Monday, August 31, 2009

Cerberus Restructures

It took a few years, but private equity group Cerberus' investments in Chrysler and GMAC have finally come home to roost in a big way.

So big that the group was forced to offer its investors an option to exit the their Cerberus positions. According to the weekend edition of the Wall Street Journal, slightly over 70% of investor assets, some $5.5B, are being redeemed.

I wrote two posts, here and here, back in May of 2007 and January of 2008, concerning Cerberus' purchase of Chrysler, then some early performance signs after the buyout. Even that far back, I was sceptical that Cerberus could refine gold out of the dross that had and has become the third-ranked US-based car maker.

As one would have guessed, Cerberus' investments in the two entities were zeroed out when the private equity group went to the federal government for a rescue.

Looks like I was correct in my belief that Chrysler was just too far gone to be viable, even if my expectation that high interest rates would eventually be the firm's undoing. Cerberus didn't choke on high interest rates for its highly-leveraged play for Chrysler and GMAC but, instead, failed due to an inability to simply raise private capital for them.

As I mentioned in the May, 2007 post, there's something decidedly ironic and telling about the Schumpeterian aspect of Cerberus' failures. Just because something is cheap doesn't mean it's attractive.

The industry structure of automobile manufacturing has been problematic for at least a decade. Barriers to entry are low, wages in foreign countries require extremely productive US operations if those costs are to be offset, and increasing numbers of subsystems have become outsourced, making auto "manufacturing" more a case of auto "assembly."

Cerberus' senior managers do seem to have become overly-confident and foolishly optimistic. Now, they and their investors are paying a heavy price.

It's pretty eye-opening that more than 2/3 of their investors are going to beat a path out of Cerberus, assuming the private equity group goes ahead with its restructuring plans. That surely is a vote of no confidence whatsoever in the group's ability to both rescue its current slate of investments, and do a better job choosing future ones.

I can't say that I blame those investors. Cerberus has shown an appallingly-bad habit recently of buying mediocre, or worse, properties and being unable to handle them as market conditions deteriorated. This is supposed to be the strong suit of private equity, and, in that, Cerberus has failed.

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