Thursday, May 17, 2007

More on Cerberus Offer to Buy Chrysler

As the week has progressed, more ink has been spilled over the Cerberus-DaimlerChrysler deal.

As one reads the numbers, it's just appalling to see how Daimler paid around $36B for Chrysler, and is now letting 80% of it go for $7.4B, and paying another $400-700MM in pension topups. Whatever the exact numbers, it marks a stunning end to Daimler's attempt to enlarge its automotive empire.

The Wall Street Journal's Tuesday edition had the requisite article discussing various aspects of the deal, along with a very interesting table. Entitled "Soured Deals," the exhibit reminds us of these gems from the past:

-PennCentral Railroad (1968) ended in bankruptcy 1970
-Revco's LBO (1986) ended in bankruptcy 1988
-ATT buys NCR (1991) spun off five years later for a $4.1B capital loss
-Quaker Oats buys Snapple (1994) sold off with a $1.4B capital loss nearly three years later
-Time Warner & AOL (2001)

I don't have the auto industry acumen that the staff of Cerberus evidently has. Perhaps they see a way to recover value from the weakest Detroit auto manufacturer, despite sector economics that would seem to be beyond the scope of Cerberus' internal management team to address and solve.

Never the less, I can't help but think that this deal forestalls the natural course of Schumpeterian dynamics. It's well understood that this sector has global excess capacity. The obvious high-cost, most excessive capacity is in American auto plants. That would seem to suggest that Cerberus is buying into a losing proposition.

Most pundits immediately rush to discuss the union/labor pension and healthcare cost issues. How Chrysler is saddled with uncompetitive, excessive costs per car that must be trimmed. Nevermind that prior Chrysler management freely negotiated to give these benefits to labor. And union labor leaders freely accepted the IOUs in exchange. In fact, this ill-considered bargain was the subject of one of my
very first posts on this blog.

Perhaps Cerberus is after the combined auto loan portfolios of GMAC, which it already owns, and Chrysler. Then, some pundits argue, there is the tie between Cerberus' auto supply company holdings and Chrysler. But this would seem to actually be a burden, because what Cerberus cuts from Chrysler's buying may hurt its own other units. Of course, once the private equity firm takes its new acquisition behind the curtain of secrecy, there's no telling how the subsequent accounting and cash flows will make the deal ultimately pay off.

Swirling throughout all of this, and, one would think, very sensitive to that last point, is the UAW. How will it know that its members are getting the deal that the UAW believes them to be getting? Will UAW leaders get to pore over Cerberus' books, and comment on its executives' compensations? I just have a very hard time believing that Ron Gettelfinger, head of the union, is going to roll over and give some highly-paid private equity executives benefit and/or wage give-backs that he withheld from Daimler. If he is doing so, does this mark a conversion on the road to Damascus, so to speak, for the UAW? Will it now become sensible and cut its own members' compensation and deferred and accrued benefits, to save jobs?

Again, if so, this is big news indeed!

Assuming the deal closes, what about the product and marketing management issues still dogging Chrysler? It's vehicle lineup was not chosen by the guys and gals on the factory floor. Cerberus apparently cannot simply close dealerships without running afoul of some pretty stringent and expensive franchise law. To me, the union benefits and wage argument for why Detroit can't compete globally has always seemed a convenient smokescreen for the underlying current problem. That is, GM, Ford and Chrysler have consistently made poor product design and marketing decisions for decades. Combined with the legacy of poor labor relations and cost management left by earlier senior managers in the auto sector, the resulting burden seems, to me, just too much to expect the weakest of the three American auto producers to be salvageable.

Then there was the editorial in the Journal extolling private equity for taking a risk on Chrysler, so taxpayers would not, once again, be forced to do so. I guess there is some sort of benefit to this, in an indirect way. But I still have the sinking feeling that Schumpeter would have preferred to see the number three Detroit auto company just close up shop with its current losses, rather than prolong the pain and bleeding.

The fact that the various deals mentioned in the Journal's article, mentioned above, reminds us that, in prior years, other very intelligent and experienced people entered into some ill-advised transactions. Not every sector-restructuring deal ends happily and profitably

If I had to bet, I would bet that the Chrysler-Cerberus deal will not meet the latter's expectations for ultimate profit and disposition of the assets it is buying.


Citizen Carrie said...

I can't help but think that this marks a radical change in the behavior of private equity firms. Too bad nobody can figure out what Cerberus is trying to achieve. Do they really want to make Chrysler a going concern? Or is Cerberus starting to show signs of hubris after being fairly successful in its short history?

C Neul said...


Thanks for your comment.

I think you are correct in noting this as a radical change in the behavior of these firms.

Personally, as you will not be surprised to learn, I believe Cerberus is showing hubris.