehicles with 3-litre diesel engines, mainly Audis and Porsches.

    The U.S. Justice Department is still examining potential civil and criminal penalties.

    VW had already set aside $18 billion and investors are wondering if this will be sufficient.

    Citi Equity Research described the agreement with U.S. authorities as a big step forward, with the headline amount of the agreement broadly in line with expectations, but wondered about the pending civil and criminal penalties.

    “Ugly as this episode is, we think Volkswagen is making progress to change for the better,” said Citi analyst Michael Tyndall.

    Remedial actions
    “What is not covered is spending claims for civil penalties or potential criminal liability. There also doesn’t appear to be a fine as such, but we presume this is the pending civil liability, which will be influenced by how successful Volkswagen is in taking remedial actions,” Tyndall said.

    Tyndall said it was unlikely that VW would have under-estimated its potential costs with its original $18 billion provision.

    “We think it is enough to conclude this issue,” Tyndall said.

    Investment researcher Evercore ISI said the deal was reasonable and would end uncertainty, and also believed the $18 billion would be adequate. It also acknowledged civil and criminal liabilities might loom, but didn’t think they would be a big deal.

    Looking forward, Evercore ISI reckons VW’s unions this summer will agree deals about battery making, component production reorganisation, restructuring and early retirement.

    “VW needs to keep up the pace and management needs to push ahead with urgency,” said Evercore analyst Arndt Ellinghorst.

    The Financial Times’ Lex column was a bit more guarded, although it described the buy-back deal as generous. It also had doubts about VW’s ability to reform itself.

    “True it still faces investor lawsuits everywhere, including Germany, and pressure from Brussels (the European Union) to compensate VW owners in Europe,” Lex said

    Unwieldy mess
    “A bigger question is whether VW can change. Leave aside for a moment the concerns about its structure and governance. Over the past five years it has bloated into an unwieldy mess. Manufacturing productivity – output per worker – is about 40% behind its peers, 30% if one adjusts for the fact that it makes most of its own components. Material costs to sales surged to 78% last year. Bringing the ratio back to where it was a few years ago would save about $7 billion – the equivalent of last year’s operating profit,” Lex said.     

     A big worry for Volkswagen is the possibility of potential liabilities of compensation claims from dealerships, or law suits from states for fraud.

    VW shareholders have been demoralised since news broke September 18 that the company cheated to defeat U.S. environmental rules which limited noxious emissions from diesel engines. This concerned around 500,000 diesel engines in the U.S. The scandal then moved on to the rest of the world with 11 million engines involved in cheating not only diesel emissions, but also fuel economy claims. Earlier this year the U.S. sued Volkswagen for up to $48 billion for allegedly violating environmental laws. Some estimates earlier this year of the final cost to VW soared past the previous record for environmental penalties held by BP with $53.8 billion for the Deepwater Horizon oil spill.

    Reputational damage
    There are costs too which can’t be calculated in simple money terms from reputational damage to VW. This inevitably will impact sales numbers and customer faith.

    The FT’s Lex suggested VW faces an uphill future.

    “VW faces a long struggle to rebuild its reputation among car buyers. Getting on with the task of slimming down to boost profits and productivity should go some way to restoring its reputation among investors,” Lex said.