Spin-Offs That Won't Go Away
Like grown children badgering their parents for handouts, auto-parts companies Delphi and Visteon keep turning up on the doorsteps of GM and Ford. Spun off from General Motors Corp. (GM ) in 1999, Delphi Corp. (DPH ) is now threatening to file for bankruptcy court protection by Oct. 17 if it doesn't get a truckload of GM's money and union concessions. And Visteon Corp. (VC ), spun off by Ford Motor Co. (F ) the year after, is dumping 24 mostly money-losing plants on Ford this month as part of its second bailout in two years.
The two parts makers remain GM's and Ford's largest suppliers, but there's a bigger reason why the auto makers are still on the hook for these offspring: Except for their stock, they never completely cut all ties to make them independent companies. Visteon began life without full-fledged administrative systems such as payroll, information technology, and accounting -- it paid Ford to do that work. Next month, Ford will assume responsibility for the retirement benefits of Visteon's union workers and GM would pay benefits to Delphi retirees if the parts maker fails. One industry watcher and consultant, Maryann N. Keller, says that because so many Delphi executives were GM lifers, the company was reluctant to drop unprofitable business from GM.
Indeed, Delphi and Visteon -- which together employ more than 250,000 people and book nearly $50 billion in annual revenue -- may have been destined to fail. GM and Ford lumbered them with huge labor costs while extracting promises from them to cut their prices. "These companies were not spun out as viable businesses," asserts Keller. Ford argues that Visteon did have a fighting chance to succeed, but, like other suppliers, it was hit by many problems, such as falling Big Three sales and rising costs for commodities. "A lot has changed in the intervening years," says Ford spokesman Oscar Suris. GM declined to comment.
Now some of the costs that the auto makers tried to move off their books are coming right back to them, making the whole spin-off exercise something of a charade. GM may well have to cough up $2 billion to $3 billion for Delphi over the next couple of years, says Brian A. Johnson, an auto analyst at Sanford C. Bernstein & Co. (AC ). And in agreeing to take back 24 Visteon factories and their 17,000 workers, Ford said in May that it will book about $1 billion in restructuring charges. Ford already took a $1.6 billion Visteon-related charge in 2003. Plus, the company may have to continue paying part of the wages of union workers in order to sell the plants to other suppliers. As matters stand, it expects to lose up to $450 million on the facilities this year and next. These are burdens that the companies can ill afford: In the North American market for the first half of the year, GM lost $2.5 billion and Ford $244 million.
Back at the height of the 1990s bull market, the spin-off stories sounded swell for both GM and Ford and for shareholders in the new parts outfits. The auto giants said they would shed highly paid workers, inefficient plants, and some retirees -- and be free to buy parts from other companies with lower costs. "There was no logic to paying those kind of wages for parts [manufacturing]," says one former Ford executive. "It was economic suicide. Once GM did it, we had to."
And at Delphi and Visteon, profits were rolling in and balance sheets were healthy, thanks to strong sales of SUV parts and pension plans that were largely funded by the soaring stock market. Also, both companies boasted hot new technologies that they said would attract orders from the likes of Toyota Motor Corp. (TM ), Honda Motor Co. (HMC ), and other auto makers once they were independent. And both pledged to boost business overseas, where they weren't tied down by United Auto Workers contracts. Visteon Chairman Peter J. Pestillo, a former Ford vice-chairman and labor relations chief, declared at Visteon's launch: "This opens the door wide to new business." Visteon's shares jumped at first, from $13 to $21 in 13 months, before plummeting, while Delphi's shares fell along with GM's and are now off 75%.
Delphi tried to play down the labor costs in presentations to institutional investors and analysts during a roadshow. Two analysts who attended recall that J.T. Battenberg III, a longtime GM official who recently retired as Delphi's chairman and CEO, argued that Delphi's average wage was competitive with other suppliers'. Trouble was, the average included the low rates in Mexican and Asian plants. His point, says Joseph S. Phillippi, president of consulting firm AutoTrends Inc. and a former Lehman Bros. analyst, was that Delphi could lower costs by moving more factories overseas. But Keller adds: "It didn't show that the bulk of the business was in noncompetitive factories." Battenberg declined to comment. Delphi said it could not comment without checking its records first.
Right from the start, the U.S. plants of both Delphi and Visteon had a tough time winning new customers. Because of union contracts, the parts companies inherited their parents' outsize labor rates -- now $22 an hour, compared with about $15 at parts companies Johnson Controls Inc. (JCI ) and Lear Corp. (LEA ). Adding in benefits, Delphi's workers cost $65 an hour, says Delphi Chairman and CEO Robert S. "Steve" Miller. That's more than twice what rivals have to stump up. And if GM and Ford thought their parts operations were too expensive, so would potential customers such as Nissan Motor Co. (NSANY ) or BMW. Since the spin-offs, additional sales to other companies haven't offset declining revenues from the parents. Says Joseph W. Cornell, president of Spin-Off Advisors LLC: "When GM and Ford did this, you could see that it was more to benefit the parents than to unleash good businesses that would blossom."
Many of Visteon's problems can be chalked up to its premature birth. For the first 18 months, Ford wrote the paychecks for white-collar workers. The company's offices were spread out among 26 different buildings, forcing managers to drive all over the Detroit area just to attend meetings. It didn't have a full-blown marketing and sales operation and had few relationships with other auto makers because it made 90% of its sales to Ford. Salespeople, to win new customers, sometimes quoted prices that were too low to cover costs. In the fall of 2000, Visteon's then-president, Michael F. Johnston, and Robert H. Marcin, senior vice-president of corporate relations, went to Tokyo to build ties with Nissan -- and ran into a buzzsaw of criticism from Nissan's top purchasing executive, Marcin recalled later. The Nissan official said two Visteon salespeople had visited him that day and neither knew the other was coming. And he told them that he didn't believe Ford had relinquished control of the company. He feared that Visteon would hand over Nissan's product plans to Ford. Says Merrill Lynch & Co. (MER ) analyst John A. Casesa: "Visteon never had the tools to start with."
Visteon still depends on Ford for 65% of its sales and has lost $3.4 billion since 2002. And Ford has been a tough customer: It once gave Delphi a big order instead of Visteon to save 3 cents apiece on car stereos that cost several hundred dollars each, says a Visteon executive.
Freed of its uncompetitive plants, Visteon now expects better times. Most of its remaining business comes from foreign markets where it produces parts and doesn't have to deal with the UAW. In fact, Visteon is now one of the largest makers of interior systems for cars in China. "Tomorrow is really different for us," crows Visteon Chairman and CEO Mike Johnston.
Now Johnston's problems are reverting to Ford. Under its plan to unload or revamp the plants it's getting back from Visteon and to buy out employees, Ford hopes to reap $600 million to $700 million a year in lower supply costs by the end of the decade, says Ford Chief Financial Officer Donat R. Leclair. That's the plan, anyway. Says Leclair: "It assumes a whole series of things."
Though it was far better prepared than Visteon for its kick out the door, Delphi today is in much worse shape than its rival. It lost $608 million from operations in the first half of the year, vs. $288 million at Visteon. Its pension plan will eat up $1.1 billion in cash next year, says Standard & Poor's (MHP ) debt analyst Martin King.
Delphi hired Miller, a turnaround specialist, in June after an accounting scandal that, in part, involved transactions with GM. He's calling on GM to foot at least part of the bill for rescuing Delphi, either by taking workers back, buying them out, or paying Delphi more for parts. He has also told UAW leaders that Delphi must have a new labor agreement to cut wages, benefits, and jobs, close plants, and nix the long-standing practice of paying workers 75% of their wages after they're laid off. Its 4,000 furloughed workers are costing Delphi $400 million a year, he notes. Says one union official: "He has demanded everything except making the workers bring their own materials to work to make the parts." Miller responds: "Should we fail in our discussions with GM and the UAW, we will have to consider [bankruptcy court] reorganization."
It turns out that while GM was readying Delphi for the spin-off, it was also preparing for a quick switch of business away from Delphi. The parts maker was getting about a quarter of its business from outside GM; now it's 51%. "We thought we had a good long runway" to exit some product lines, says James A. Bertrand, president of Delphi's Automotive Holdings Group, the unit that mostly supplies GM. The group's 11 manufacturing sites are set for restructuring, sale, or closure. The plants, some making commodity products such as air filters and spark plugs, account for 9% of Delphi's revenue but most of its losses. Miller is pushing GM and the UAW for concessions to make the plants viable. One possibility: GM would give workers a one-time cash payout of $75,000 or more, and the workers would accept lower wages.
Meanwhile, Delphi has diversified into electronics such as satellite radio and medical devices. "Delphi is a tale of two companies," says Miller. "Half is profitable, growing, and a technology leader. The other half, through its legacy from GM, has costs that are not competitive."
The ugly half may land the company in bankruptcy court before Oct. 17, the day that tougher corporate bankruptcy rules take effect. Either way, Miller says he will transform Delphi. GM's response: "We're in discussions with Delphi," Vice-Chairman and CFO John M. Devine told investors on Aug. 30. Then he added: "That said, we'll do what's best for GM." Of course, that's what GM executives were doing from the get-go.
By David Welch in Detroit and David Henry in New York