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Tuesday, 28 October 2008 08:06

Short Squeeze Makes Volkswagen World’s Most Valuable Company--Temporarily

Volkswagen briefly became the world’s largest company by market capitalization after an extraordinary surge in its share price driven by a near-panic by hedge funds and other traders to stop losses on positions betting on a fall in the stock.

Surging nearly 150% to more than $1250 per share to a value of $187B before falling back, VW’s share price made the company more valuable than Exxon for a time. More valuable even, than the top 10 other automakers put together, and it was all triggered by shrewd and profitable Porsche, announcing its derivative options. Some are now saying Porsche itself is an even better hedge fund than it is an automaker. Certainly it has made more money hedging than building cars in the past year.

Volkswagen's shares more than doubled after Porsche moved to take control of Europe's largest carmaker and hedge funds, rushing to cover short positions, were forced to buy stock from a shrinking pool of shares in the free float causing the share price to rocket.

VW shares rose 147% after Porsche unexpectedly disclosed that by means of derivatives it had increased its stake in VW from 35% to 74%, causing an outcry by investors, analysts and corporate governance experts and sending a shockwave through European financial markets.

Porsche said that it held 31.5% in derivatives in VW. The sudden disclosure meant there was only a free float of 5.8% causing panic among hedge funds, many of which had bet on VW's share price falling.

"This was supposed to be a very low-risk trade and it's a nuclear bomb which has gone off in people's faces," said one hedge fund manager.
"This is probably the biggest short squeeze in history," said another, referring to when hedge funds have to cover their positions (buy back shares that are rising value). He added it could cause further losses as owners of the shares who lent them to hedge funds can name their price: "It is a short squeeze to infinity," the fund manager said.

In addition to the severe damage to speculative funds, more than $20B in losses are estimated, many are now wondering if Porsche is more a hedge fund than an automaker.

Is Porsche a carmaker or a hedge fund in disguise?

The question has been raised since Porsche, already the world’s most profitable automaker, revealed that in the year ending July 2007, it made $4.5B from options trading and only about $1.25B from selling cars. Add in its share of profits from VW, Europe’s largest automaker, it’s no surprise that Porsche chose to draw down of its $12.5B credit line this year because it could get better returns from investing it than the original cost of borrowing.
A Porsche spokesman said: “We make money from hedging and building cars. The difference is that hedge funds don’t make cars the last time I checked.”