Tuesday, October 28, 2008

Porsche and VW

VW shares shot up on the Deutsche Börse over the last two days in what looks like a classic "short squeeze." I'll take this as an opportunity to go into full-pedantry mode and explain what a short squeeze is. Those of you who already know, or who neither know nor care to learn, are of course free to click yourselves elsewhere at this point!

The price of a share of equity in Europe's largest auto manufacturer increased by 147% Monday, and is up again, though somewhat less dramatically, today.

Here's a closely-related fact: as of last Thursday, 12.9% of VW's shares were on loan to short sellers.

A short squeeze in an uncomfortable event in the life of a short seller. Specifically, it is what happens when a substantial share of a company's stock is out on loan for purposes of a short play, and the stock's price unexpectedly starts to rise. The short sellers need to cover, and they all may decide they need to cover at the same time, because they now expect the stock price to continue rising and they have to cut their losses. So they head for the same exit door at the same time, shouting "buy, buy, buy!"

This of course makes the price of passage through that exit increasingly expensive.

That, then, is what is going on with VW. Over the weekend, Porsche unexpectedly disclosed that through the use of derivatives it has recently accumulated a 74.1% stake in VW, up from 34%. The state of lower Saxony owns 20.1% This means that there is a "free float" of only 5.8% of VW's capitalization. It also means, as a matter of arithmetical necessity, that some of those shares on loan must actually be the property of Porsche or Saxony, though the short sellers presumably obtained them through the services of a prime broker.

It didn't take long for short sellers to do the math and decide that the exit door was shockingly narrow.

VW is one of the shares on which the Teutonic DJIA, the Dax index, is built. So Dax has shot up along with VW. This morning the Financial Times quotes one analyst thus: "This is a special situation and I think it will go on as long as Deutsche Börse doesn't make a decision regarding these extreme movements in VW shares."

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