Volkswagen (VWAPY) – Premium Mean Reversion – 18% Upside

Current Premium: 23%

Average Premium: 5%

Upside: 18%

Expiration Date: TBD

This idea was shared by DiSam.

 

This is not a new idea, however, I believe, it fits nicely among currently actionable special situations.

Volkswagen is one of the largest automobile manufacturers and a stock that doesn't need much introduction. The company has two share classes - 295m ordinary shares (US ADR ticker - VWAGY) and 206m preferred (ADR ticker - VWAPY). The shares are almost identical from the economic value perspective, only that ordinary shares have voting rights, while preferred shares have €0.06/share higher dividends. However, it's important to note that voting rights of the ordinary shares are basically useless as over 90% of ordinary shares (and voting power) is controlled by 3 major shareholders:

  • Porsche - 53.3%;
  • State of Lower Saxony - 20%;
  • Qatar Holding - 17%.

On top of that, ordinary shares have a very limited float, whereas preferred shares offer slightly higher dividends and are included in a wider specter of various indexes:

In the rational world, I'd say that preferred shares should be trading above the ordinary shares, or at least be equally valued. This used to be the case till the short spike during COVID outbreak (prefs sold-off more than the ordinaries). Last month the premium spiked up again, this time to 49%.

The premium has narrowed down to 23% since then, however, is still significantly above the historical levels. This offers an opportunity to play on the premium mean reversion. There's plenty of VWAGY shares to borrow on IB - 400k shares at a 2% annual fee.

Worth noting that a similar German case has already been published on SSI (BMW.DE), which didn't quite work out - BMW.DE  ordinary shares continue to trade at a large premium to the preferreds. However, this time, we at least clearly know the reason behind such widening of the VWAGY premium - Volkswagen's Battery Day announcements and plans to conquer the EV market subsequent to which uninformed EV investors rushed to buy Volkswagen (a bit more details below). Most of these investors were likely uninformed about the cheaper preferred shares - even several media articles appeared suggesting "Don't buy the wrong Volkswagen".

There is no clear catalysts for the premium mean reversion, however, I believe that with time the spread is likely to narrow down back to its historical levels of 5%-10%.

Two more points:

  • Current events happened in light of the Porsche spin-off rumors, which might also have an effect on the gap of these securities. Although, it's worth mentioning that when the rumors came out (Feb'21), it made no effect on the spread between the two shares.
  • Part of the reason why such elevated premium still exists and was not arbitraged right away despite seemingly plentiful borrow and liquidity is the reluctance to get involved in shorting Volkswagen's ordinary shares after the infamous short squeeze in 2008. Although VWAGY float is still very small (less than 10%) and there is some risk of getting burned on the short side, the current situation is completely different from 2008 and the chance of another squeeze seems limited.

 

Background information

The spikes in Volkswagen share prices (and also the widening of the spread between two share classes) happened after the Volkswagen's "Power Day" announcement on the 9th of March (the spread increased from 13% to 22% on the 10th of March), the Power Day itself (15th of March), and Q4'20 earnings release (16th of March). During that week, Volkswagen basically announced its plan to beat Tesla and become the world's largest EV manufacturer by 2025, which sparked a lot of hype and uninformed investors rushed to buy Volkswagen's stock most likely without much consideration to cheaper alternatives (i.e. the preferred shares).

 

9 COMMENTS

  1. Ilja

    VWAGY premium over VWAPY has widened again to 32%, mainly due to increase in the price of ordinary shares (VWAGY).

    1. snowball

      BWM (ordinary) premium over BMW3 (preferred) has narrowed to 17%, returning to its pre-2019 historical norm.

      Do you think the future “norm” for VOW premium should be similar to BMW (i.e. mid-teens) or its own historical range ( i.e., parity)?

  2. rc99ar

    Is there a reason to play this in the ADR’s instead of VOW/VOW3? The borrow on the ADR’s is up in double digits. Would be better if IBKR would lend out my VWAPY.

    1. snowball

      Definitely better to trade the Frankfurt-listed shares: plenty of borrow available at IB for VOW at very a low rate of 1.24%.

  3. snowball

    The Ordinary’s premium over the Preferred is approaching March 2021 levels.

    If history rhythms, we will expect to experience a lot of pain first for a few days, as the premium runs up to 50%, and then hopefully will see the premium retreat back to the 20s within a month.

    The VOW/VOW3 premium dynamics are puzzling, now that we have three episodes in our “observation sample”.

    The March 2020 episode could potentially be explained by, during a market turmoil, investors choosing to dump the more liquid preferred shares to raise cash, and/or it was easier for some deeper-pocket investors to prop up the less liquid ordinary shares.

    But then one year later in March 2021, when VW’s stock price was popping, we should expect to see the opposite happening: investors should rush into the more liquid preferred to build up long exposure. Yet this time it was again the ordinary shares that were favored.

    Then I thought maybe I had a good theory: the ordinary shares tend to trade at a larger premium in more volatile environment (like in March 2020 and March 2021).

    I was wrong again: the last several months have seen vol of VW shares come down, but the ordinary shares are winning big again…

    1
  4. snowball

    I notice that, in the years prior to the 2008 short squeeze, the “historical norm” for the VOW pref discount was quite similar to today’s level, at around 30%.

    So what has changed since then? Regulatory disclosure requirements on short and derivative positions? New group/ownership structure after the merger of VW and Porsche AG in 2011/2012?

    Is it possible that the small pref premium prevailing during 2010-2019 was actually an anomaly and not the norm? and that we are now reverting back to the true norm?

    Another food for thought: With plenty of liquidity in the leveraged loan market, there also is a possibility that a taking-private of VW/Porsche is being planned by someone somewhere.

    If that event materializes, will there be another short squeeze on the ordinary shares?

    Yes, Porsche/ Lower Saxony/Qatar control >90% of voting rights, but under German law a 95% threshold has to be crossed for a squeeze-out of minority shareholders (so those ordinary shares out in the open can be very valuable).

    1
  5. snowball

    Some of my observations (and questions):

    (1) Google search volume for VWAGY ticker spiked in March 2021, but has since returned to normal level. (Is there any tool for tracking similar data for twitter posts?)

    (2) Average trading volume of VWAGY was very similar to that of VWAPY before March 2021, but has since spiked, come down, and remained elevated at 3-4X pre-March-2021 average level.

    In fact, the ADR currently has a similar average trading volume level as the Frankfurt-traded VOW.

    I assume that some of the Frankfurt volumes are tied to ADR market-making activities, so it may be fair to say that American retail investors currently play a bigger role than German local retail or global institutional investors in shaping the prices of VOW/VWAGY (who I assume don’t trade VWAGY).

    (3) I read somewhere that Robinhood makes only VWAGY (but not VWAPY) available to its customers. Is it true?

    (4) Is there data on the total numbers of VWAGY/VWAPY certificates currently issued by the custodian banks?

    (5) I don’t see many discussions on Reddit/wsb, and most of them are not crazy. Some are even suggesting doing an arbitrage or reminding others not to buy the “wrong ticker” . Where can we find the VWAGY bulls’ home base on the internet?

  6. g4734g

    So VWAGY fought its way back from a big 1.50 loss this am after earning, to now green by 20-30 cents….meanwhile VWAGY remains down over 3% for the day….This trade has been a complete miss thus far to say the least

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