By David Welch
When General Motors (GM ) Chairman G. Richard Wagoner Jr. and now-retired GM Chairman John F. Smith Jr. agreed to buy 20% of Fiat Auto in March, 2000, they were seen as the nice guys. They spent $2.4 billion and agreed that at some point between now and 2010, Fiat could sell them the rest of the company. In the meantime, Fiat and GM would share purchasing and engine development to cut their costs. Experts agreed the deal was more lenient than DaimlerChrysler's (DCX ) proposal to take Fiat Auto over outright.
But forget about Wagoner as Mr. Nice Guy. Since 2000, when the deal was struck, Fiat Auto's condition deteriorated, and Wagoner has decided to play hardball. The Feb. 1 deadline for mediation between GM and Italian industrial conglomerate Fiat SpA (FIA ) -- which was held to find a settlement over the company's option to force GM to buy the remainder of Fiat -- came and went without a deal.
Many analysts had speculated that Wagoner would give Fiat anywhere between $1 billion and $3 billion in cash to erase this "put option," which would allow Fiat to stick GM with sole ownership of its auto unit. Instead, Fiat got nothing, even as it reiterated publicly that it believes GM still is legally bound to buy it out.
LOADED DOWN IN DEBT.
Yet Wagoner has apparently decided that what Fiat CEO Sergio Marchionne wants is too much. And GM seems willing to take the issue to court in New York. It has argued that Fiat recapitalized its business in 2003, reducing its stake in Fiat Auto from 20% to 10%, and sold off a controlling stake in its finance arm, thus voiding the put option. Fiat disagrees.
Either way, it could take a while for the drama between GM and Fiat to play out. That could be beneficial to GM. Fiat has lost money for three straight years. It has 10 billion euros in gross debt, 3 billion of which is due in 2006. It's burning cash at a rate of 1.5 billion euros a year.
If GM manages to keep the issue in court long enough, Marchionne could be forced to look elsewhere for the money he needs to pay the auto unit's debt. And any more changes to Fiat's balance sheet or business structure could further jeopardize the validity of the put option. "Fiat needs cash worse than GM needs to avoid owning Fiat," says National City analyst Dan Poole.
RUNNING OUT OF GAS?
Certainly, the stakes are high enough for GM. Its profits and cash flow are already shrinking. GM's European operations lost $1.4 billion last year and are set to lose $500 million more this year. Taking over Fiat, which has 7% market share in Western Europe compared with GM's 9%, would double its problems there. Fiat Auto has posted net losses every year for the last six years. It has an estimated 5 billion euros in net debt and has lost share in its home market steadily since 1999. Fiat argues that amendments to the March, 2000, put agreement would force GM to take over its debt.
Fiat's prospects for a rebound aren't good, analysts say. The new Punto compact -- an expected big seller -- goes on the market in 2006. By 2007, Fiat will be at the peak of offering fresh new products. If it's targeting only a breakeven year or slim profits during that time frame, then its long-term earnings picture isn't very good, says Philippe Houchois, an auto-industry analyst with J.P. Morgan in London.
Indeed, Fiat's value is so low right now that Fiat SpA won't get much cash, if any, by exercising the put. Houchois says Fiat has no equity value, so GM would take it over for nothing and assume the debt. In any case, Marchionne would unload Fiat Auto, but he wouldn't get much for it in its current state.
MULTIPLE PLOT LINES.
GM thinks it has an argument against assuming the debt. Fiat said recently that GM would have to take over 6 billion euros in debt owed by Fiat Auto to the parent company. But GM maintains that Fiat's intercompany debt is not part of the master agreement and subject to negotiations at the time of the put.
There's still a chance that GM could end up taking over Fiat. If the courts rule that a sale of Fiat's financing arm nullifies the put option, Fiat can buy the lending unit back and try to exercise the put again.
Yet GM must not have complete confidence it will win any court case. After all, it initiated the mediation period in an attempt to head off a legal battle. Wagoner wanted to settle this peaceably. But the way things are shaping up, settling this sweetly isn't how it's going to end.
Welch is BusinessWeek's Detroit bureau chief