A Merger's Bitter Harvest

Newly formed giant CNH is reaping huge losses--with more to come

Jean-Pierre Rosso was sure he had the winning ticket. After taking charge of Case Corp. (CSE) in 1994, Rosso had beaten long odds and revitalized the farm-implement pioneer. Still, it was a distant third to Deere & Co. (DE), with little chance of catching up.

So the Case chairman and chief executive put down a new wager in 1999, engineering a $4.6 billion merger with No. 2 New Holland to create CNH Global (CNH). With combined sales of nearly $11 billion, the new company instantly narrowed Deere's lead in agriculture machinery. Rosso bragged that CNH, based in Racine, Wis., might even give giant Caterpillar Inc. a run for its money in construction rigs. Together, Case and New Holland would be "the preeminent equipment company in the world."

Who could fault Rosso for being cocky? This was the same game plan, after all, that General Electric Co. (GE) and others had followed with great success. And it seemed so simple: acquire enough market share to be one of your industry's top two players, and then exploit your position, using economies of scale to squeeze the most out of everyone else, from vendors to customers.

CLASSIC MISTAKE. Bigger isn't necessarily better, however. Today, CNH is a cautionary tale of what can happen when managers become so preoccupied with the nitty-gritty of combining two big outfits that they neglect larger issues outside the company--the business cycle, say, or the competition--that are turning their markets upside down. It is also a reminder that in today's fluid economy, size alone does not ensure buyer loyalty.

The lessons are hard ones for CNH investors. Since the merger in November, 1999, CNH has posted four straight quarters of losses, totaling $306 million, and a further $105-million loss is expected for the fourth quarter. Its 2000 revenues are estimated at $2.5 billion less than the two companies' combined 1998 total. Its shares, which finished at $15.44 on the first day of trading, now fetch just $9. Its $9.3 billion in debt is back-breaking.

Even more troubling for the company's long-term prognosis is that Deere and other competitors have been stripping market share from CNH across virtually its entire product line. In an error common to flubbed mergers, CNH dropped the ball with customers. Fearful that CNH would discontinue duplicate products, farmers and dealers have been switching brands. The result: Deere is more dominant than ever. Jim Johnston, who runs a 7,000-acre farm in western Iowa, gave up on Case after his local Deere dealer dangled a sweet deal in front of him last fall. "It was a no-brainer," he says. Once CNH rolls out new products, it should reclaim some of Deere's gains, but it won't have a new combine harvester in showrooms until 2002. "Deere is laughing all the way to the bank," says analyst David Bleustein of UBS Warburg.

Rosso, who turned over the CEO title to Paolo Monferino last November, confesses that CNH's numbers might not turn positive for another three years. Says Monferino: "This is not something you can do in a six-month period. We didn't do this merger for short-term objectives." The two men say Monferino's promotion had been planned for months. Monferino, 53, is an Italian native who had been a top-ranking exec at New Holland and its parent, Italy's Fiat Group, while Rosso, 60, is a Frenchman who had been at Honeywell Inc. before he was hired as CEO to revive Case.

How did the merger go so wrong? Rosso, who remains chairman, pins much of the blame on the downturn in the U.S. farm economy that began in 1998 with the collapse of export markets in Asia. Given the high prices of farm equipment--a combine or big tractor can cost upwards of $175,000--farmers typically shop for new gear only when operating incomes are strong. But with inventories overflowing after a series of bumper crops and a strong dollar damping exports, U.S. farmers weren't in a buying mood in 2000. Meanwhile, farm-implement sales are tanking in Europe and construction-equipment orders are stalling on every continent. That hurts, since CNH does nearly 60% of its business outside the U.S. Notes Rosso: "Our business is cyclical."

LAME EXCUSE? But the business cycle explains only so much. Indeed, while CNH tallied nothing but losses, Deere more than doubled its income, to $485.5 million, in fiscal 2000, which ended Oct. 31. The company, based in Moline, Ill., also boosted annual sales by 12%, to $13.1 billion. Even AGCO Corp., the industry's No. 3 producer, swung back into profitability last year. CNH did itself in, analysts conclude.

Management's first big mistake was to drag out the asset sales demanded by antitrust authorities. CNH didn't complete the last of its required sales, a Case tractor factory in England, until Jan. 22 --20 months after the deal was announced. The delays forced Rosso and his team to postpone cost-cutting plans. That in turn spooked farmers and dealers, who couldn't get straight answers on which products CNH would continue to build and support with parts and service--a credibility gap Rosso concedes he didn't bridge.

The second big mistake was related to the first: Rosso, trying to avert a price war, let a full year lapse before countering Deere with a marketing campaign of his own. Taking advantage of disarray inside its newly merged rivals, Deere and its dealers leaped in as soon as the CNH deal was official with a discount program targeted directly at Case and New Holland loyalists, offering them low interest rates plus $5,000 in cash if they swapped their gear for new green equipment from Deere. To rub it in, Deere then slashed the prices on the trade-ins, undercutting sales of new products from CNH and stoking farmer nervousness about the resale value of their Case red and New Holland blue machinery. "That's really hitting with both fists," says AGCO Chairman Robert J. Ratliff.

While conceding that 2001 will be rough, Rosso and Monferino contend that the worst is behind them. They insist that CNH will maintain two separate dealership networks. But by modeling the company after auto makers, CNH will combine assembly at a single plant for each product line, building Case and New Holland equipment on common platforms. This will reduce operating expenses and help trim its 31,000-strong worldwide payroll by 3,000 while giving CNH more clout with suppliers. All told, management calculates that it has achieved $155 million in annual savings already and can reduce annual outlays by $600 million by 2004. CNH also has launched a $15 million dealer program to offset Deere's incentives. And it has begun shipping a new four-wheel-drive tractor that could win back market share and plans to introduce an array of new construction gear.

PATIENT BOSS. Oddly, CNH management is under little pressure to hurry up. Fiat, which owns 84% of CNH, says it will guarantee CNH's debt through at least 2003 and has reassured Rosso that its insider-heavy board is behind him.

But the longer the transition takes, the longer Deere's lead could grow. While CNH is laying off workers, Deere is hiring to keep up with demand. It plans more new-product rollouts in 2001 than ever before. Deere is also ahead in moving toward common platforms and already has global economies of scale in procurement. And to thwart a CNH comeback, it is boosting its 2001 research-and-development budget by at least 15%, or $80 million. "This isn't just a one-time event," vows Robert W. Lane, Deere chairman and CEO. "We fully expect these gains will stick."

Analysts wish that Fiat's management would crank up the heat. "If you're a minority shareholder at CNH, no one is looking out for your interests," says analyst Lisa Shalett of Sanford C. Bernstein & Co. "This is a debacle." For Case shareholders, staying No. 3 might not have been so bad after all.

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