Chrysler's Lowball Strategy
Insiders at Cerberus Capital Management deny that they're just trying to strip out costs and flip Chrysler. But they are leaving nothing to chance when it comes to managing its money.
Chrysler is proving to be a tough test for the private equity giant. Despite announcing the company's second restructuring plan (BusinessWeek.com, 11/2/07) this year on Nov. 1, the good news for new CEO Robert Nardelli and his two vice-chairmen—incumbent Tom LaSorda and former Toyota Motor (TM) North America boss James Press—is that they have the autonomy to make decisions much faster than Chrysler could under Daimler (DAI). The hard part for the trio: They're being asked to turn around a company in an industry that burns cash like no other while spending as little as possible.
Cerberus is managing Chrysler to conserve cash. After spending $7.4 billion in August to acquire 80.1% of the automaker, it doesn't want to plow in any more money, because creating more equity would reduce the firm's the return when it eventually sells the company.
This is in stark contrast to auto deals such as the Renault-Nissan (NSANY) alliance. When Renault bought into the Japanese automaker in 1999, the French company injected $5 billion in cash and later sold billions in assets to pay off debt and develop a slew of new models. Volkswagen (VOWG) made a big investment in Bentley, as well.
Cerberus could raise more money. But Mark Neporent, its chief operating officer, says Cerberus has enough right now. Besides, the capital market is an unfriendly place at the moment. Cerberus also could call on a slew of hedge funds in its equity syndicate for more money, but the private equity firm is loath to invest more cash unless it absolutely needs to. Standard & Poor's says Chrysler has enough liquidity to handle its restructuring and the expected weakness of the car market.
That means Nardelli has to work with the same $3 billion capital budget that Chrysler had under Daimler's ownership. Unless he can cut costs, he won't get much more. "Making improvements and limiting the capital budget aren't mutually exclusive," says Tim Price, a Cerberus managing partner.
Undaunted, Nardelli is making changes—and fast. He's not a car guy, but the former Home Depot (HD) CEO, Press, and LaSorda met with engineers at the company's test track in August to examine the lineup for problems. After jumping in the slow-selling Dodge Avenger and Chrysler Sebring, Nardelli complained about the noisy engines. In all, Chrysler's new team found about 300 improvements they need to make to current and future products as possible. "We said: 'Here's what's wrong, now fix it,'" LaSorda says.
How will Chrysler pay for the improvements? By cutting elsewhere, says Frank Klegon, Chrysler's executive vice-president for product development. He says Chrysler is looking to low-cost providers for parts such as headlamps and electronics, components that only a mechanic would touch. The savings will pay for stuff that drivers touch.
Chrysler also is going the low-cost route in terms of overseas expansion. While General Motors (GM) has spent billions building factories and expanding its presence in emerging markets, Chrysler, which has no global operations, must pair up to do so.
In a bold move to develop more compact and subcompact cars, LaSorda says Chrysler will work with Chinese partner Chery Automobile (BusinessWeek.com, 9/26/06). His goal is to increase overseas sales from 250,000 this year to 300,000 next year, while committing little of Chrysler's capital. LaSorda points to the deal with China Motors to build minivans in Taiwan. It's a joint venture using the partner's plants and no capital from Chrysler. To strike more deals like that, Chrysler hired L. John Cataldo from General Electric (GE), where Nardelli earned his stripes as a turnaround specialist, to scout alliance deals.
The strategy has its critics. James Hall, vice-president of consulting firm AutoPacific, says that building cars with partners takes too much time. Cutting costs on parts to spruce up the cabins in Chrysler's cars—a weakness identified by Cerberus and Chrysler managers—risks improving the products in one area only to make detectable downgrades in another. "That's not how you do it," Hall says. "You spend more on the cars to get better pricing in the market."
Mending Dealer Relations
Still, Chrysler's latest moves should solve some near-term problems. This year's restructuring should cut plant capacity from 2.8 million cars to about 2 million. That should help dealers to hit Chrysler's goal of cutting inventory from 455,000 vehicles to well below 400,000 cars. "The old management didn't view the dealers as customer," says a Cerberus executive. "Rather than shove a bunch of cars on them, we want to ship them the cars they want."
The company also is moving to mend relations with dealers, many of whom were fed up with Chrysler's salespeople forcing cars on them. Press and Steven Landry, Chrysler executive vice-president for sales, have revamped the company's dealer incentives. Rather than giving dealers bonuses just for moving volume, they're giving them $200 when they order a car and another $200 when they sell the car. Dealers can pocket the money if they want, or pass it along to the buyer, but either way the strategy supports the dealers, Landry says. Chrysler hopes the plan and the production cuts will spur dealers to order cars that customers want, vs. selling excess inventory. "We're trying to get to the spot where dealers are calling us," Landry says. "We haven't been there for a very long time."
"Not a Game of Monopoly"
In a signal of Cerberus' commitment to Chrysler, it has put at least five advisers on Chrysler's payroll and more may be coming. Of the five, four took jobs in financial disciplines, including former Chrysler finance guy Thomas Gilman, who will take over the Chrysler Financial Services lending arm. Cerberus leaves carmaking to the car guys, Neporent says. "We know what we don't know."
Cerberus executives swear that its Chrysler investment is more than just a money play. They say reclusive CEO Stephen Feinberg is determined to fix the company to prove that America can succeed in the car business. They point to a meeting held past 2 a.m. just before Cerberus finalized the deal to buy Chrysler in May. At the meeting, some of Cerberus' strategists were war-gaming Chrysler's breakup value. Feinberg cut them off. "This is not a game of Monopoly. We're talking about an American icon," Feinberg said, according to sources familiar with the meeting. "One option that was off the table was failure," says Cerberus' Price.
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