Issues & Opinions

In a market alert this afternoon, the WSJ reports “Cerberus Appears Set to Win Chrysler“.
Addendum - the story at the link above has changed to the version to be printed in Monday’s Journal. The post below was written based on an early version of the story at the same link, as it stood at approx. 2:30PM CST

One of the many attractive things about penning lightly-read missives about markets, politics, and the phenomena surrounding them is the ease with which it’s possible to toss out consequence-free predictions as to ultimate outcomes. So pardon me while I indulge myself.

First off, the recent history of the alleged auction for Chrysler: As recently as last Monday, May 7, some thought that Daimler was planning to hang on to Chrysler. From the WSJ Deal Blog, in an article entitled “Gearing Up to Hold on to Chrysler?“, Dana Cimilluca provided this snapshot of the state of affairs:

The new ad campaign that Chrysler announced today, coming amid a report suggesting that only one serious bidder remains in DaimlerChrysler’s auction of the U.S. automaker, has Deal Journal wondering if there’s going to be any sale at all.
…
A costly ad campaign is not exactly what you’d expect a company to launch just before it changes hands.

(ellipsis mine, emphasis in original)

I’m sympathetic to the thought process that says large outlays for brand-building seem not to fit well with serious attempts to sell the company, but the effort that goes into such important activities could be said to transcend trivial matters such as who ultimately owns the company. Similarly, I’d be shocked to find, while the company was engaged in an on again/off again effort at divestiture of the Chrysler brand, that all new product development had been halted. So, while I enjoyed the analysis, I wasn’t horribly moved by the idea of the ad campaign indicating anything about the sale or non-sale of the company.

The additional assertion, also made elsewhere, that the list of bidders had been culled down to one struck me as far more telling of the ultimate result. Cimilluca continued:

The announcement follows a report in German magazine Automobilewoche over the weekend that says the only serious bidder left for Chrysler is Canadian autoparts maker Magna International, which is teamed with Onex, a private equity firm in Canada. Blackstone Group and Ceberus Capital, private equity firms that were also in the running, have taken a back seat, according to the report. An earlier advance from billionaire Kirk Kerkorian was spurned.

(emphasis in original)

And then things got interesting. Magna International, even with the backing of Onex, appeared still to need financial heft in order to put a proposal on the table that kept them in the race. Solution, found in the WSJ on Friday? “Magna to See Perestroika?“:

Magna International Inc. shareholders greeted news of a $1.54 billion investment by Russian oligarch Oleg Deripaska by pushing shares up 7%. Now the Canadian auto-parts maker has the ammunition to finance a bid for DaimlerChrysler’s U.S. unit. But considering the deal effectively hands this survivor of Siberia’s notorious aluminium wars future joint control of Magna perhaps investors should restrain their jubilance.

OK, maybe not such a solution. Deripaska has “issues”, not least these, reported in the WSJ on Friday, May 11, “Russian Connection Could Complicate Chrysler Auction“:

Our reporters write that U.S. law-enforcement officials suspect Mr. Deripaska may have ties to Russian organized crime. He has consistently denied participating in any criminal activity, however.

The proposed capital infusion into Magna would give Mr. Deripaska — who had his visa to travel to the U.S. canceled earlier this year because of Washington’s legal concerns — significant control of Magna.

All that chum we see in the water following the end of week maneuvering by Magna to do a deal that might be out of its weight class seems to have changed the dynamic. Re-enter, Cerberus.

As to the current shape of Cerberus’ interest in Chrysler, they’ve got several solid business reasons for interest in the business, aside from their demonstrated overall competence in LBOs, and notwithstanding their who-knows-if-it-will-actually-occur interest in Delphi, the bankrupt auto parts supplier (taken to that state by Robert S. “Steve” Miller, who’s apparently never seen a company he can’t make better via bankruptcy).

Aside from all that, Cerberus could benefit from combining Chrysler Financial with their still-rather-new 51% interest in GMAC, greatly reducing costs.

But will that be enough? Among other challenges to a Chrysler deal for Cerberus, from the WSJ market alert story:

The key to the deal, people familiar with the discussions say, isn’t the headline price but what happens to the company’s $18 billion in pension and health-care liabilities, essentially a debt owed to Chrysler’s United Auto Workers employees. Daimler’s goal is to get this debt off the German company’s books.

Daimler would contribute Chrysler into a new corporation while keeping a minority stake in the business, people familiar with the matter said. Chrysler’s $18 billion in pension and health-care liabilities would travel along with the rest of the company. The new company would be majority owned by the new buyer. This party would then contribute a big slug of equity to fund the operations.

The devil, as always, hides in the details. It seems clear that the Pension Benefit Guarantee Corp will have some say in the structure of any such deal, and the promises that go along with it on the part of any buyer who’s not proposing to leave the liabilities with Daimler. In addition, there’s the prickly matter of the UAW, heightened by its existing scuffle with Cerberus at Delphi:

However, a sale to Cerberus will likely face opposition from the unions, which have said they oppose a private-equity takeover of Chrysler. The UAW, in particular, has a contentious relationship with Cerberus because of a deal to purchase auto supplier Delphi Corp. Cerberus, which was leading a group of Delphi investors, will likely pull out of the deal after the UAW refused to give in to demands for wage cuts.

A deal like this, if it’s anything other than a prelude to bringing in Steve “The Grim Reaper” Miller as an expert on restructuring through bankruptcy, will be greeted with skepticism by anyone whose ox may stand to be gored, and the UAW is at the head of that receiving line. Can they make it hard enough for Cerberus that a deal becomes impossible? Your guess is as good as mine, but Delphi, while arguably in a different position, provides a template for discussion, and all told, Delphi may be the cleaner of the two transactions, having already dived into the Chapter 11 pool.

What does that leave for a potential result? Blackstone Group and Centerbridge Capital Partners have reportedly submitted additional bids, and can’t be counted out of the story. While neither appears to have the clear opportunity for Cerberus’ synergies in the transaction, neither has the scorched Earth relationship with the UAW, at least not yet. And what of Kerkorian’s Tracinda, “who publicly offered $4.5 billion in cash for Chrysler, [and] was frozen out of the talks”?

He and his team appear still to be on the outside looking in, but while I’ve got no solid basis for saying so, I think that could change. Why? Because, while the headline numbers for Cerberus’ reported deal, such as assuming $18 billion of pension and healthcare liabilities and contributing an as-yet unenumerated “big slug of equity to fund the operations” may seem to compare as overwhelming favorites to Tracinda’s $4.5 billion offer, life’s seldom that simple.

The reason Chrysler is on the block is a desire on Daimler’s part to put a sordid and ill-advised deal behind them. For an interesting analogy for the destruction of Daimler’s capital in Chrysler, see Dennis Berman’s piece from today’s WSJ Deal Blog, “Daimler’s ‘Brewster’s Millions’ Moment: Squandering $36 Billion“. Berman’s story includes, for comparative purposes only I hope, an assumption that Cerberus, in addition to the commitments detailed above, will be paying $5 billion to Daimler. Cerberus didn’t make the mistake of buying Chrysler at the top, and neither did Blackstone, Magna, or Centerpoint. Tracinda, as you might recall, was actually a seller at the top, which might contribute to its red-headed stepchild status in the bargaining.

Daimler alone should arguably bear the brunt of the mistake, and any firm planning to relieve Daimler of some of that pain by overpaying would do well to compare its offer to what the demonstrably smartest player in the transaction has offered. Kerkorian, York, et al, haven’t likely offered the absolute fair value, and might well have increased their offer if given the chance for true due diligence, but I’d be shocked to find that they were more than 10% lower than the proper, “all in and Daimler can deal with the legacy benefits” price for the business.

All of which provides, for me, a handy reminder - there are no bad businesses, only overpriced businesses. And consider, please, the fact that some businesses’ proper price is less than zero, but that doesn’t make them bad businesses. Beware the future of those who might think to overpay for Chrysler. And if it turns out that sanity happens to return to the bidding process, either Daimler could keep the company, gnawing on its mistakes via future losses until next time it goes on the block, or Mr. Kerkorian might get another roll of the dice.

Addendum - The WSJ story has been updated to include: “DaimlerChrysler AG would get a substantial payment for the transaction…”. Yikes. If I were an LP in the Cerberus fund making the offer, I’d assume that this means the only way to make money on the transaction is to completely throw out existing labor arrangements. I might also hope that the UAW really digs in its heels, saving my fund the future losses from having overpaid.

Addendum - Based on the near-final version of this story, to appear in tomorrow’s Journal, there’s another take possible on the matter. Cerberus could be, by this transaction, attempting to effect a model makeover in the US car industry, rather than some standard five to seven year “fix and float”.

Industry analysts estimate that the overseas and U.S. operations of Japanese auto makers like Toyota Motor Corp. have a labor-cost advantage over Chrysler of as much $30 an hour.

Cerberus has a record of slashing costs at operations it acquires, and some analysts say a Cerberus-owned Chrysler could move much more aggressively to cut labor costs, prune Chrysler’s overpopulated network of U.S. dealers and shift investment to developing markets overseas. But any final deal for Chrysler also hinges on what happens this summer, when the United Auto Workers kicks off negotiations for new master contracts with all three Detroit auto giants.

If they can claw back some larger portion of that cost differential, they’ll have set a new tone for dealing with organized labor in troubled “big manufacturing” companies. The jury, represented in this drama by the UAW, remains out. What will the reaction of private equity be if, after a deal gets done, production grinds to a screeching halt? Regardless, if they’re successful in their bid, I wish them all the luck they’re going to need.

Addendum - (5/14/07) Other views, both pithier & more succinct, can be found on the matter, of course.

Addendum - (5/14/07) According to the WSJ Deal Blog, ignore the $7.4 billion headline number - Cerberus is effectively being paid $650 million to take the company from Daimler. “…consider, please, the fact that some businesses’ proper price is less than zero…”, indeed.

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