The Reckoning - GM, Chrysler & Cerberus Angle to Survive the 2008 Collapse

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October, 16 2008

Late last month, Detroit News reported Cerberus Capital Management initiated talks with Daimler AG to purchase its remaining 20% stake in Chrysler LLC. In August 2007, Cerberus purchased a majority interest in Chrysler in a $7.4 billion deal.

Soon after word came out about Cerberus wanting to buy out Daimler, the Wall St. Journal reported Renault was itching to come back to the US market after a 20-year absence and Chrysler was a possible partner.

Earlier in the month at the Paris Auto Show, Jacques Verdonck, Renault's vice-president for corporate and strategic planning, stated, that one option for the company is to try to establish a presence in the U.S. by itself, although this would be both "risky and costly."

Verdonck identified developing at least three new products specifically designed for the US. market, while creating a dealer network, as the biggest cost and risk for re-establishing Renault independent of a partner.

He later went on to he acknowledged that Chrysler "would make a good partner" in the US. However, Renault Chief Executive Officer Carlos Ghosn said earlier this year that now is not the time for Renault to make a bold move into a new market such as the US.

Then this past weekend the New York Times reported, General Motors has had high level discussions with Cerberus about a possible merger with Chrysler. From what I have read it would appear the discussion were preliminary and currently on hold as a result of the banking crisis. This would not be the first time GM has shown interest in Chrysler as GM had approached DaimlerChrysler about a potential deal prior to Cerberus buying 80% of Chrysler last summer.

It would appear Cerberus may be having second thoughts about owning and operating an auto company. Chrysler CEO, Bob Nardelli was recently quoted that he fears the “extremely fragile” auto industry could collapse as credit markets tighten up as the problems with the banks and Wall Street continue. Nardelli is also quoted as stating:

"We thought the $4-a-gallon gas was going to be our biggest challenge, but that's been minimized by the credit market."

"I'm not sure it's registered at the highest levels the impact of losing the auto industry," he said. "When I say the entire industry, it's not only the OEMs; it's the Tier 1, Tier 2, Tier 3 (suppliers)."

From official statement, Cerberus does appear to be actively looking for partners for Chrysler. Beyond GM, Renault and Nissan, Cerberus has had contact with Fiat SpA of Italy and India's Tata Motors. Chrysler also has a joint venture with Volkswagen.

Nardelli recently told employees:

“I can tell you that we have approached and have been approached by third parties who are interested in exploring future possibilities with Chrysler."

Adding more pressure on Cerberus are the problems it faces with GMAC finance, they own with General Motors. As the news and speculation of the GM-Chrysler merger was unfolding, there was some discussion that GM would swap its position in GMAC for Chrysler, leaving Cerberus as full owner of GMAC. Though Cerberus has denied they want to exit the automotive business, there is no denying it faces series problems at GMAC and may want to limit its exposure to the auto industry. In the last few years, Cerberus has invested approximately $21 billion into Chrysler and GMAC. On the surface it also makes sense that GM may want to limit its exposure to GMAC and focus solely on automotive.

As Cerberus grapples with the global banking problems, GMAC just announced credit restrictions on new car loans. The financial services company will only lend to prime borrowers with credit scores greater than 700. Last week, GMAC increased by 75 basis points the rate it charges dealers for providing consumer automotive financing with no incentives.

Over the past year as auto sales sharply declined and home foreclosures increased GMAC lost .4 billion. GMAC provided 43 percent of GM's second-quarter auto loans. GMAC automotive finance made up 42 percent of GMAC revenue in 2007, up from 29 percent a year earlier and insurance rose to 42 percent from 38 percent in the previous year as the mortgage business declined. GMAC's mortgage lending unit, Residential Capital, has reported seven straight money-losing quarters. However, GMAC is eligible to participate in the $700 billion rescue plan approved by Congress last month that is now in the process of being implemented by the Bush administration. The plan enables the Treasury to buy up bad auto loans and mortgages (structured investment vehicles) if it deems that doing so is critical to the finacial health of the US. This may give GMAC some breathing room to weather this economic storm. Although, restricting credit will have negative effect on GM vehicles sales.

How this plays out is anyone’s guess right now. One thing appears to be certain, Cerberus looks to be ready to deal Chrysler. I have been very bearish on Chrysler for a very long time because of the many systemic problems with the company and its position in the US market.

There are three possibilities for Chrysler.

1) Bankruptcy and liquidation. For GM and Ford, this would be the “best” option for the US industry as it would remove excess capacity in the US and the pricing pressure on those two companies as Chrysler heavily incentivizes their product. A Chrysler bankruptcy could very well make GM and Ford stronger in the US. Beyond the limited appeal of the Jeep brand, Chrysler does not have much in the way of assets worth keeping. Even the minivan market has been contracting in recent years and Chrysler’s lineup of van are not what they used to be. Honda and Toyota, with their offerings have eroded its position in the market.

2) An out right merger with General Motors. This I believe comes with much risk. For this to work, Chrysler as we know it would have to be dissolved with GM only keeping those assets worth value. Certainly GM may get access to the alleges $10-11 billion, Chrysler has in the bank, however, GM would be responsible for managing the liquidation of the excess dealers, plants and brands. GM may need the cash but at the risk of many headaches. GM does not need this distraction right now and may be just better off asking the Federal government for a big loan beyond what GM will receive from the billion that will be distributed to the auto industry to invest in fuel efficient vehicles.

3) A partnership with Renault-Nissan or other established foreign company. I believe this may be the best option in order for some semblance of Chrysler to survive and maintain jobs. One problem is, Chrysler  in order to preserve cash has restricted expenditures for new product. Therefore any company that desires to re-establish Chrysler as a viable company will have to spend billions on new product and this could take years. A quicker solution maybe for the partner company such as Renault to tool Chrysler’s NA plants with vehicles already produced in other countries. In the case of Renault, they could sell rebadged vehicles as Dodge or Chryslers through the already established dealer network. Again, Chrysler and Dodge are weak brands in the US and Jeep may not be as valuable as it once was give the market decline and fuel economy considerations in the SUV market. In addition, Renault does have a major presence in the US through their Nissan partner which includes a larger dealer network and manufacturing. If the US auto market remains in a long term slow down, it may make more sense for Renault to being building product in the US at Nissan facilities and utilize Nissan’s dealer network to re-establish Renault in the US.

Maybe the outcome will be for Renault-Nissan (R-N) to resurrect a partnership deal with GM that the company rejected back in 2006. GM may not be strong enough financially to dismiss an offer this time around. Back in 2006, I did not believe a deal was good because it would have diluted GM’s shareholders equity in the company and R-N would have received most of the cost savings because of GM’s large scale and reach. I still believe R-N would get most of the upside in a deal, however, this time, GM might not have any options to raise $10 -$15 billion it may need to continue operations until the economy recovers. That is unless the US government decides to become a shareholder of last resort.

The US auto market only appears to be getting worse. J.D. Power and Associates, has just released its October sales estimates based upon tracking data and expects sales to fall below 12 million units on an annualized basis. If the October sales rate dropped below 12 million units, overall U.S. sales for 2008 could also drop below the 13.6 million units the forecasting firm has projected. October may be the second month in a row where sales fall below 1 million vehicles.

GMAC’s credit restrictions and the general down turn in the economy are beginning to take their toll on GM’s balance sheet. I have been hearing that GM is about to take more draconian measures to cut cost in their North American Operations. These moves will include more buy outs, including involuntary layoffs and a possible extended shut down of major organizations with its North American operations beyond production. Most of GM product development has already been shut down in the US except for near term programs to be launched shortly and some small car programs with many product programs being shipped to their overseas operations in Brazil, Korea and Europe for development.

The current economic conditions could very well mean significant changes in the US automotive landscape and if GM merges with Chrysler, that to accelerate quickly. At the minimum, I do expect a serious capacity reduction in the US. More so than before, I believe Chrysler’s days as an independent company are winding down either by choice or forced upon them. GM remains a question mark but I do expect drastic action to stem off bankruptcy beyond what has already been announced.  A partnership with Renault-Nissan may make sense this time around if bankruptcy is the other option.  In the end I expect a government bailout if the harsh economic climate lingers, which I do. 

For additional insight:

GM: Better off bankrupt, Fortune, October 2008

One Plan: GM may absorb Chrysler, Detroit News, October 2008

D3 Merger Talks Surface, J.P.Morgan NA Equity Research, October 2008 (Mirror Link)

GM's bumpy ride continues, RTTNews, October 2008

Struggling U.S. Auto Lenders Look For Government Help, Dow Jones, October 2008

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