Why Fiat's Slide Is GM's Problem

On May 31, Fiat's top brass flew to Rome for a frantic, three-day huddle with the company's three largest lenders. Moody's Investors Service and Standard & Poor's were weighing a downgrade to junk status of the top Italian industrial group, which has $33 billion in gross debt. That would have revealed the true extent of Fiat's (FIA ) weakness and disarray and sent the European corporate debt markets into chaos.

Fiat Chairman Paolo Fresco returned to headquarters in Turin with a $2.8 billion debt restructuring and asset-sale plan. The deal with Banca di Roma, IntesaBci, and San Paolo IMI--to which Fiat owes $13 billion--may yet stave off the dreaded downgrade.

But Fiat's financial problems are hardly over. Many of them come from Fiat Auto--and those may soon belong to General Motors Corp. (GM ) GM bought 20% of Fiat Auto in 2000 for $2.4 billion and granted Fiat a put option--the right to sell GM the rest--as of January, 2004. Now GM faces a big dilemma. It's short of cash, so a big acquisition would be a serious burden. But if GM waits until 2004, it could be stuck with an even bigger lemon.

Fiat Auto has been careening downhill since GM bought its stake. It lost $1.3 billion in 2001 and is expected to lose another $1 billion this year. Management forecasts breaking even in 2003 and making a slight profit in 2004. But analysts say it'll take three years and $3 billion to $5 billion to reverse its decline.

Will Fiat sell now or later? Much depends on how much GM would pay. Investment bankers say Fiat Auto would be worth nothing if a buyer had to take on its about $1.7 billion of debt. The put terms let Fiat and GM each name bankers to negotiate a "fair market price." But time isn't on Fiat's side. "Things will only get worse for Fiat," says a board member.

Fresco could sell healthy group assets--such as insurance, aviation, or energy businesses--and invest the cash in the car unit. If management can stem losses by 2004, Fiat might be able to command as much as $3 billion from GM, bankers say. But to get that much, Fiat needs to prove there are buyers for its cars instead of an ever-shrinking market. Trouble is, Fiat Auto CEO Giancarlo Boschetti is deferring investments in new models to stop the bleeding.

Fiat executives can't dither indefinitely. Under the June 2 accord with its banks, Fiat has to slash net debt to $2.8 billion by yearend, from $6 billion today. If Fresco fails, the banks can force an asset sale. The banks can also trigger a rights issue that would convert the just-restructured $2.8 billion debt into stock, giving them about 25% of Fiat's shares. "There is discipline," says one Italian banker involved, adding that Fiat has roughly $10 billion in salable assets.

The restructuring forces tough decisions on controlling shareholder Gianni Agnelli, 82, whose family owns 30.5% of Fiat. He has long opposed exiting autos, a 103-year-old family business. But faced with "losing everything," as one banker put it, the ailing patriarch recently gave the green light to Fresco to sound out GM. "If GM offers a good price, the deal is done," says one Milan investment banker. The risk of Fiat's fortunes sliding further might just get GM to the table.

By Gail Edmondson in Rome

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