GM Leaves Fiat in the Dust

The U.S. auto giant is forking over $2 billion so it won't have to buy the Italian carmaker. Now, can Fiat reverse its troubled course?

By Gail Edmondson

General Motors (GM ) shareholders can sleep easier now that the company no longer risks being forced to buy ailing Italian carmaker Fiat Auto. On Feb. 13, GM agreed to pay $2 billion to terminate the five-year-old put option that gave the Italian industrial conglomerate Fiat Group (FIA ) the right to sell Fiat Auto to GM for a fair market price.

It was a bad deal from the beginning for GM and the subject of a yearlong dispute between the two companies, but the hand-wringing over a looming court battle to enforce the put is over.

For Fiat, however, the race is on to reverse a cash-burn rate of $1.9 billion a year. Since 2000, the Turin-based auto maker has accumulated $14 billion in net losses, triggering financial crisis and repeated recapitalizations at its parent company. In 1990, Fiat ranked second only to Volkswagen in Europe, with sales of 1.9 million cars and a robust market share of 13.8%. But the $27 billion outfit is now Europe's weakest, with sales in 2004 falling to 1 million -- nearly half the level of 15 years ago -- and European market share hovering at 7.6%.


  Hurt by weak models, underinvestment, and toughening competition, Fiat has steadily lost ground to the likes of Toyota (TM ), Nissan (NSANY ), and Hyundai, not to mention Peugeot, Renault, and Ford (F ).

As sales declined, overcapacity savaged profits: Fiat's factories are currently operating at 65% to 67% of capacity. "The medicine is tough but simple. They have to bring down capacity and launch successful new models," says Patrick Juchemich, senior auto analyst at Sal. Oppenheim in Frankfurt.

Since mass layoffs and factory closings are politically taboo in Italy, fixing Fiat means turbocharging sales as fast as possible. That task falls to Fiat Auto Chief Executive Herbert Demel, a former Volkswagen and Audi senior executive who knows how to wring costs out of a production line and build in German-style quality. But Demel, who joined Fiat just 14 months ago, is racing against the clock. The September launch of the third-generation Punto, Fiat's best-selling subcompact, won't do much to rev sales until 2006, meaning losses will continue this year.


  Some hopeful signs are on the horizon. Fiat's new Panda compact SUV, introduced in 2004, has outstripped expectations, reaching sales of some 250,000. The Lancia Ypsilon mini also has outsold forecasts, reviving Fiat's badly flagging sister brand Lancia. But margins are razor-thin on these small vehicles, and the carmaker needs more hit models to reverse the negative direction.

If successful, the Punto may help nudge Fiat to breakeven in 2006. The company is also introducing a new large car, called Croma, this summer, and two new models at Alfa Romeo, including the popular 156. But forecasted sales volumes for these models are much lower than the Punto, which is still Italy's top-selling car, expected to reach some 400,000 a year.

Fiat's biggest challenge: Gain ground in the fiercely contested compact class. Its Stilo compact, launched in 2001, was designed to challenge Volkswagen's Golf. But the annual sales of 150,000 fell far short of the expected 400,000, saddling Fiat with the heavy costs of an underutilized built-for-Stilo factory. Now, a new Stilo is not due out until 2007.


  "Not only was Fiat Auto slow in sharing platforms across products and brands, it also used platforms for two successive generations of models," failing to reap cost savings from new vehicle design, says Philippe Houchois of JP Morgan. Houchois notes that the current Punto is really a 14-year-old product.

Fiat had started to address the platform issue with partner GM. The new Punto, for example, shares a platform with the upcoming Opel Corsa. Though both parties will continue supporting the existing shared platform, the joint venture for this purpose is being dismantled, and Fiat will likely search for a new partner when it comes to future needs, analysts say. One possible ally: PSA Peugeot-Citroen, with whom Fiat already builds a small truck. The GM-Fiat purchasing joint venture is also being unwound, but Fiat will retain some purchasing advantages as a member of GM's global purchasing alliance.

One thing is clear: Fiat can't afford any more missteps. The Punto and other upcoming models have to grab bigger market share and fill idle production lines with orders.


  Fiat Auto is carrying some $6.4 billion in net debt and needs to finance a new generation of models. The injection of $2 billion from GM at least takes some of the pressure off at Fiat Group, which is facing a September payment of a $3.9 billion convertible loan, arranged three years ago when a financial crisis loomed. If the loan were to convert to equity, a consortium of Italy's largest banks would become the controlling shareholder at Fiat Group, displacing the founding Agnelli family, which currently controls the conglomerate through family holdings, with a 30% minority stake.

As Fiat's car business skidded into crisis in 2002, the Agnellis sold off key assets to recapitalize the carmaker. The parent company now insists that the long-promised turnaround at Fiat Auto is on track for 2006. This time, it will be hard to extend the deadline.

Edmondson is a senior correspondent in BusinessWeek's Frankfurt bureau