Fiat: Running on Empty

Management is in turmoil, cash is low, and there's no hot model in sight. Can Fiat be saved?

Clad elegantly in dark suits and power ties, the political elite of Italy gathered on Apr. 11 at the Quirinale, Rome's fortress-like 16th century presidential palace. The occasion: the launch of the Lancia Thesis, a new luxury car built by Fiat (FIA ). The ceremony was a heartening interlude for Fiat group Chief Executive Paolo Cantarella, who has been struggling to contain the losses and restore the market share of the Turin-based auto maker. Pier Ferdinando Casini, the president of Parliament's lower house, called for the country to buy Italian and "be a bit nationalistic." Prime Minister Silvio Berlusconi made the symbolic move of placing an order. "As far as I'm concerned, Fiat has one new customer as of today," said the billionaire politician, who owns a Mercedes.

Berlusconi, who once crooned for his supper on a cruise ship, has a performer's flair for the perfect gesture. Fact is, Fiat Auto desperately needs new customers--hundreds of thousands of them. While Fiat wielded its political clout in Rome for decades to keep competition at bay, Volkswagen (VLKAY ), Peugeot (PEUGY ), Renault, and Ford (F ) were battling for market share and catapulting ahead of Fiat in quality, technology, and performance. Since the early 1990s, the Italian carmaker has ceded a third of its market share in Europe.

In the past quarter-century, Fiat has had several near-death experiences and always managed a friendly bailout. "We've been through many crises. It was worse in 1993," says Cantarella, referring to the year when huge losses prompted an emergency $2.5 billion recapitalization by Fiat's bankers.

Yet there's a growing consensus in the industry that the repeated bailouts did little to revitalize Fiat, which was once Europe's largest carmaker. Its strategy of moving upmarket is foundering: Sales of the all-important Stilo, a midpriced compact designed to compete with the Volkswagen Golf, are running at only 60% of forecasts. Since 1998, Fiat Auto has lost $2.5 billion, including $1.3 billion in 2001. Although analysts initially forecast less red ink this year, the prospect of $270 million losses in the first quarter has them scurrying back to their calculators. "Fiat [Auto] is finished," says a top executive at a European rival, echoing the view of dozens of car-industry managers, suppliers, ex-Fiat execs, investment bankers, consultants, and analysts interviewed by BusinessWeek.

Many in the industry predict Fiat will wind up as a division of a much larger global carmaker. "You get the feeling that the decline is beginning to accelerate, and that it might be impossible to stop it," says one long-serving board member.

How this saga unfolds has profound implications for the company's founding family, for General Motors Corp. (GM ), and for Italy itself. Fiat was founded 103 years ago by the grandfather of Giovanni Agnelli. At 82, "Gianni" is still the unofficial padrone of Italy Inc. and the honorary chairman of Fiat group. Though brother Umberto, 67, has diversified the clan's business, the car company still makes up 42% of revenues. Selling Fiat Auto, or presiding over its final decline, would be a devastating blow to Gianni's prestige.

But if losses continue, even the charismatic Gianni may have trouble keeping the family under his sway. Some 100 descendants of the founder hold a 30.5% stake in Fiat group, which, besides Fiat Auto, has interests in insurance, farm and construction equipment, publishing, energy, trucks, aircraft engines, and Ferrari. Without Fiat Auto, Fiat group last year would have earned a $500 million net profit instead of losing $704 million. "Fiat isn't an automotive company; it's a national industrial conglomerate in crisis," says Stephen B. Cheetham, an analyst at Sanford C. Bernstein Co.

The top brass at GM are watching this family drama with keen interest. GM CEO G. Richard Wagoner Jr. clinched a deal in 2000 that gave the Detroit giant 20% of Fiat Auto for $2.4 billion. GM also agreed to a "put option" that allows Fiat to sell the remaining 80% to GM starting in 2004 at a fair market price.

If Fiat group fails to reverse Fiat Auto's decline over the next 18 months, then GM may have to swallow a deal that forestalls its own turnaround and eats into its precious cash pile. Sources close to GM management say GM Vice-Chairman and Chief Financial Officer John M. Devine, who joined GM after the deal was made, isn't enamored with the partnership. But Devine will say only that GM is "war-gaming" strategies to handle its worrisome engagement with the troubled Italian auto maker. Meanwhile, in Europe, GM is still struggling to turn around its Opel unit and can ill afford the $2 billion to $4 billion that buying the rest of Fiat would cost. "Opel and Fiat have nothing to bring each other. Both are in serious difficulties," says Jurgen Pieper, chief auto analyst at Metzler Bank in Frankfurt.

The demise of Fiat Auto as an independent carmaker would also rock Italy Inc., revealing the painful truth not only about Fiat's mismanagement but also about decades of flawed industrial policy. Italy kept quotas on Japanese cars after other European countries had done away with them. Rome also granted Fiat subsidies and other concessions. "The terrible story of Fiat reflects the protectionism, ineffectiveness, corruption, and compromise typical of the way Italy has done business for the past 30 years," says one Italian entrepreneur.

Cantarella and his boss, Fiat group Chairman Paolo Fresco, still express optimism. They say Fiat is suffering from a cyclical downturn and that new cars such as the Stilo and the Thesis will bolster sales. They insist a December restructuring at Fiat Auto, including the closure of 18 plants and 6,000 job cuts outside Italy, will stanch the flow of red ink. Meanwhile, plans to sell $2.7 billion in group assets should ease a cash-flow crunch.

Maybe. But many believe the December shakeup was too little too late. Years of underinvestment in R&D vis-à-vis the competition have produced a new generation of cars incapable of winning the battle for market share. Add to that Fiat group's huge off-balance-sheet debt, and the result is a company with little room to maneuver. "As long as they are bleeding cash, they will be forced to sell the furniture to pay the debt," says one London analyst.

Indeed, there's a lot of red ink to stanch. In a year when it lost $704 million, Fiat group had to shell out nearly $1 billion in interest payments. Over the past two years, capital expenditure has exceeded cash flow from operations by $2 billion. Analysts say Fiat's off-balance-sheet debt--which includes heavy borrowing against receivables--pushes its total obligations to almost $13 billion. Fiat counters that borrowing against receivables is a widely used practice and less expensive than other forms of borrowing. But even Fresco admits that Fiat Auto's losses are unsustainable: "Over time, no one can keep filling a black hole."

The ratings agencies agree. On Apr. 25, rating agency Standard & Poor's placed Fiat's short-term corporate credit rating on CreditWatch, with negative implications. If Fiat group's debt is downgraded, it will have a rating equivalent to that of a junk bond. Although the company announced a $1.6 billion refinancing of Fiat Auto on April 30, analysts concluded the move places no new fresh cash into the auto maker's accounts.

The auto business' woes could give an advantage to Umberto Agnelli against his aging brother Gianni in the battle over Fiat's future. Umberto, edged out as Fiat Auto chairman in 1990 by Gianni, has long advocated the sale of Fiat Auto. Insiders say backing for Umberto has grown since March, when heavy losses prompted Fiat group to cut its dividend by 50%. Umberto declined to comment. But on Apr. 29, Gianni reiterated the family's determination to stay in the car business: "I want to again emphasize that we believe in Fiat Auto."

Given Fiat Auto's accelerating decline, it's no surprise that the rumors of a management shakeup are flying. Gianni also stated on Apr. 29 that Cantarella and Fresco have his full support and would be nominated for reappointment at a May 14 shareholders' meeting. Yet Fiat Auto CEO Roberto Testore resigned just five months ago amid a drastic restructuring, taking the heat for the company's poor performance. Now some insiders say more execs could go. "Cantarella will be ousted," says a top Italian manager close to the family. "The problem is, they don't know who to put in his place." Fresco, a vice-chairman at General Electric Co. before retiring in 1998, says Cantarella's job is secure. But for now, Fresco may take firmer control of the group himself. Analysts welcome the move, hoping that Fresco can inject Fiat management with GE's performance-driven culture.

Fresco wants to push Fiat's hierarchical management culture into the 21st century. Last year, he hired his former boss at GE, Jack Welch, to consult on human-resources management. Welch, who claims no knowledge of a pending management shakeup, says Fiat suffers from too many layers of management and a consensus culture that protects underperformers. "Getting competitive is a long-term project," he says. "One thing I tell them is they have to get more candor in the appraisal system. People have to know where they stand."

The man who must carry out these management changes at the carmaker is newly named Fiat Auto CEO Giancarlo Boschetti, 62. The former head of Fiat's $7.1 billion truck division, Iveco, Boschetti also must tackle Fiat's chronic weakness at the dealership level. "Boschetti is the best sales-and-marketing guy in the company," insists Fresco.

GM execs are desperately hoping that Boschetti will turn Fiat Auto around. There's no out for GM if the Agnellis decide to exercise their put in 2004. Fiat can opt to sell to someone else as long as it permits GM to make its own offer--and auto-industry experts believe Fiat may well be forced to sell before 2004. The longer it waits, however, the harder it will be to interest a third party, since GM and Fiat are working to merge their model lineups on the same platforms starting in 2005.

Fiat could buy some time by selling off its sporty Alfa Romeo line or floating a chunk of its 90% holding in Ferrari, the luxury-sports and race-car maker. The Ferrari stake could fetch some $1.5 billion. A rebound in the Italian auto market also would temporarily relieve some of the pressure. With a $15,600 price tag, the Stilo was designed to curb Fiat's dependence on low-profit small cars such as the Punto. Cantarella says Stilo sales will rebound after the introduction this year of lower-priced models and a station-wagon version. But seven months after the Stilo's debut, analysts are increasingly skeptical. "After a lukewarm launch, it's hard to rebuild excitement," says Karl Ludvigsen, an auto consultant in London and a former Fiat manager.

Fiat is even losing ground fast in its home market. Once fiercely loyal to their unreliable Fiats, Italians are starting to demand quality. Fiat's market share in Italy has slid from 44% in 1992 to under 32% in March. Everyone from taxi drivers to students are snapping up Japanese, French, and German cars. Roberto Crovato, a 55-year-old engineer from Milan, just bought a Jazz from Honda Motor Co. (HMC ) "Fiat cars are very expensive," says Crovato. "They cost too much for what they offer."

Fleet owners are disgruntled, too. At an international car-rental agency in Rome, agents say a flaw in the Stilo's electronics has caused engines in 5% of its fleet to shut off while drivers are on the road. Problems with the airbag system have also surfaced, agents say. As a result, the agency won't rent out any of the hundreds of new Stilos sitting in its lot. Cantarella, an engineer by training, says the problems may simply stem from customers' unfamiliarity with the electronics. There are other complaints, though. Taxi driver Ireneo Mancini, 43, says he's fed up with "bad gears" that result in repeated trips to the repair shop. "If Fiat doesn't resolve this problem, I'm moving to an Opel."

Fresco says quality is Fiat's top goal: "We are not the quality leader yet. But we are catching up." Many suppliers in Turin--Italy's equivalent to Detroit--would love to see Fiat bounce back. But they fear the worst and are racing to lower their dependence on the carmaker. "It's a matter of survival," says one.

Fresco insists the company can still survive as an independent auto maker. He gestures to the cast wrapped around his leg, acquired when he broke his ankle recently. "My leg is not working, but my head and my arms are fine, and I'm getting around," he says. "And guess what? My leg will heal. The same goes for Fiat Auto. The rest of the group is healthy." If a cure depended only on Fresco's powerful faith, he might be right. But this may be a turnaround no one can pull off.

By Gail Edmondson in Turin, with Christine Tierney and David Fairlamb in Frankfurt, Diane Brady in New York, and David Welch in Detroit

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