Hardball or Backdoor: Fiat CEO Willing to Walk Away From Chrysler Alliance

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Tag: Fiat, Chrysler, Alliance, Bankruptcy, Bailout

April 16, 2009

In late January, Fiat and Chrysler reached a tentative agreement to form a business alliance (See Fiat and Chrysler Ink Partnership Agreement).  The deal was pending the US governments assessment of Chrysler’s viability plan submitted back in Fabruary.  Last month the government concluded Chrysler was not viabile as an independent company and agreed to an alliance with Fiat (See GM and Chrysler Restructuring Plans Not Viable). 

Fiat would initially get a 20% (down from 35%) stake in Chrysler, however, the Obama administration ordered that the deal must be approved by April 30.  If Chrysler and Fiat finalize the agreement and debt concessions by the union and bondholder are met, the US government will grant Chrysler up to $6 billion in additional loans. Chrysler already has received $4 billion and C$1 billion from the Canadian government. 

If a final agreement is not met by the deadline (14 days left), the Obama administration has warned that Chrysler would go into bankruptcy. Chrysler and Fiat negotiators are in talks with the US union about reducing Chrysler's $10.6 billion obligation to the VEBA health care trust.  Talks are underway with the Canadian union to reduce labor costs.  The US Treasury also is negotiating with the major banks holding $6.9 billion in Chrysler debt; the four largest lenders are JP Morgan Chase, Citigroup, Goldman Sachs and Morgan Stanley.

In an interview this week with a Canadian newspaper Globe and Mail, Fiat CEO Sergio Marchionne said he is ready to abandon plans to form a partnership with Chrysler unless the unions accept substantial labor cost reductions by the end of the month.  It appears the Canadian Autoworkers Union has been reluctant to make concession with the company.

Marchionne said:

“Absolutely we are prepared to walk. There is no doubt in my mind.”

He also said Fiat will not ask the US government for an extension to complete a deal.  In the newspaper interview, Marchionne estimates there is only a 50-50 chance the Fiat-Chrysler alliance could be reached because of the lack of progress on labor negotiations specifically with the Canadian union.

The company had €3.9 billion in cash at the end of year compared to €6.9 billion at the end of 2007.  As a result of its cash position the company will suspend its dividend and share buyback program.Fiat also reported a 70% drop in 4th quarter profit as demand for its vehicles declined in its key western European and south American markets.  Net profit for the 4th quarter of 2008 was €180 million, down from €597 million in 2007.  Fiat ended 2008 with 5.9 billion of industrial debt (See Insight Into Chrysler's New Partner - Fiat Releases 2008 Results).

In the same interview with the Globe and Mail, Marchionne was asked about buying GM’s Saturn.  The CEO denied purchasing Saturn was a back up plan if the Chrysler deal did not materialize. 

Marchionne said:

"It's not a brand I have any affinity for."

Chrysler has 3,700 dealers in the US selling Chrysler, Jeep and Dodge brands and plans to cut the number of retailers.  For comparison, Toyota, which is the second-largest US seller and also has three brands, has 1,400 dealers in the country.  GM the largest company by sales ended 2008 with over 6,200 dealers in the US and plans to cut that by about 25% to about 4,000.

As part of its restructuring plan presented to the US government in February, GM said it plans to phase out and discontinue the Saturn brand by 2011 (See Analysis of GM and Chrysler's February 17th Restructuring Plans).  The company also planned to seek a solution for its Saturn Distribution Corporation.  The distribution network is an independent GM subsidiary with which Saturn dealers have their franchise agreements.  The distribution company consists of approximately 400 stores.

Earlier this month a local Connecticut newspaper was reporting and announcement of a new partner for Saturn should happen in the next three weeks.  Furthermore it the unnamed vehicle supplier will provide "world class" cars to Saturn.  Rumors at that time suggested that the French company PSA would provide either Peugeot or Citroën vehicles to the franchise.

This week it was reported the private equity firm Black Oak Partners and the investor group Telesto Ventures have approached GM about buying the assets of its Saturn brand and distribution network.  No details were provided but the press release vehicles would be sourced from global manufacturers and will in most, but not all cases, be offered under Saturn’s brand.

Discussion

It would appear from the Marchionne interview, he is doing one of two things: Pressuring the unions for deeper concession or looking for a way out of this Chrysler alliance.  Since the news first broke I have not been a proponent of the Fiat-Chrysler alliance for a number of reasons.  The most important is that I do not believe Fiat has the balance sheet and cash to fully support Chrysler while the companies are integrated.  I also question if Chrysler can survive with the additional $6 billion in government assistance over the next three years until the Chrysler-Fiat product is in production and its ability to generate positive cash flow in the mean time. 

More importantly I do not believe Fiat's European fleet that would form the basis of Chrysler's next generation fleet would sell in sufficient volume to generate the revenue that is needed to support the company.  The US market historically lacks of acceptance of mini and small cars which dominate the European market.  For the foreseeable future including one with tighter fuel economy standards, the midsize segment will remain the heart of the US market.  Fiat lacks the powertrains and midsized vehicle platforms that could be adapted by Chrysler in the near term, specifically for hybrids.

As crowded as the US market was prior to the current depressed conditions, when the market does recover it is unlikely to be able to support Chrysler as well as Fiat and Alfa Romeo brand vehicles.  Fiat has said they will use Chrysler's assembly plants to build Fiat and Alfa vehicles in North America to improve Chrysler's plant utilization.  It is not reasonable to assume Fiat will sell 200k to 500k vehicles in the US anytime soon.  After years in the US, Volkswagen was only selling about 300k to 400k vehicles.  It would be safe to assume that Fiat would optimistically sell 50k to 100k in the first few years after re-entering the market.  This would be consistent with other new brands entering the US such as Toyota’s SCION brand and even Daimler’s SMART line.  That level of volume would utilize approximately one shift at one plant.  Fiat and Chrysler will not get any significant economics of scale in minivans, trucks and SUVs that dominate Chrysler’s portfolio.  That was one of the reasons why the Daimler deal did not work out. 

That leads me to Marchionne’s statement dismissing the possibility of taking over GM’s Saturn.  For starters, the dealer network is smaller than Chrysler’s and aligned with their likely volume.  That should help keep profitability up at the old Saturn network which was selling approximately 200k vehicles in a good year.  Saturn is a great franchise system with excellent dealers and focused on customer satisfactions.  It is possible Fiat could also use outside investors such as Black Oak Partners and/or Telesto Ventures as distributors for the product and run the retail side of the business.  That could include renaming the stores and setting up the dealers to service Fiat products.  Moreover, I am sure GM would be willing to consider selling its Spring Hill assembly plant to Fiat.  GM could transfer production of the Traverse to its Delta Township plant in MI and better optimize production at that location as the Saturn Outlook is phased out.

Under this situation, Fiat gains access to a US production site, and available dealer network and eliminates any exposure to Chrysler.  With the Saturn distribution network on the market, this seems the best option for Fiat if intent on returning to the US.  With a weak balance sheet and Chrysler coming to the potential alliance with a lot of baggage (excess dealers, weak brands, union issues) during these tough economic times, a take over of Saturn including Spring Hill looks like a turn key operation and more reasonable.   Marchionne does not need and affinity for Saturn, he just needs a plant and distribution.  The name on the store window can change.

 

Additional Resources/References

Fiat CEO: Concessions or no alliance with Chrysler, Detroit News, April 2009

Fiat says it could abandon Chrysler due to unions, Automotive News, April 2009

Fiat CEO says other options to Chrysler deal, MSN, April 2009

Italian auto renaissance, Globe and Mail, April 2009

Fiat to Chrysler: Cut costs or we walk, Globe and Mail, April 2009

 

 

 

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