Cases in International Finance

8/9/2019 Cases in International Finance

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Case #1: Lufthansa

If Karl Marx could see what the foreign exchangemarket is doing to captains of industrya successful

corporate executive of one of the worlds prestige

airlines can put on a multimillion dollar currency

speculation and win and still get lambasted by the

critics. Its enough to make a capitalist cry!

Intermarket, 1985


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Some interesting Facts

1926: Lufthansa was born throughthe mergerof Deutsche Aero Lloydand Junkers Luftverkehr it inheritsits crane logo from DAL

1934: Lufthansa offers its firsttransatlantic flight

1990: Lufthansa resumes flights toBerlin following German unification

1990: Lufthansa joins the star alliancewith Air Canada, SAS, Thai Airlines andUnited Airways the first multinationalairline grouping


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Lufthansa Today

Lufthansa is the national carrierof Germany headed by Wolfgang Mayrhuber (since 2003)

Revenue (2004): E 17B

Net Income (2004): E 383M

Passengers (2004): 50.9M

Load Factor (2004): 74%

Lufthansa has 253 aircraft with an average age of 10.5 years.

Boeing: 40%

Airbus: 60%


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In January 1985, under the Chairmanship of Heinz Ruhnau,Lufthansa purchased twenty 737 jets from Boeing for $25,000,000apiece ($500M Total)

Length: 100 Feet

Wingspan: 86 Feet

Cruising Speed: 470 MPH

Max Altitude: 35,000 Feet

Range: 1000 Miles

Seats: 123

At the time, the exchange rate was DM 3.20 perdollar. At thisrate, the planes would cost Lufthansa DM1.6B


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1.7

1.9

2.1

2.3

2.5

2.7

2.9

3.1

3.3

DM/$

1/1/1981 1/1/1982 1/1/1983 1/1/1984 1/1/198

Over the previous year, the dollar had been appreciating againstthe Deutschmark..


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Lufthansas Options

Option #1: Remain Uncovered

The riskiest option with the greatest potential gain (if the dollarweakens against the Deutschmark) and the greatest potential cost (if thedollar strengthens).

Option #2: Full Forward Hedge

The safest of the options. If Lufthansa bought dollars forward atthe current rate of 3.2, they could lock in a cost of DM1.6B

Option #3: Option Hedge

If Lufthansa purchased put option on DM at 3.20 DM/$ (or calloptions on dollars), they could take advantage of the potential gain froma dollardepreciation, but still hedge the possible appreciation risk


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Lufthansas Options

Option #4: Money Market Hedge

Lufthansa couldobtain dollars now, by borrowing Deutschmarks,converting them todollars at DM 3.20 and then depositing them in either aUS bank or a Eurodollar account until needed. In principle, this shouldhave the same effect as the forward hedge

Option #5: Partial Hedge

Lufthansa could purchase $250 M dollars forward at DM 3.20 atallow the remaining balance to be un-hedged.

Option #6: Cash Flow Matching

Lufthansa could try and generate $500M in ticket sales in the US very unlikely!


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Lufthansas Options

1

1.2

1.4

1.6

1.8

2

2.2

2.2 2.4 2.6 2.8 3 3.2 3.4 3.6 3.8 4

Cost(BillionsD

M

Uncovered

Full Forward

Partial Hedge

Option Hedge


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1.5

1.7

1.9

2.1

2.3

2.5

2.7

2.9

3.1

3.3

3.5

1/1/85 5/1/85 9/1/85 1/1/86 5/1/86 9/1/86 1/1/87 5/1/87 9/1/87

Ruhnau was convinced that the dollar was going to fall andopted forthe partial hedge. He was proved right as the dollar plummeted in themid eighties.


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Did Ruhnau make the right decision?

Alternative Relevant Rate Total Cost

Uncovered DM 2.30 DM 1.150 B

Put Options DM 2.30 + Premium DM 1.246 B

Partial Hedge .5(2.30) + .5(3.20) DM 1.375 B

Full Forward DM 3.20 DM 1.6 B

While Ruhnau was correct on the direction of the dollar, he could

have saved some money using options rather than a partial hedge!


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Case #1: Porsche

Porsche makes most of its cars in Germany,

so its costs are mainly in Euro. Yet a large

chunk of its revenues come from sales in

America.

The Economist, June 5, 2003


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Porsche was founded in 1931 byFerdinand Porsche, a formerDaimler Benz director.

One of the firstPorsche modelslookfamiliar?


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The first real Porsche designedin 1948

September 30, 1955:James Dean is killed

driving his Porsche550 Spyder


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Porsche Today

Porsche is led by President and CEO Dr.Wendelin Wiedeking (since 1993)

Net Sales (2003): E 5.582B

Net Income (2003): E 565M

EPS(2003): E 32.29

EPS Growth (2003): 22%

Porsche is essentially a privately held company. All 8.75M votingshares are held by the Porsche family. The remaining 8.75M non-voting shares are primarily held by institutional investors


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The Jewel in the Porsche Crown has always been the 911 Series.(14 different 911 models currently)

Porsche 911 Carrera

Engine: 3.6l 6 Cylinder Engine

Power: 325 Hp @ 6,800 RPM

Acceleration: 0-60 in 4.8 Sec.

Top Speed: 177 Mph

Units Sold (2003): 27,789

Average Price: E 92,000

Cost: E 78,000

Profit Margin: 16%

The 911 commands almostexclusive ownership of its market

segment (high end sports cars).While sales are cyclical, priceelasticity is very low.


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The Boxster was introduced in 1996 to compete with the lowersend sport scars alreadyon the market.

Porsche Boxster




Top Speed: 160 Mph

Units Sold (2003): 18,411


Cost: E 41,000

Profit Margin: 8%

The Boxster is less cyclical thanthe 911, but much more price

sensitive particularly sinceintroduction of the BMW Z4 in2003


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Porsche recently gained entry into the lucrative SUV market. FuelledbySUV crazy Americans, the launch of the Cayenne in 2002 has beenhailed as one of the most successful produce launches in history

Porsche Cayenne




Top Speed: 133 Mph

Units Sold (2003): 20,603


Cost: E 61,000

Profit Margin: 10%

The Cayenne is clearly at the highend forSUVs Porsche is quickly

moving todevelop a lowerpowered, lower cost version.


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Porsches Growing Sales

0

10000

20000

30000

40000

50000

60000

1994 1995 1996 1997 1998 1999 2000 2001 2002

Cayenne

Boxster

911


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Porsches Competitive Position

Automaker Sales(Billions)

Revenue(PerVehicle)

Margin Debt (%ofAssets)

ROIC

Audi E 22.6 E 27,000 6.6% .2% NA

BMW E 42.3 E 32,211 8.0% 47.5% 11.3%

Fiat E 58.2 E 25,829 1.6% 31.3% -2.9%Mercedes E 50.2 E 39,000 6.4% NA NA

Peugeot E 54.4 E 16,192 5.3% 42.9% 10.5%

Porsche E 5.6 E 72,889 16.4% 6.4% 20.5%

Renault E 36.3 E 14,250 4.1% 47.6% 3.7%

Volkswagen E 86.9 E 13,583 5.2% 42.4% 6.8%

We learned the hard way that banks are never there when youneed them : Porsches anti-debt philosophy


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Porsches Foreign Exchange Exposure

United Kingdom UnitedStatesAutomaker Sales Pr oduction Sales Production

BMW 11% 15% 26% 11%

Fiat 6% 0% 0% 0%

Mercedes 9% 0% 19% 7%

Peugeot 12% 6% 0% 0%

Porsche 11% 0% 42% 0%

Renault 9% 0% 1% 1%

Volkswagen 7% 0% 13% 7%

Porsche has the heaviest US exposure (and this is increasing), yet it

has the lowest rate of natural hedging in the sector (Citigroup)


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Pricing Pressures

Porsches Newest Model, the 911 Carrera 4s Cabriolet (2003)waspriced in continental Europe at E 85,000 (a 15% markup over cost of$72,000). Simultaneously, the new Cabriolet was introduced in theUS for $93,000

Implied Exchange Rate =$ 93,000

E 85,000

=1.09 $/E (.91 E/$)


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EUR/USD


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Porsches Problem Defined:

Porsche has three model lineswith different marketcharacteristics 45% ofPorsches sales are in the US($1.836B peryear)

With the exception of anassembly plant in Finland (also aEuro country), all Porsches aremanufactured in Germany

As the dollar continues todecline, what options does Porschehave to cover its currency exposure?


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What did Porsche Actually Do?

Porsche chose an aggressive strategyof put options on dollars(i.e. contracts to sell dollars at a fixed price). Porsche maintains a3 year rolling portfolioof put options with strike prices basedoncurrency forecasts. - Sales revenues through model year 2006 arecompletely hedged.

Currency Exposure Covered by Derivative Instruments

BMW: 35%

Mercedes: 30%

Porsche: 100%

Volkswagen: 30%

Is this the best strategy?

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