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UPDATE 3-VW sees weak start to 2003, better second half

(Adds interview with Lower Saxony premier, paras 18-20)

By Nick Tattersall

HAMBURG, April 24 (Reuters) - Volkswagen braced shareholders for a significant fall in first-quarter profit on Thursday, hit by weak exchange rates, development costs and equity writedowns, but said new models would help business in the second half.

After his first year at the helm of Europe's biggest car maker, Chief Executive Bernd Pischetsrieder told the group's annual general meeting that the weakness of the dollar and a fall in value of the company's equity investments had continued to hit profits in the first three months of this year.

"However, we assume there will be a substantial improvement in operating profit during the course of the year, particularly in the third and fourth quarters," he said, but repeated that in 2003 as a whole the result would fall below last year's 4.76 billion euros ($5.2 billion).

VW stock, which has underperformed the DJ European autos index by around seven percent since the company first warned last month that profits would be down this year, fell 3.2 percent to 33.87 euros by 1450 GMT.

"The outlook for profit looks uncertain, and that is difficult for the shares at the moment," said Gerald Roessel, a fund manager at Invesco Asset Management, which holds VW stock.

VW, along with other mass-market car makers, is battling weak demand on both sides of the Atlantic, but its profits are under particular pressure as key models age simultaneously and development costs for replacements pile up.

The group boasts that on average it will launch an updated model variant somewhere in the world every three weeks this year, with China seen as a particular motor for sales growth.

China overtook Germany as Volkswagen's highest-volume market in the first three months of the year, with sales of VW-brand cars almost doubling to 149,500 units. By contrast, sales in its home market slipped six percent to 114,000 units.

The company said it still expected to lift unit sales back over five million this year from 4.98 million in 2002, helped by the launch of an updated version of its top-selling Golf later in the year and its recently introduced Touran minivan.

BEARDED ENGINEER TIGHTENS GRIP

Pischetsrieder said no decision had yet been made about reorganising board responsibilities after the sudden departure of sales and marketing director Robert Buechelhofer, who quit earlier this month over a dispute about policy.

"Our deliberations will have to assess whether we should keep to the regional sales structure or whether group brands should be given global responsibility," Pischetsrieder said. But he emphasised that the management board would remain responsible for all products and markets.

Buechelhofer's resignation has fuelled investor hopes that a new guard is emerging at VW and that Pischetsrieder's grip on the board is tightening.

His relationship with Buechelhofer, said to have been one of his harshest critics within the company, had been tense dating back to their time together at BMW .

Pischetsrieder's influence will be further strengthened with the departure of finance chief Bruno Adelt, whose contract expires at the end of 2003. Adelt will be replaced by Hans Dieter Poetsch, Pischetsrieder's first major appointment and, like the boss, a former BMW executive.

Under Pischetsrieder, VW has been modifying the "platform strategy" championed by his predecessor, Ferdinand Piech, which saved costs by building several models on the same basic platform but diluted the identity of individual marques.

Pischetsrieder has been shifting towards a modular approach, in which different models share components rather than platforms, keeping costs down but also allowing cars to be replaced independently of one another.

He says that will reduce VW's capital spending and high development costs by 20 percent over the next decade, with a long-term aim of cutting it to 10 percent of revenues.

However, Pischetsrieder has done little to assuage concerns about the so-called "VW law", which caps shareholder voting rights at 20 percent and could thus give the state of Lower Saxony where the firm is based a blocking minority.

The European Commission started legal action against the law, which effectively shields VW from a hostile takeover, in March. But Lower Saxony premier Christian Wulff said even if the law were to be abolished, such a bid could still be blocked.

"Even if one could imagine the VW law no longer existing, I have always said that one could work with others to form a majority that would prevent a hostile takeover," he told Reuters on the fringes of the annual meeting.

Some analysts also criticise VW for investing excess cash in equities. The company declines to say how much it invests in shares as against bonds, but had to make a 400-million-euro writedown on equity investments in the third quarter last year.

"We believe the risks being taken with VW cash in the equities portfolio are unacceptable," CSFB analysts, who rate the stock "outperform" and say it represents "fantastic" value in the long term, said in a recent research note.

"What concerns us is that the impact on the equity portfolio reduces the transparency and reliability of earnings... If VW has too much cash, it should repay debt or buy back shares."

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(Additional reporting by Jan Schwartz in Hamburg and Jess Smee in Frankfurt)