What Could The Dieselgate Scandal Cost Volkswagen?

September 24th, 2015 by Trefis Team

The repercussions and aftermath of Volkswagen AG‘s (OTCMKTS:VLKAY) emissions scandal is bound to cost the German company dearly. After one-third of the company’s valuation was wiped off between last Thursday to Tuesday, the stock rose around 8% on Wednesday. More drama unfolded, with the group’s CEO Martin Winterkorn announcing his resignation, accepting responsibility for the irregularities, but, at the same time, maintaining that he wasn’t aware of any wrongdoing on his part. Volkswagen is a large company, and in fact, it is the highest selling automaker volume-wise in the world.  Given the scale of this scandal, the German group will now be facing large fines, class action suits, investor backlash, possible criminal investigation, and a loss in customer perception.

So what will be the grand total of all expenses that Volkswagen will have to incur owing to the dieselgate scandal? Let’s try and figure this out..

Government Fines and Settlements– Volkswagen has sold 482,000 cars in the U.S. since 2008, which were fitted with the defeat device that helped in cheating the emissions test. According to the EPA, the fine for each vehicle that did not comply with federal clean air rules could be up to $37,500 (£24,000), which means that Volkswagen could be facing fines of up to $18 billion. [1] This is, of course, the worst case scenario.

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Last year, Toyota reached a $1.2 billion settlement with the U.S. Department of Justice, after it was found guilty of concealing the problem with its sticky gas pedals that resulted in the recall of 10 million vehicles. On the other hand, GM recalled around 2.6 million cars over 10 years over the faulty ignition switch that would inadvertently turn off while driving, and disable safety features, such as power steering and airbags. This ignition switch is blamed to have caused at least 124 deaths and 275 injuries. GM reached a $900-million settlement with the U.S. government to avoid criminal charges. And then there was the recent Takata airbag recall, which affected over 35 million vehicles. While there are more instances of recalls and fines levied on automakers in recent times, these specific examples give us a reference point to estimate what Volkswagen could be facing now, given that these offenses, just like Volkswagen’s emissions scandal, had far-reaching consequences.

However, what sets aside the recent Volkswagen scandal is the deliberateness and, to a degree, brazenness of the crime committed. The German group isn’t just guilty of hiding the glitch and misleading the authorities, but the company designed software specifically to falsify emissions data. The EPA’s $18 billion fine might get settled for a lesser amount in the coming time, also depending on how Volkswagen goes about the damage control.  In addition, the company could be looking at fines from the U.S. Department of Justice and the California Air Resources Board. German prosecutors might also look to open an investigation, considering that Volkswagen said that 11 million cars worldwide used this software. Germany’s transport minister has said that Volkswagen has admitted using the same fake emissions test in Europe as well. [2] So the fines may keep on piling.

Recall Expense– As aforementioned, Volkswagen has now admitted that approximately 11 million of its diesel models used the defeat device that would reduce emissions while being tested, and pollute 10 to 40 times the legal limit during normal conditions. As a result, the German group will have to incur the expense of recalling these vehicles, and fixing the problem. Volkswagen said that it was setting aside €6.5 billion ($7.25 billion) to cover costs of the scandal, and a provision for the scandal would be made in the upcoming Q3 income statement. In fact, the amounts could be reevaluated given the investigation is still ongoing.

Private Settlements– Volkswagen will also face private class action suits that might extract billions from the company for years to come. 50 class actions have already been launched in the U.S., and the German group might have to pay heavy damages, considering it not only cheated the authorities, but also its customers, who till now thought that they were driving a ‘much’ cleaner car. ((Volkswagen row widens, bbc.com)) Besides, according to an analysis in the L.A. Times, the federal government paid out as much as $51 million in tax incentives for Volkswagen’s diesel vehicles based on the falsified emission results. [3] So there is a lot of redeeming to do for the company, one would think.

Loss of Future Sales– According to a study, of the average company involved in fraud, the financial punishment imposed by the market was 7.5 times greater than its legal penalties. [4] Apart from the fines and settlements that Volkswagen will face, the company is in grave danger of losing a meaningful portion of its future sales. Let’s put this in perspective. As stated earlier, Volkswagen has sold 482,000 cars in the U.S. since 2008 involved in these allegations, which is 12.24% of all Volkswagen vehicles sold in the U.S. between since 2008. So considering that the U.S. forms around 6-7% of all company volumes, 0.7-0.85% of Volkswagen’s annual volume sales are in jeopardy. And get this — this is just the 0.5 million of the 11 million affected cars, so the decline in future sales due to this scandal could be 1-2% annually, or even more in the near term. A significant portion of the 11 million cars affected are from Europe, and customer backlash and loss in perception is bound to cost Volkswagen in terms of lost sales in the next few years.

The Estimated Total Cost To Volkswagen And The Market Response So Far 

According to our estimates, the net present value of the cost of the entire dieselgate scandal for Volkswagen, including these four factors, could be up to $34.5 billion. The interactive model for the same can be viewed on the Trefis Institutional site, and estimates can be altered to come up with customized scenarios to forecast the total diesel emissions scandal cost.

Now, considering that we estimate an over $30 billion cost to Volkswagen relating to the emissions scandal, the market might have been somewhat kinder to the company, raising its stock price by approximately 8%, after almost one-third of the company’s value was wiped out following the admission of the fraud. The estimated value lost from Thursday to Tuesday was  about $30 billion, which, despite the one day reprieve,  shows the enormity of this situation.  Given that the total cost to Volkswagen could be even more than $30 billion, however, it may take some time for this situation to be resolved and for investors to feel comfortable with the German automaker again.

See Our Complete Analysis For Volkswagen AG

 

See the links below for more information and analysis:

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Notes:
  1. VW emissions scandal hits 11m vehicles, bbc.com [↩]
  2. VW manipulated diesel emissions test in Europe, says German minister, bbc.com [↩]
  3. U.S. taxpayers duped into shelling out $51 million in green subsidies for ‘clean’ VW vehicles, latimes.com [↩]
  4. Social Science Research Network Analysis [↩]