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Why the Exit Ramp for Schrempp

By Gail Edmondson Just a year ago, DaimlerChrysler (DCX) Chief Executive Juergen Schrempp vowed to remain at the helm of the $170 billion German auto giant through 2008, eagerly accepting a three-year extension of his contract. He was determined to prove to critics that his troubled global strategy -- based mostly on a 1998 merger with Chrysler that has cost parent Daimler billions of dollars in restructuring charges -- could finally succeed.

TOO RISKY. It was no secret either that the former mechanic wanted to head the company's supervisory board after stepping down. So why did Schrempp agree abruptly on July 27 to bow out at the end of this year, turning the reins over to Chrysler boss Dieter Zetsche? And why is he leaving the company he joined at age 16 with no golden handshake?

One likely reason: DaimlerChrysler's woes -- particularly severe cost and overcapacity problems at Mercedes -- have grown worse than Schrempp is letting on, and there may well be another nasty earnings surprise looming. "The company is really in deep water," says one senior German manager close to the situation, adding that Deutsche Bank's top management started discussing a face-saving way to ease Schrempp out 12 months ago.

Insiders say Deutsche Bank (DB), with a 10.4% stake in the carmaker, likely served as a catalyst for the shakeup, deciding that backing Schrempp for another two years posed too great a risk. Deutsche Bank Chief Executive Josef Ackermann has repeatedly stated the bank's intention to sell its shares in Daimler at the right price.

TEFLON WORN THIN. Sure enough. When the news of Schrempp's departure sent DaimlerChrysler's shares soaring 8.7%, Deutsche Bank sold 35 million shares to institutional investors, lowering its stake to 6.9% and booking a $360 million pretax profit.

The consensus view is that Mercedes' $1.1 billion first-quarter loss dented Schrempp's credibility irreparably. Since the 1998 merger with Chrysler, the charismatic CEO kept an iron grip on power at Germany's industrial icon despite a series of billion-dollar management debacles. Each time the company struggled to recover from one, another mishap punctured the balance sheet, from Chrysler's implosion to failed ventures with Mitsubishi and Hyundai and a dysfunctional toll-collection system.

"DaimlerChrysler gives the impression of having spent the last five years restructuring itself rather than focusing on its business," says Oliver Pouteau, auto analyst at Oddo Securities, in a June 8 report. Pouteau forecasts an operating loss of as much as $2.4 billion at Mercedes this year, including restructuring charges, the first full-year loss since 1993. "Mercedes, once a solid source of earnings growth, is currently collapsing," he says.

STILL SMARTING. Severe quality problems at Mercedes Benz this year forced the biggest recall in the company's history. Adding to these woes is the financial implosion at Smart, the mini that can't seem to turn a profit and has cost DaimlerChrysler $3.6 billion in all.

In his July 28 conference call with analysts, Schrempp conceded that "clearly, DaimlerChrysler is not where it wants to be. But I am certain it will arrive. We have created preconditions for success." To hear Schrempp tell it, he is leaving at just the right moment: "The changeover to focus on the automotive business has been accomplished. We played a decisive role in consolidating the global auto industry. And the financial results in the second quarter show DaimlerChrysler continues to develop positively."

Yet the reality lies far from Schrempp's cheery assessment. While second-quarter operating profit jumped 28%, thanks to lower taxes, asset disposals, strong commercial truck sales, and an uptick in Chrysler earnings, the real worry is a barely profitable Mercedes division. It suffered a 98% decline in operating profit, to $14 million, after restructuring charges.

LABOR'S SHINY DEAL. Over the years, Schrempp did little to ensure that costs at Mercedes remained competitive. "Mercedes is no model of efficiency or productivity," says Pouteau. And far-flung crises diverted management attention away from Mercedes, just as rivals were turning on the turbo drive. Mercedes' homegrown quality problems and an onslaught of more-competitive models made by rivals BMW and Audi have now sent sales plunging for two models vital to DaimlerChrysler's profits, the E-Class and the C-Class sedans.

Adding to Mercedes' woes, shortly after his contract was extended last year, Schrempp made an ill-advised pact with Mercedes' labor unions to bolster plant-floor flexibility in exchange for job guarantees for its 160,000 German workers through 2012. Insiders say that, with excess production capacity running at 30%, the job pact Schrempp sealed with DaimlerChrysler labor boss Erich Klemm makes it impossible to turn around Mercedes. "There will be another big-time hit at Mercedes," says the senior manager close to DaimlerChrysler.

Mercedes will suffer another setback if Eckhard Cordes, a loyal lieutenant to Schrempp, departs. Cordes, who turned around the company's $42 billion commercial-vehicle division, went to work in November to repair Mercedes. He vows to boost earnings by $4.2 billion over three years and restore Mercedes' to a healthy 7% operating margin by 2007.

UNDERDOG WINS. Yet according to German press reports, Cordes submitted his resignation to the supervisory board at an extraordinary meeting on July 28, claiming he did not have the full backing of the board to restructure Mercedes. Cordes was viewed as the key rival to Zetsche and top contender to replace Schrempp. DaimlerChrysler declined to comment on the reports about Cordes' resignation.

Taking the helm from Schrempp, 60, will be Zetsche, the 52-year-old boss of the Chrysler Group, which makes up 35% of DaimlerChrysler's revenues. Zetsche was seen as a long shot to replace Schrempp since he led the boardroom opposition last year to Schrempp's plans for a bailout of Mitsubishi Motors.

Since arriving at an ailing Chrysler in 2001, the highly regarded Zetsche has slashed costs and revamped Chrysler's model lineup, steering the auto maker back to profitability despite fierce rebate wars and a stagnant market. But analysts still question whether Chrysler's turnaround is sustainable. Chrysler's operating profit for the first half totaled $955 million, down 3% over 2004. For the first half of 2005, DaimlerChrysler reported an operating profit of $2.7 billion on sales of $84 billion, down 37% over last year.

FIGHTING THE CLOCK. Now all eyes will look toward Deutsche Bank to see whether it reduces its stake further, eliminating one of the key obstacles that prevented disgruntled fund managers from exerting more influence on management. Deutsche Bank and DaimlerChrysler epitomized for a generation the close ties and cross-shareholdings between banks and industry in Germany, ties that could spawn conflicts of interest and thwart shareholder rights and good corporate governance.

Deutsche Bank also received a major financial incentive to unload its stake earlier this month when Germany's Christian Democratic Party announced its economic platform for upcoming federal elections. Chancellor candidate Angela Merkel plans to reinstate taxes on capital gains from the sale of corporate stakes held by other companies. Chancellor Gerhard Schroeder eliminated the gains in 2000 as part of an incentive scheme to unwind the extensive cross-shareholdings that impede reputable corporate governance in Germany.

If Merkel is elected in September, as polls show is likely, Deutsche Bank should be in a hurry to sell its stake before a new law comes into play.

COLLATERAL DAMAGE. Schrempp's exit also paves the way for the departure of Hilmar Kopper, DaimlerChrysler supervisory board chairman . The 70-year-old Kopper is the former Deutsche Bank chairman and a friend and mentor to Schrempp. He probably won't stay on the board beyond the shareholders meeting in May, 2006.

Kopper has staunchly supported Schrempp despite repeated calls by fund managers for his ouster, especially when Chrysler was racking up huge losses, and later when Mitsubishi Motors veered into a financial crisis, making Daimler's controlling share in the Japanese auto maker nearly worthless.

While markets roar their approval over the change at the top of DaimlerChrysler, the legacy Schrempp and Kopper leave behind for a new generation of managers is a major repair job at Germany's industrial icon.

Edmondson is a correspondent for BusinessWeek in Frankfurt

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