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GM Plus Chrysler Equals Survival?

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

General Motors (GM) and Chrysler have had discussions about merging operations amid widespread speculation that neither can survive the current global economic meltdown in the financial markets, according to executives at both companies who spoke on 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 GM issued a statement denying that it's considering Chapter 11 protection.

GM 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 if sales continue to fall. Since Chrysler is privately held, information available about its true financial condition is not known.

At the end of the second quarter, GM was going through $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 found it difficult to get loans for new cars amid the credit crunch, leading GM to raise its cash-back incentives. GM will report third-quarter earnings later this month.

Waiting for a Breather

The executives who confirmed the talks between GM and Chrysler said negotiations, which began in August, have been tabled until the financial markets calm down. "Talks will pick up again," said one high-ranking executive. The Dow Jones industrial average lost almost 20% last week, its worst week in history. GM lost 46% of its market value last week, closing 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. The automakers' bond prices and bank debt 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? Large-scale cost savings. One GM executive who spoke on condition of anonymity said the automaker and Chrysler could get rid of massive overhead and boost profits for the remaining company. The companies would cut thousands of white-collar jobs and factories. The cost savings GM is looking at would also help get a deal financed, said the executive.

Ripe for Consolidation

GM would find even greater savings, the executive added, with a partner like Ford, since both companies have global operations 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 consultant J.D. Power & Associates, agrees. "I'd be surprised if we didn't see consolidation by the next calendar year."

Getting there would be incredibly difficult. Two GM executives familiar with the talks say there's no certainty that a merger will happen. But even if there's no GM-Chrysler deal, it's clear that GM's top management is at least open to more dramatic options than simply restructuring their business. "This is about massive cost reduction," says one GM executive, who added: "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.

Skeptics don't see a merger between troubled Detroit companies as a panacea. John Casesa, a partner at 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. These marriages of marginal players didn't result in long-term survival.

A Freefall in Truck Sales

GM and Chrysler could easily cut billions in costs, 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. Each is struggling to brake a freefall in truck sales, Casesa says, and merging won't end the shared struggle to lure customers into showrooms.

"GM would be a lot better off if Chrysler just went away," said one industry analyst who consults with GM, 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," he adds.

Chrysler is majority owned by Cerberus Capital Management, 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.

Car Loans Are Harder to Come By

Cerberus and Chrysler management have for weeks defended 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. And the credit crunch is worsening its outlook. J.D. Power's Dilts said last week that many dealers are 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.

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 writes another car loan. It would have to lay out additional cash or considerations to acquire the remaining 20% from Daimler.

Will Ford Sell Mazda?

Chrysler issued a statement late Friday, Oct. 10, about the reported merger discussions with GM. Chrysler "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."

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, the same executives said, have not gotten very far. Ford, which is 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 the parent taking the 49% of General Motors Acceptance Corp. (GMAC), GM's financial subsidiary, 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 $10 billion to $20 billion a year and possibly $500 to $1,000 per car, say some industry insiders.

Staggering Job Losses Could Ensue

"There are a lot of costs that can be saved, and value unlocked, when two companies rationalize all the technology that has essentially become a commodity, like engines," says David Cole, chairman of the Center for 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."

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

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

Goodbye to Familiar Brands

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

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 Hummer to raise cash. Acquiring Chrysler would give GM the Jeep brand, which is valuable worldwide. But GM would initially be saddled with the Dodge and Chrysler brands as well, which it hardly needs as its Pontiac and Buick brands continue to 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 independent marketing consultant Dennis Keene. "I wouldn't want to hear about any long-term plans for the Chrysler brand or the 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."

Hundreds of Dealers Expected to Go Under

GM and Chrysler also have far more dealers than either company needs. They have been trying to reduce their 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 (TM) and Honda (HMC) 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's expensive to pay them to sell or merge.

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

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