>PORSCHE AUTOMOBILE (CITI)

■ What's New — We are cutting our target price to €31 from €34.60, maintaining the ‘Sell’ (3S) code. The value of PAH is no longer linked to the operating performance of the Porsche core operations (simply an associate). Instead it is dominated by the Rights issue due to happen before June 30th 2011 to allow repayment of Tranche 1 of Porsche’s December refinancing, and the Merger with VW, which will need to happen shortly thereafter. Investors now rightly focus on PAH Prefs on the basis of whether they are a cheap/expensive way into VW Prefs. As of today, one cannot fully define the Exchange Ratio, but our analysis suggests that at any price above €32 they are currently a more expensive way to own New VW than buying VW shares directly.

■ Why so?? — The merger of the two companies is based on values, not share prices, so the number of VW shares available to PAH Pref holders does not change once valuations and liabilities are determined. However the PAH share price determines the potential Rights issue price. We assume a PAH Rights at market, so as more PAH shares are created with a lower price, the eventual exchange ratio will fall, but this is not a linear relationship. At the current price of VW Prefs (€70), only below €31 do Porsche Prefs begin to look a more attractive entry point

■ Assessment of Liabilities still the critical factor — We make ‘central case’ assumptions about the imponderables among the liabilities of Porsche SE — notably the tax and litigation issues that can’t be fully calculated. This includes options tax/options unwind and litigation liabilities of a total of €3bn. €1bn more value within Porsche offers a 4-5% upside in the value Pref holders achieve on exchange, and boosts the family ownership of New VW by nearly 1%.

■ Risks — We will be wrong about our low-end assessment of the Porsche share price if we have judged the unquantifiable liabilities too harshly. We do not see failure to complete the merger as a risk to our negative view: in that event we see the value as resting between €20 and €28, with VW shares the only material asset of the rump company, and much of its dividend income required for debt service. We make only detail changes to forecasts with this note.

To read the full report: PORSCHE AUTOMOBILE