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GM Plus Chrysler Equals Survival?

Posted by Internet Guru
October 11, 2008

The automakers may try to salvage one healthy company out of two sick ones

General Motors (GM) and Chrysler LLC have had discussions about merging their operations amid widespread speculation that neither company can survive the current global economic meltdown and havoc in the financial markets, according to executives at both companies who spoke on the condition of anonymity. The talks were reported on the Web sites of The Wall Street Journal and The New York Times late Friday, Oct. 10, the same day that GM issued a statement denying that it is considering Chapter 11 protection.

General Motors shares have been trading at 50-year lows this week as credit-rating agencies Standard & Poor’s (MHP) and Fitch Ratings both issued reports expressing concern that GM and Ford Motor (F) won’t have enough cash to last through 2009 as sales continue to fall. As Chrysler is privately held, the information available about its true financial condition is not known.

At the end of the second quarter, GM was burning $1 billion of its cash reserves a month after reporting a $15.5 billion quarterly loss. That burn rate is believed to have accelerated as consumers have had difficulty getting loans for new cars amid the credit crunch and GM has increased cash-back incentives. GM will report its third-quarter earnings later this month.
Waiting for Market Calm

The executives who confirmed the talks between GM and Chrysler said that negotiations, which began in August, have been tabled until after the financial markets calm. “The talks will pick up again,” said one high-ranking executive. The Dow Jones industrial average Index lost almost 20% last week, its worst week in history. GM lost 46% of its market value last week, and closed at $4.89 on the New York Stock Exchange on Oct. 10.

The stock price isn’t the only worrisome measure of Detroit’s woes. Bond prices and bank debt of the companies have been trading at deeply discounted levels, on fears that one or more of the companies won’t survive. Most GM and Ford bonds trade at 30¢ to 50¢ on the dollar. Chrysler bank debt trades at around 30¢ on the dollar.

The motivation for a GM-Chrysler merger would be to achieve large-scale cost savings. One GM executive who spoke on the condition of anonymity said that the automaker and Chrysler could get rid of massive overhead and boost profits for the remaining company. The two automakers would cut thousands of white-collar jobs and factories. The amount of cost savings that GM is looking at would also help get a deal financed, said the executive.
Greater Savings with Ford

Similarly, the executive said, GM would find even greater savings with a partner like Ford since both companies have global operations that they could combine. But he declined to say that GM is in talks with Ford. GM management on the whole thinks the industry is ripe for consolidation. Gary Dilts, senior vice-president at automotive consultancy J.D. Power & Associates, agrees. “I’d be surprised if we didn’t see consolidation by next calendar year.”

But getting there will be incredibly difficult. Two GM executives familiar with the talks say that there is no certainty a deal will be done. But even if a transaction isn’t done between GM and Chrysler, it’s clear that GM’s top managers is at least open to some bigger options than simply restructuring their own business. “This is about massive cost reduction,” says one GM executive. who added that, “No deal comes without risk.”

Indeed, it won’t be easy to make sense of the two companies at a time when liquid assets are so short for both companies.
Merger No Panacea

Skeptics don’t see a big merger between troubled Detroit companies as a panacea.

John Casesa, a partner with auto industry consulting firm Casesa Shapiro, likened a GM-Chrysler deal to the ill-fated mergers of the 1950s, when companies like Hudson and Nash merged, or Packard and Studebaker. The industry’s troubled marginal players got together but these marriages didn’t result in long-term survival.

GM and Chrysler could easily cut billions in cost, Casesa says. “They would have one set of pickup truck engineers, one for minivans and crossover sport-utility vehicles, one group for marketing or accounting, and so on…But that’s the easy part.” The bigger challenge, says Casesa, is holding on to the revenue of both companies. Both companies are struggling to slow a freefall in truck sales, Casesa says, and merging won’t solve the problem each company has with luring customers to showrooms.

“GM would be a lot better off if Chrysler just went away,” said one industry analyst who consults with GM, but who spoke on condition of anonymity because of the sensitivity of the discussions. “A whole lot of loyal Dodge, Chrysler, and Jeep buyers, the ones who are left, would turn to GM, as well as Ford if they had to change brands,” said the consultant. “But if you buy the idea that GM basically has to eliminate brands, and therefore a lot of that sales volume, they lose some of that scale and have the headaches and costs of winding down Chrysler on top of that,” said the consultant.
Nardelli: “Very Difficult” Times

Chrysler LLC, is majority owned by Cerberus Capital Management LLC, a private equity firm that bought 80.1% of the automaker from the former DaimlerChrysler in 2007. Recently, Chrysler has been in talks to acquire the rest of Chrysler from Daimler, a move believed to make a sale of the company simpler.

Cerberus and Chrysler management have for weeks been defending the investment firm’s long-term commitment to managing Chrysler. “We are ahead of our goals for cost-cutting and cash flow,” said Chrysler CEO Robert Nardelli at a recent event promoting the automaker’s electric car technology. “We are committed to running Chrysler, though I admit the times we

are in are very difficult.”

Chrysler sales are down 30% year to date. But the credit crunch is worsening its outlook. J.D. Power’s Dilts said last week that many dealers were having trouble closing loans for customers. “Some dealers are only able to close about half the people trying to buy cars,” he said. That means dealers will be ordering far fewer vehicles. Financing that dealers rely on to carry their lot inventory has also been harder to get.
Chrysler Issues Statement

Cerberus’s financial outlay for acquiring its 80% of Chrysler from Daimler has been about $8 billion. According to executives with knowledge of Chrysler’s assets, Cerberus can earn back $6.5 billion of that from Chrysler Financial’s book of auto loans even if it never wrote another car loan. It will have to lay out additional cash or considerations to acquire the remaining 20% from Daimler.

Chrysler issued a statement late Friday about the reported merger discussions with GM. “[Chrysler] LLC as a matter of policy does not confirm or disclose the nature of its private business meetings. As we have said, the company is looking at a number of potential global partnerships as it explores growth opportunities around the world. Beyond those partnerships already announced however, Chrysler has not formed any new agreements and has no further announcements to make at this time.”

“Without referencing this specific rumor, as we’ve often said, GM officials routinely discuss issues of mutual interest with other automakers,” GM spokesman Tony Cervone said. “As a policy, we do not confirm or comment publicly on those private discussions, which in many cases do not lead anywhere.”
Ford Trying to Sell Mazda Stake

GM and Ford have had discussions about a merger or formal tie-up in the last two years, as well, according to executives with knowledge of those discussions.

But the talks, those same executives said, have not gone very far. Ford, also worried about cash, is in talks to sell its stake in Mazda Motor to enhance its liquidity.

Talks about a tie-up of GM and Chrysler have centered on Cthe hrysler parent taking the 49% of General Motors Acceptance Corp. (GMAC), the financial subsidiary of GM, that it doesn’t already own in exchange for Chrysler’s automotive operations. The resulting combination would create economies of scale for GM. Combining engine and transmission development and production alone could save between $10 billion and $20 billion per year and possibly between $500 and $1,000 of cost per car, say some industry insiders.

“There are a lot of costs that can be saved, and value unlocked, when two companies rationalize all the technology that has essentially become commodity, like engines,” says David Cole, chairman of the Center of Automotive Research in Ann Arbor, Mich. “The intellectual property that gives a company a competitive edge is in the development of software and electronics, as well as design, but the hardware is mostly commodity at this point.”
UAW Part of the Equation

GM would be left without a captive finance company, though, which would leave the automaker at a disadvantage to make car loans and leases.

Clearly, a combination of GM and Chrysler would also be a mess to sort out for GM managers whose ability to manage and restructure the company it already controls has been heavily criticized in recent years. The company has been in an almost constant state of restructuring since 1993, and has seldom seen daylight. It would involve the merger of more than 100 automotive plants and more than 190,000 employees, and more than 10,000 dealers in North America. The job loss would be immense, devastating an already reeling Michigan where unemployment is nearly 10%. Rationalizing the two companies could easily take five years.

The United Auto Workers, the principal union representing workers at both companies, will have to be a major part of negotiations, and will want to preserve as many jobs as possible, while demanding big buyout packages for those who get left out of the new combined company. That will take a lot of cash, which is in short supply for both companies.
Hummer on the Block

The public would surely see familiar brands disappear. GM is widely believed to have more brands than it needs. It is already trying to sell its Hummer brand to raise cash. Acquiring Chrysler would give GM the Jeep brand, valuable worldwide. But GM would initially be saddled with the Dodge and Chrysler brands as well, which it hardly needs to supplement its Pontiac and Buick brands, which have been in decline.

“If I were an investor, I’d want to hear how the combined GM and Chrysler is going to makes sense of all these brands from the get-go,” said Los Angeles-based independent marketing consultant Dennis Keene. “I wouldn’t want to hear about any long-term plans for Chrysler brand, Dodge brand, and either Buick or Pontiac should go in the process too…it’s time for Detroit to get real about these declining brands.”

GM and Chrysler also have far more dealers than either company needs. Both companies have been trying to reduce the number of dealers to improve the profitability of each one. The companies have been in a bad situation relative to their Asian rivals, because unprofitable GM and Chrysler dealers do not invest new capital in their stores, service centers, and personnel while Toyota and Honda dealers have been opening new, more up-to-date facilities. State franchise laws make it difficult for automakers to force dealers out of business, and it is expensive to pay them to sell or merge.
Leadin

The National Automotive Dealers Assn. recently said it expects some 700 dealers, out of a total of 21,461, to go out of business this year, with more likely for next year. Those dealers are disproportionately selling Detroit products, so they are already feeling the pain as much as the car companies themselves.

Original article: GM Plus Chrysler Equals Survival? From businessweek

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