Fiat Should Form an Alliance with GM, Not Chrysler

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Tag: Fiat, GM, General Motors, Chrysler, Alliance, Opel

April 27, 2009

December of last year, Fiat CEO Sergio Marchionne told the Rome daily La Repubblica (See: Red Ink Warning – The Auto Slump is Global Including the Imminent Fallout)

"The auto sector has the obligation to find a new type of management that will bring about consolidation within the next 24 months."

He also told Automotive News in an interview:

"…the only way for companies to survive is if they make more than 5.5 million cars a year."

Soon after the above statements were made, Fiat announced its intentions to form an alliance with the near bankrupt Chrysler.  Fiat originally proposed to take a 35% position in Chrysler in exchange for the technology sharing.  After the US automotive task force determined Chrysler is not viable as a standalone company, it endorsed the proposed Fiat alliance but only at an initial 20% stake (See GM and Chrysler Restructuring Plans Not Viable).  The US government established April 30th as the deadline for Chrysler to reach an agreement with Fiat in addition to concessions from debt holders and the UAW labor union.  If an agreement is reached, Chrysler will receive $6 billion in additional federal loan guarantees.

To help speed up the negotiations, the Detroit News has reported the Obama administration's auto task force has been meeting separately this week with officials from Chrysler, Fiat, Daimler and the UAW to pressure them to accept tough concessions and work out other terms that could pave the way to a new Chrysler.   Separately, Chrysler negotiated labor concessions with its Canadian union.

With only days left before the deadline negotiations appear to have reached a impasse with debt holders.  Chrysler's lenders proposed to convert $6.9 billion in secured debt to a $4.5 billion first lien secured loan, plus $1 billion in preferred equity in the company and a 40% equity stake. They want a seat on Chrysler's board and demanded that Fiat invest $1 billion in the automaker.  This was in response to the US Treasury’s proposal earlier this month that called for the lenders to wipe out all but $1 billion in debt with no cash or equity offers.  Chrysler’s largest debt holders include: JP Morgan Chase, Citibank, Goldman Sachs and Morgan Stanley.

The official from the Obama administration responded to the proposal by stating:

"It is neither in the interest of Chrysler's senior lenders nor the country for them to advance a proposal that would yield them an unjustified return as Chrysler, its employees and other stakeholders are working tirelessly to help this company restructure.

Our hope and expectation is that these lenders take a more constructive position in the coming days that reflects the actual situation that they and the company face."

According to the NY Times the US government is preparing to push Chrysler into Chapter 11 bankruptcy.  Of interest is Fiat would be allowed to complete the alliance with Chrysler in bankruptcy.  The UAW and Chrysler have reached an agreement, however, the debt holders are resisting.  Unlike most of GM’s debt, Chrysler’s is secured with the company’s assets.

Most of the activity at Chrysler appears to be aimed at pressuring the banks into taking a bigger haircut.  Marchionne has stated several times that the company does not intend to inject cash into Chrysler but will share its small vehicle platform and engine technology with the company as part of an alliance proposal.

Fiat just announced the company’s financial performance for the 1st Quarter 2009 (Full Press Release).  The company reported a loss of €410 million, compared with profit of €405 million a year earlier. The company said sales slumped 25 % to €11.27 billion in the period. Fiat reported a trading loss of €48 million, after a profit of 766 million a year earlier.

The company had €3.9 billion in cash at the end of 2008 compared to €6.9 billion at the end of 2007.  At of the end of the 1st Quarter 2009, the company’s cash position improved to €5.1 billion as the company withdrew €1.2 billion from a new line of credit.  As a result net industrial debt rose to €6.6 billion from €5.9 billion at end 2008.  The company’s cash flow from operating activities was for the most part breakeven for the quarter.

Fiat  reported €5.6 billion in revenues which was down 18% from the same period last year.   Sales volume declined 17.6% to a total of 464,600 cars and light commercial vehicles.  At its current pace, Fiat will sell less than 2 million vehicles this year.  The automotive group sold 2.15 million cars and light commercial vehicles in 2008. (See Insight Into Chrysler's New Partner - Fiat Releases 2008 Results).

As part of its own restructuring, GM had announced it is considering divesting a controlling interest in its European Opel/Vauxhall operations (See GM Reports Full Year 2008 Financial Results and Opel Restructuring).  Opel is facing a liquidity problem and has requested loan guarantees of 3.3 billion from European governments where it has facilities.  To meet conditions set by the German government, GM is seeking investment partners for Opel.  Concern was raised that money going to GM’s European operations could be funneled to the US and reducing GM's position in Opel would prevent that.

At a recent press event, GM's CEO Fritz Henderson has stated the company has received interest in Opel from six parties.   For the past week there has been some speculation that Fiat has interest in Opel and its UK division Vauxhall.  Other investors could include the parts maker and contract manufacturer Magna, Chinese manufacturers, private equity and sovereign wealth funds.

Automotive News reported Fiat and Opel are in discussions over a possible tie-up.  Furthermore the German magazine Spiegel has said Fiat and Opel will sign a letter of intent on Tuesday. Other reports have stated Fritz Henderson has already held discussion with Marchionne about the possible deal.  According to Automotive News, Fiat also wants to form an alliance with GM’s operations in South America.

If a deal is reached with Fiat, this would be the second tie-up between GM and Fiat this decade.  In May 2005, GM and Fiat concluded an agreement to dissolve purchasing and powertrain joint venture companies formed in 2000.  The deal would turn back the clock for both Fiat and GM. Nine years ago, GM bought 20% of Fiat Auto for $2.4 billion while Fiat took a 5% stake in GM. The companies combined their European and Latin American purchasing and powertrain operations in two 50-50 joint ventures. As part of the initial alliance Fiat and GM signed cross-supply agreements for engines and transmissions both in Europe and Latin America.

The companies also agreed to establish procedures aimed at enhancing the savings on jointly developed vehicle architectures.  The May 2005 agreement formally dissolved the joint venture joint venture.  Furthermore,  GM also paid Fiat $2 billion to terminate a put option that Fiat could have exercised that would have forced GM to purchase the company.

Discussion:

Fiat has taken on a lot of debt in the last couple years and has only €5.1 billion cash on hand as of the 1st Quarter.  If a deal is reached with Opel, that business unit will be recapitalized by European government loans by around €3.3 billion.  Chrysler would be sitting on about $10 billion dollars of government debt if the alliance is reached and about $6 billion of cash.

Under this new business framework of Fiat’s it will take years for any economic gains to materialize. It will take at least a full product cycle to realize any substantial benefits related to the larger economics of scale argument.  That could be at least three years to get the first commonized product to market and likely another three to redesign the rest of the applicable fleet.  Adding more complexity would be integrating two companies at the same time and possibly GM being a minority owner in Opel.  For that reason, I am very skeptical about Fiat’s strategy and leery about potential success.  The biggest wild card remains Chrysler as news reports are indicating the company is about to file for Chapter 11 bankruptcy.

Even if Chrysler can emerge from bankruptcy with some deal in place with Fiat, I have concerns that the brand will be damaged beyond repair.  This year, Chrysler’s sales have dropped almost 50% and it is likely the company will sell less than a million vehicles in the US for the full year.  A Chapter 11 bankruptcy could be especially damaging to what little brand equity the Chrysler name has if the reorganization is not timely and lasts for months.  As a result it is likely that revenue will further dry up even with government guarantees for the customers on warrantee repairs and resale value.  Chrysler's new debt would likely not be manageable.

In today’s economic climate, Chrysler’s sales could drop further and possibly approach  a half million vehicles on an annualized basis.  About the only brands that will likely have value in this scenario would be Jeep and Dodge truck.  Both Jeep and Dodge truck are segments of the US market that share very little overlap with Fiat and not good candidates for platform or powertrain sharing.  Frankly, Fiat is not a good partner to support Chrysler's best assets. Furthermore Fiat’s small cars strength does little for Chrysler because it is not a strong market in the US.  Even with tougher fuel standards, the small car market is not likely to increase significantly in volume to make impact revenue.

In less than a year, Chrysler has burned though at least $10 billion dollars (last summer Cerberus stated Chrysler has $10 billion in cash) and there has been very little guidance on the company’s financial position.  The Obama administration’s auto Task Force has not been transparent and provided any details as to how much money the company is currently burning or if the burn rate is approaching more acceptable levels at the current sales pace.  As I discussed a couple weeks ago, I continue to believe Fiat is not a good fit for Chrysler (See Hardball or Backdoor: Fiat CEO Willing to Walk Away From Chrysler Alliance).  At this time, I am uncertain if $6 billion dollars is sufficient to sustain the company if the burn rate is not controlled.  Fiat also just does not have the cash on hand to subsidize Chrysler.

Futhermore, there is all but a zero percent chance that Chrysler will sell 3 million units in the US again and produce the level of profits they did in the mid 1990s just prior to the $30 billion merger with Daimler.  Hence I believe the government will not recoup the $10 billion that in the end it will invest in Chrysler.  The best outcome is for Chrysler to be placed into receivership and its best assets sold.  If Marchionne still wants to enter the US market through Chrysler, let him bring the cash to the auction.  Jeep, Dodge truck and maybe the minivans could be salvaged and made viable at other auto makers.

As for a potential Fiat-Opel deal, I believe this is more workable than the Chrysler alliance.  Since the 2000 deal GM secured with Fiat, I have always been a proponent of this equity alliance.  Just recently I advocated such a deal in (See Analysis of GM and Chrysler's February 17th Restructuring Plans).  It was stated:

Personally if sanity every returns to the automotive markets I would like to see GM, Fiat and Chrysler form an alliance. Not on this site but I was an advocate of the GM-Fiat deal from earlier this decade that was dissolved around 2005. There continues to be great opportunities between GM and Fiat in Europe and Latin America. This assumes each can be viable in the near term to pull it off.

At one time, Fiat was one of the largest brands in Europe by market share but fell on hard times leading to the deal with GM.  Fiat was loosing market share and hemorrhaging cash.   Tthe company also had a strong presence in South America.  Fiat was a natural fit to align with Opel as there was sufficient overlap in product to establish economics of scale and scope through platforms and powertrain sharing.   Opel at the time was in a similar situation as the unit lagged the market shift to diesel engines and losing  market share and money.  Fiat gave GM diesel powertrains that it lacked relatively quickly and overtime would have help with parts sharing volume in the euro zone.

Circa 2005, GM had to grapple with its own structural problems and could not afford to take on Fiat’s and the deal was dissolved.  However, under Marchionne, Fiat has made progress at restructuring the operations and again builds relevant product such as the Fiat 500.  The company continues to be strong in South America but lacks a presence in North America and China.  It is understandable why, Marchionne would want to take on Opel as the potential for parts sharing and greater economics of scale still exist.

Opel has been a 10-year problem for GM.  Cutting a deal with Fiat will remove much of that problem and at the same time maintain the benefit of the assets.  The big plus is, both companies have a working relationship on some level.  The integration of Opel into Fiat can begin almost instantly.  GM has been very successful in the past with Alliance such as GM-Daewoo and with their joint venture partners in China.  GM will continue to operate fully in Europe under the Chevrolet operations.  More importantly, Opel will be funded and GM’s obligations for future investment would be shared with a partner as will Opel’s liabilities as well as its profits and losses.

I do not believe it is likely GM will give up control of its Latin American operations Fiat unless it is part of a greater deal.  Up until recently Brazil has been a profit center for the company.  Fiat also does not have the money to purchase the operations from GM.  To take over Opel, the speculation is GM will give up a portion of its stake for as little as $500 million which would be invested directly into Opel.  Fiat has sufficient funds to afford that.

It should also be remembered that it was Fritz Henderson who initiated discussion with both Ford and Chrysler last summer about a proposed alliance.  Ford turned down GM’s overtures moving on to Chrysler.  The talks with Chrysler were derailed at least publically as both GM and Chrysler faced a cash shortage.  It is possible Henderson could have something else up his sleeve once GM’s situation is stabilized.

To me a GM-Fiat tie-up still holds a lot of promise.  If a deal is agreed upon with Fiat, I am more bullish on this arrangement than the Chrysler-Fiat deal.  Ultimately, I think a full fledge merger or formal alliance between GM-Fiat merger is a likely outcome when the global auto market is finally stabilized. In the end I would like to see Marchionne walk away from Chrysler and cut a deal with GM for their Saturn assets in addition to Opel.  In return GM would take a position in Fiat again.  This will give Fiat true economics of scale and GM's vast technical resources.  I just hope Marchionne wakes up and sees Chrysler is not worth the trouble.  As I said a few weeks ago, Saturn would make a better fit for Fiat than Chrysler.  The company would have all the upside of entering the US market cheaply without the baggage associated with Chrysler.  In addition a deal with GM could also open up China and Korea to the company.  For the health of the US auto market, it is time for the lights to be turned off at Chrysler.  Only four days left to see how this plays out.

 

References:

US Is Said to Push Chrysler to Prepare for Chapter 11, NY Times, April 2009

Fiat Confirms 2009 Earnings Target After Posting Loss, Bloomberg, April 2009

Fiat mum on Chrysler creditors' B demand, Detroit News, April 2009

Feds press for Chrysler deal, Detroit News, April 2009

Chrysler lender proposal is unjustified, says Obama official, Automotive News, April 2009

Chrysler lenders propose equity swap terms, Automotive News, April 2009

Chinese bidders express interest in GM's Opel/Vauxhall, Automotive News, April 2009

More than six serious investors interested in Opel, Automotive News, April 2009

Fiat may link with GM units in Europe, Latin America, Automotive News, April 2009

Who will survive the auto crisis?, Automotive News, December 2008

Fiat plans to take over Opel, labor boss says, Automotive News, April 2009

Can Fiat pull back from the brink in China?, China Car Times, September 2008

Fiat and GM Sign Separation Agreement, The Auto Channel, May 2005

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