Picture: BLOOMBERG/LIESA JOHANNSSEN-KOPPITZ
Picture: BLOOMBERG/LIESA JOHANNSSEN-KOPPITZ

The disruptive threats Herbert Diess saw coming for big, incumbent vehicle-makers soon after he took over the top job at Volkswagen are playing out as predicted — only faster and in more dramatic fashion.

In an interview, the CEO said additional cost reductions and a speedier overhaul of the German industrial giant were vital to withstand new rivals with superior financial firepower. He’s been reflecting not only on trying to keep pace with Tesla  but on the risk that Apple adds another mighty competitor with almost unlimited resources to the automotive arena.

“Despite all efforts, we’re currently in a rather more difficult situation than in 2018, when I took office,” Diess said. “What really has changed — and what I hadn’t expected to this extent — is the view of capital markets on our industry.”

In the almost two-and-a-half years since Diess told investors VW needed to aim for valuation levels more in line with Apple, Amazon.com and Google to still be around for another two decades, the gap has only grown. Elon Musk has beaten him to the punch by fetching an almost $700bn market capitalisation with Tesla, making the company worth more than the next six most-valuable carmakers combined.

This is more than just a matter of bragging rights. In a single week in December, Tesla and Chinese electric-vehicle makers Nio and XPeng raised $9.7bn worth of capital by selling stock. The $5bn that Tesla raised was equivalent to about half of VW’s annual net cash flow.

VW group sold 8.31-million vehicles through the end of November, dwarfing Tesla’s full-year deliveries of almost 500,000 cars. But Tesla’s ability to sustain profits for five straight quarters after years of losses ignited investor enthusiasm both about its business and those trying to replicate its success. China’s XPeng and Li Auto listed on US exchanges in 2020 along with several start-ups that merged with special-purpose acquisition companies, including Nikola and Fisker.

‘Old auto’

Some analysts are warning the trend is overdone. The combined roughly $1-trillion market cap of traditional global vehicle manufacturers remained largely unchanged over the past 12 months, while the value of new rivals went through the roof.

“Valuations of and sentiment towards traditional vehicle manufacturers continue to be far too pessimistic,” Sanford C Bernstein analyst Arndt Ellinghorst said in a note last week. “We remain convinced that established companies with global reach, brand equity and strong balance sheets will play a dominant role in the future of mobility.”

UBS analysts led by Patrick Hummel have made VW their top pick among European vehicle-makers, predicting that “winning EV strategies are likely to be rewarded with higher multiples.” The world’s best-selling vehicle-maker has pledged to become a global EV force, with the industry’s largest investment plan of almost $90bn over five years.

VW cautioned in November that the ongoing fallout from Covid-19 would weigh on earnings in 2021 but stuck to its midterm financial targets, which include restoring net cash flow to more than €10bn as early as 2022. Delivering on these goals could go a long way to defy sceptical investors that remain unconvinced VW can become more nimble.

“We haven’t sufficiently proved yet that we can hold our ground in the new competitive environment — our valuation is still located in ‘old auto,’” Diess said. “This leads to a grave disadvantage for us in terms of access to required resources.”

On its own

Investments VW and its peers are making in EVs, software operations, mobility platforms and self-driving technology will be enormous. Investors would face much higher dilution if the companies were to try raising funds by selling stock as Tesla has, and such a scenario is further complicated at VW by its complex shareholder structure.

While profits from Porsche, Audi and its Chinese ventures have filled VW’s coffers over the years, its high fixed costs were exposed when sales tanked during the pandemic. Earnings at several peers proved more resilient.

“We must significantly improve our costs and work on efficiency, to gear the traditional auto business significantly more towards returns,” Diess said. He sought to rally the troops in December by declaring VW would pit its largest factory in Wolfsburg, Germany, against Tesla’s plant still under construction near Berlin.

VW also embarked on a plan to reduce material costs by 7% within two years and hammer out a deal with unions in the first quarter to lower fixed costs 5% by 2023. Diess, who ruffled feathers in 2020 by trying to narrow the group’s focus on its main car operations, insists the company can ill-afford to waste time.

“The overhaul is still progressing too slowly,” he said.

The former BMW executive received a fresh vote of confidence in December from VW’s supervisory board to pursue his overhaul and trim costs. He warns there could be dire consequences if the company that employs 670,000 people worldwide does too little, too late to change.

“Not everyone realises the threat to our company to the same extent,” Diess said.

Bloomberg

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