Volkswagen AG (ADR) (OTCMKTS:VLKAY) will cut investment of its namesake brand by at least one billion euros (US$1.3 billion) a year to cope with the aftermath of the emission scandal now popularly known as “Dieselgate.” Herbert Diess, the new head of the Volkswagen brand, said that a cost-cutting program, not excluding a major sell-off, is already underway and will be expanding rapidly.
Ironically, the Volkswagen division is the least profitable of the entire VW Group, also known as VAG, whose profits come mainly from Audi, Porsche, and China. Nevertheless, the now disgraced and former VW Group CEO, Martin Winterkorn, had already planned to boost the Volkswagen brand through a combination of cost-cutting measures and new technology. How will Volkswagen stock react?
Impacts of VW “Dieselgate” Dissipating Through German Economy
Meanwhile, the Dieselgate scandal has started to radiate its effects to the wider German economy. The ZEW index dilutes the opinion of some 350 economists and analysts, bullish and bearish, over Germany’s economic prospects for a six-month period. It dropped by 10.2 points for October; by comparison, the ZEW for September measured 12.1. October’s ZEW indicator is the lowest such indicator in the past year. (Source: “German ZEW index declines to one-year low,” TradingView web site, October 14, 2015.)
The ZEW, in fact, fell far below expectations, settling at no lower than six. The Volkswagen scandal has prompted Germans to feel rather timid about their ability and expectations to run Europe’s largest economy after months of robust expansion and despite the Russian-Ukrainian and eurozone crises, thanks to rising domestic demand. Nevertheless, even as he announced cuts, Diess unveiled a new product strategy at Volkswagen.
The company will retain its diesel engines, the very same at the heart of Dieselgate, replacing the guilty sensors with more modern and expensive emission controls (VW engineers had resorted to purposely using fraudulent software to meet EPA targets). Moreover, the Volkswagen Group plans to increase the production of hybrid vehicles and develop a new electric-powered compact car. Finally, the Phaeton—now a more than $100,000 luxury sedan powered by a 6.0 liter, 12-cylinder gasoline engine whose platform is shared with a Bentley (one of VAG’s other brands)—will be replaced by a similarly bodied all-electric variant. (Source: “For VW, Total Overhaul Ahead,” Handelsblatt, October 14, 2015.)
Therefore, the Volkswagen Group has repositioned itself in the market through hybrid and electric cars. The sale of some of the group’s brands is also possible. The new standardized electric-powered drive system would be designed to complement all types of bodywork and models, including luxury and more affordable vehicles, delivering range from 180 to 320 miles or so.
As Dr. Herbert Diess promised the company’s board of directors, “We are very aware that we can only implement these innovations for the future of the Volkswagen brand effectively if we succeed with our efficiency program and in giving our product range a new focus.” (Source: “Volkswagen Brand Board of Management takes strategic decisions,” Volkswagen AG web site, October 13, 2015.)
The next few months will make the picture of the “new” Volkswagen clearer and show whether the more electric product range will be complemented by the sale of some of the Group’s brands.
To date, there have only been rumors; surely Bugatti, Lamborghini, Bentley, and Ducati, four strong but elitist brands, are very far from the Group’s heritage. Porsche, while intimately tied to the VW Group’s DNA, might also become more independent. The sale of some of the brands seems inevitable because while a company can optimize resources as much as it wants, VW cannot simply shift to hybrid and electric-powered products after reducing investments by more than a billion euros without sacrificing some of its profitable brands or without affecting Volkswagen stock.
At stake is the dignity of a company that has built the largest automotive empire in recent years. Its future looked bright until less than a month ago. Now, the company’s survival depends on the reprogramming of its approach.
Like any redemption, VW will have to make painful moves. Matthias Mueller, the new VW Group CEO, warned 20,000 gathered workers that while they “will overcome this crisis,” it “would not happen without pain.” Additionally, Mueller vowed that “we [the company] will do everything to ensure that Volkswagen will stand for good and secure jobs in the future as well.” (Source: “New Volkswagen CEO tells staff crisis recovery will ‘not happen without pain’,” The Hamilton Spectator web site, October 6, 2015.)
Therein lies the dilemma: how will Volkswagen make such a momentous shift to electric and hybrid cars if the cuts in investment will affect machinery and infrastructure, slowing the process of innovation? If anything, given the rhetoric from the company, it would seem as if Volkswagen has consigned the electric car to a post-scandal recovery period rather than now.
VW’s immediate priorities will be to unlock its savings to pay what will be a hefty fine in the United States; according to analysts at Sanford C. Bernstein, it could amount to $7.4 billion. At the same time, in Germany, VW Group will have to consider all the additional fines that will come from other countries, a possible class action lawsuit, and any legal costs incurred in the process. According to estimates by Credit Suisse but denied by the German manufacturer, VW will have to disburse some $87.0 billion, not to mention the lower value of Volkswagen’s stock.
Here’s the Bottom Line on a VW Electric Car
In 2014, the Volkswagen Group invested $17.4 billion in research and development, which is more than any other company in the world. To put it into a Silicon Valley perspective, often perceived as the pinnacle of research costs, VW’s investment is greater than the former Google and Apple Inc.’s R&D budgets combined, according to analyst Arndt Ellinghorst from Evercore ISI. (Source: “VW to Delay, Cancel Non-Essential Investments Due to Scandal,” Bloomberg, October 6, 2015.)