Mon Sep 26, 2005 3:24 PM BST

By Michael Shields, European Auto Correspondent
FRANKFURT (Reuters) - Porsche (PSHG_p.DE: Quote, Profile, Research) stock fell as much as 11.7 percent on Monday on concern its plan to acquire 20 percent of Volkswagen (VOWG.DE: Quote, Profile, Research) will wipe out cash the world's most profitable carmaker could have given investors.

The voting stake in Europe's biggest carmaker would cost about 3.3 billion euros (2.2 billion pounds), but Porsche said it could still finance projects such as its new Panamera sports coupe.

VW shares see-sawed as Porsche's surprise plan torpedoed talk of a hostile bid for VW that shot its stock 17 percent higher last week. It remained unclear just how Porsche would increase its VW stake, which it put at less than 5 percent.

Attention focussed on the 13 percent stake that Volkswagen holds as treasury shares, but which VW has said before can only by used for option schemes or as an acquisition currency.

A VW spokesman said its shares could be used for "strategic purposes" or options. He was not more specific.

The deal sparked grumbling that VW's drive to slash manufacturing costs could lose steam if Porsche's entry secured majority control for Porsche, VW itself and the German state of Lower Saxony in an all-German public-private alliance.

"The recent surge in VW is now explained, but this deal is depressing confirmation that the old ways of German capitalism die hard," Sanford Bernstein analyst Stephen Cheetham said, calling the plan "a terrible use of Porsche's free cash".

By 1346 GMT, Porsche was down 9 percent at 616.39 euros and VW eased 0.4 percent to 51.65 after touching a three-year high of 53.19 euros on what traders called short covering and talk that Porsche would buy more VW stock on the open market.

VW stock had soared last week on heavy volume, prompting talk that a strategic investor was building a stake.

Worried that in 2007 a European court may overturn Germany's "VW law", which caps shareholders' voting rights at 20 percent, Porsche says it had to act to prevent any hostile VW takeover that could disrupt business ties with Europe's biggest carmaker.

Volkswagen makes the chassis for Porsche's Cayenne offroader and is working with Porsche to develop hybrid engines. VW supplies 30 percent of the content in Porsche's sales volume.
Investment bank Merrill Lynch (MER.N: Quote, Profile, Research) is advising Porsche, a source close to the matter said.

GERMAN PERSPECTIVE

Lower Saxony, VW's home state, is the largest VW shareholder now with 18.2 percent of the voting rights and reaffirmed on Sunday it was committed to holding its VW stake. VW is the next largest shareholder with its 13 percent voting stake.

"The decisive thing for the development of VW shares in the next few days is whether and at what price Porsche can acquire the 13 percent of shares that VW holds itself," said Stephan Droxner, analyst at Landesbank Baden-Wuerttemberg.

Lower Saxony "has been in contact with various automakers for a long time, because we have known for years of American carmakers' interest in getting into Volkswagen," state Premier Christian Wulff told the Hannoversche Allgemeine Zeitung.

"We tried to cooperate with the United Arab Emirates. Porsche offers a German perspective. We can generate synergies."

Turning to Porsche also draws on long-standing family ties.

Volkswagen Chairman Ferdinand Piech, whose family is a main Porsche shareholder, is the grandson of Porsche's founder, Ferdinand Porsche, the man who developed the legendary VW Beetle as a "people's car" for Adolf Hitler.

Deutsche Bank cut its rating on Porsche shares to "sell" on Monday, setting a price target of 550 euros per share while WestLB lowered its recommendation to "neutral" from "outperform".

JP Morgan suggested taking profits in both stocks.

But CSFB recommended buying into weakness in Porsche shares, noting the deal made long-term strategic sense by securing production of the Cayenne and perhaps using spare VW capacity at some stage to make the four-door Porsche Panamera.

Sal Oppenheim boosted VW to "buy" from "reduce", saying Porsche had given VW's earnings drive its vote of confidence.

(Additional reporting by Jan Schwartz in Hamburg, Andrea Lentz in Frankfurt and Lincoln Feast and Siobhan Kennedy in London)

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