"Fiat Is In Deep, Deep Trouble"

The company may try to force GM to buy its money-losing auto unit -- or kick in cash

When General Motors Corp. (GM ) Chief Executive G. Richard "Rick" Wagoner Jr. and Fiat (FIA ) group CEO Sergio Marchionne sit down on Dec. 14 to dine after meeting at GM's regional headquarters in Zurich, the question of industrial marriage or divorce will hang in the air. Marchionne insists he still may wield the disputed put option inked by Wagoner and late Fiat Chairman Gianni Agnelli in 2000, a put that would force GM to buy out the loss-making Italian auto maker. General Motors argues that a subsequent recapitalization and asset sell-off at Fiat have invalidated the put. Now the one-year legal truce agreed to by GM and Fiat to find a solution has just lapsed. That means Marchionne could seek to force a union as of Jan. 24, 2005. "He is considering all options," says one Milan investment banker close to the company.

Being forced to buy Fiat Auto is the nightmare scenario for GM. Four years ago, GM and Fiat had just inked a joint venture, and the companies had acquired stakes in each other. As part of the agreement, Fiat group -- which has other businesses besides cars -- got the right to ask GM in the future to buy out the rest of the $27 billion Italian auto company. Agnelli saw the put as insurance in case he could not turn around his beloved auto business. GM, eyeing the 30% share Fiat commanded in Italy, agreed to the put to make sure DaimlerChrysler (DCX ) and Ford Motor Co. (F ) would not snap up its Italian partner.

GM blundered big-time. Three years after the Fiat group skidded close to bankruptcy, stubbornly high losses and expected 2004 negative cash flow of $1.3 billion at the Turin-based car business have raised serious questions about the chances of fixing Fiat Auto. Fiat group, the holding company, will record losses of $1.5 billion this year and will probably need to raise a fresh $1.3 billion next year to pay off maturing bonds. "I wouldn't rule out a liquidity crisis in 2005," says Michael Raab, auto analyst at Sal. Oppenheim in Frankfurt.

A WAY OUT

Marchionne has his back to the wall. If he did force GM to honor the put, it's not clear what he would get for Fiat Auto. Some say the price would be negligible but that GM would be stuck with Fiat Auto's $5.3 billion in debt. Others say Marchionne could reap $4 billion or more if he gets Fiat to break even in a year or so. In either scenario, GM, facing pension legacies in the U.S. and huge losses in Europe, cannot afford an Italian car company. GM executives say privately that they are willing to tie Fiat up in court for years to avoid the put. "We have good lawyers," says one insider. But a long, nasty court battle could disrupt the joint ventures that have saved both companies billions in purchasing and development costs for engines and transmissions.

Is there a way out? One plausible scenario, say those close to Fiat, is that Marchionne persuades Wagoner to inject cash into Fiat in exchange for canceling the put. That could pave the way for an Italian state-owned holding company to participate in a capital increase in 2005. "Fiat is in deep, deep trouble. The government expects to be called in," says a Milan banker, adding that the U.S. auto maker might pony up between $600 million and $1.2 billion to exit the put. One possible glitch: Sources close to GM say that although it may be willing to provide cash, the company does not want to be part of any deal that increases its equity exposure to Fiat.

Whatever form it takes, a final cash injection by GM could yield some advantages for Wagoner. It would avoid a protracted legal battle, which could poison GM's commercial and industrial collaboration with Fiat. Aside from the 10% stake General Motors holds in Fiat, several new models have been designed on joint platforms, including Fiat's all-important third-generation Punto compact, which will be launched in September. The new Opel Corsa will follow on the same platform 18 months later.

A final cash injection would also give GM the opportunity to recoup some of its losses from its Fiat foray -- if Marchionne, a turnaround specialist, achieves a miracle. Auto industry experts say the 52-year-old Canadian, who took over in May following the death of Chairman Umberto Agnelli, has the industrial and management savvy to remake Fiat. The problem is, he is starting practically from scratch and needs several years to pull the feat off. To date, Fiat's efforts to restructure have been hampered by near-constant management turmoil. Since 2002 the company has had three group chairmen and four CEOs at Fiat Auto. "The company has lost three years," says one Italian executive close to Fiat. GM in the meantime has written off most of its investment.

Racing against the clock, Marchionne started this summer by firing Fiat managers who had obstructed change and by bringing in top international auto talent -- another first for Turin. His new team includes Stefan Ketter, the former head of quality at Volkswagen's U.S. subsidiary, and Karl-Heinz Kalbfell, a former BMW veteran and CEO of Rolls-Royce Motor Cars Ltd., who will head Alfa Romeo. Marchionne has taken personal charge of Fiat's weak dealer network outside Italy in the rest of Europe. By overseeing marketing and sales, Marchionne hopes to lighten the load for Fiat Auto CEO Herbert H. Demel, a former Audi chairman who is overhauling the auto maker's industrial operations and lowering Fiat's cost base. "Demel, with his engineering background, is the guy to push Fiat in the right direction," says Christoph Stürmer, senior auto analyst at market researcher Global Insight in Frankfurt. Stürmer says remaking Fiat will still take two to three years.

IMAGE PROBLEM

Some better models are finally coming out of Fiat's design and engineering studios. The snappy new $11,000 Panda mini, with its high roof and spacious interior, will exceed sales of 250,000 this year -- 25% higher than the company forecast a year ago. The new Fiat Idea minivan and Lancia Ypsilon subcompact are also helping stabilize sales.

Yet fierce competition from the French, Japanese, and Koreans has kept the company under pressure. Fiat's revenue per car actually dropped in the first 10 months of 2004, despite the new models, and its market share in Western Europe edged down slightly, to 5.5.%. "Their biggest problem is a bad image. This leads to a continuous price deterioration," says Arndt Ellinghorst, analyst at Dresdner Kleinwort Wasserstein in Frankfurt. To climb back, Fiat will have to pump as much as $1.5 billion more a year into new-model development than the turnaround plan envisions, experts say.

Fiat's fate -- and GM's investment -- depend in large part on the success of the next Punto. The Punto, a top-selling model in Europe that accounts for 40% of revenues, has twice revived Fiat's fortunes before. A hit Punto, combined with serious restructuring, might power Fiat Auto to breakeven in 2006. That's Marchionne's plan. But first he has to have that dinner with Wagoner -- and press a deal on a rescuer who wants out of the rescue business.

By Gail Edmondson in Frankfurt, with David Welch in Detroit

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