Selling a Lemon
What price for a lemon? So asked economist George A Akerlof, author of a nobel prize winning paper on the value of old clunkers in the used car market. His conclusion was that if no one knew how good or bad the old thing was under the shiny metal then it was effectively worth zero. He might as well have been writing about Chrysler the company, not just its cars. There has been much speculation about what Chrysler might have been worth, but with the extent of the horrors under the bonnet being unknown it was always effectively worth nothing. DaimlerChrysler was the only company that really knew the true value, and clearly its own estimate was less than that offered by Cerberus or else it would not have agreed to the deal. Payment of $7.4bn for 80.9% of Chrysler values the company at around $9.2bn. In case you are interested, Google revels in a market capitalisation of $147bn.
The long and winding road
Chrysler’s lurch into disaster is just the latest twist in a journey that has seen the company weave from one crisis to the next. To be fair, it has always suffered by being compared with the two great American behemoths, Ford and GM, but since they were both competing on the same home ground Chrysler’s chances were probably always doomed. The truth is that this industry is defined by its economies of scale so large that taken to their ultimate conclusion one car company could supply the needs of the entire earth and still operate below capacity. It is no surprise, then, that even the
Against these economic pressures Chrysler was compelled to innovate. Bright ideas are usually dangerous and a company only takes this path if the competition reigns with mediocrity. Most consumers are happy with the wheels they have, they simply want the next car to be just that little bit better. GM understood this perfectly with its planned obsolescence and annual model changes, which usually amounted to little more than moving bits of chrome trim around. Chrysler’s only answer was to attempt to leapfrog GM’s restless fidgeting by developing entire new concepts, thereby propelling itself into the unknown.
In 1934 Chrysler embraced aerodynamics with the Airflow, streamlined in the industry’s first wind tunnel. The public was not ready and it was a sales disaster, scaring the company back into the mainstream for the next twenty years. Virgil Exner’s Forward Look styling theme in 1955 brought the company back to prominence, only to be tripped up by product quality defects. Six years later fashion had moved on and Chrysler was back in the doldrums. It recovered again in the 1960s with the Dodge and
Chronically undersized as ever, enough confidence was restored by the all-American business hero, Lee Iacocca, to build Chrysler into a good prospect for acquisition. Under his leadership the company consolidated models around the K-car platform while hitting the jackpot with such innovations as the minivan and the cab-forward styling of the LH series. When the company absorbed Jeep through its purchase of AMC it could then claim a comprehensive range of American mass market vehicles. Daimler-Benz saw this as a perfect fit for its rather more exclusive range of Mercedes-Benz vehicles and so pounced on Chrysler in 1998.
The deal was billed as a merger of equals in order to make it more palatable to the American public, yet the order of seniority was clear from the new corporate name, DaimlerChrysler. The German side of the business came first but felt the need to maintain the fiction of an equal partnership even as Chrysler descended into its next financial trough. This had been inevitable given that Chrysler never had the resources to hold off its rivals for long, but synergy with Daimler-Benz was meant to have dragged Chrysler up the economic ladder by making new resources available. Instead, like BMW with Rover, Daimler-Benz found itself unable to cope with the dramas of American corporate life. Chrysler was allowed to continue as an independent company at the very moment when it most needed a prop. Access to Mercedes-Benz should have put Chrysler on an equal footing with the Japanese invaders and ahead of the local competition, yet this was far too late coming. Despite borrowing old cast-offs or sharing the odd platform, there was never any danger of a Chrysler gaining the integrity of a Mercedes-Benz.
As ever in Chrysler’s history, there were moments of glory when the company showed the rest of the industry a clean pair of heels. The return of the legendary Hemi V8 engine in the outrageous 300C yank tank saloon car thrust the company back into public favour, but like all fashions this new confidence in styling was quick to burn out and 2006 production was down by over 20% on the year before. More persistent was the mounting healthcare and pension burden, $18bn by the latest estimate, and a financial loss of $1.5bn in 2006. Chrysler was compelled to reduce its costs and set about cutting the workforce by 13,000 personnel. The German bosses then took the unprecedented step of inviting bidders by publicly speculating on the possible sale of Chrysler: there was little danger of being trampled in the rush.
Alone again, naturally
Instinctively, industry commentators looked for other car manufacturers to take on Chrysler. It was even suggested that the Chinese might be interested. However, this would have been to completely misunderstand Chrysler’s predicament. With economies of scale in the industry so huge a company needs to consolidate itself around a unified structure that is as close to that ideal as possible. As Daimler-Benz and BMW had only just found out, simply dividing the corporation between two largely unrelated divisions does nothing to achieve that aim. The only economic reason for acquiring Chrysler would have been to gain access to its production capacity, certainly not to maintain even the slightest hint of a separate Chrysler identity. For the new owner to have any chance at all the first task would have been to shut down Chrysler’s engineering functions and then turn all the factories over to the production of a common product range. This is only politically acceptable with new plant investment, such as BMW’s Spartanburg factory or the various Japanese transplants, but it is hardly likely that a foreign firm could get away with restructuring Chrysler into a purely assembly operation.
Two curious strategies then came to the fore. For the first, the component supplier Magna turned received wisdom on its head by suggesting that it could buy Chrysler and use it as a guaranteed market for its parts. However, from an economic point of view this would have been illogical: Johnny Cash tried to make a car one piece at a time and ended up in a dreadful mess. For a component manufacturer to dictate price and specification to a vehicle assembler would result in a similarly overpriced, unmarketable muddle. The only method by which a car can be conceived and put on the market is if the vehicle manufacturer listens to the customer, designs the product and then finds the best component suppliers for the work.
The second, successful strategy, suggests that the automotive industry might about to be reshaped. A problem inherent to all publicly quoted US companies is the need to impress shareholders. As long as shareholders are mortal their investment concerns will be short-term. This creates a pressure to maximise the return on the shareholders’ investments, achieved best by long-term consistent success, or failing that, the promise of a dramatic rise in the future. The expense of achieving the sudden rise in fortune means that when it does come it must be milked for all it is worth, leading then to a scarcity of funds for future investment and another downturn. In this way, shareholder demands for profit leads to a boom-bust management style, exacerbated by linking executive rewards to financial performance. This is in itself more costly than consistent performance because it requires regular restructuring. The massive economies of scale in the automotive industry are particularly averse to restructuring, which is why the unremitting pursuit of stability by
Getting back to business
The question is, then, what is in it for Cerberus? Since they are not charity we can assume that as far as they are concerned Chrysler is something of a bargain. On the other hand, by the paucity of bids from rival car manufacturers they must realise that the company has little value in its current state as a vehicle manufacturer. The sale of MG Rover’s Longbridge factory indicates the global price of a second-hand car factory, which would appear to be around £50m for an old one in a fairly unsuitable location. However, as has been demonstrated, even new facilities will be worth little more since car companies are looking only to increase their own scale, not support anyone else’s. For this reason, any equipment that is specific to Chrysler models is worth little more than scrap, suggesting that no vehicle manufacture would have offered more than $3bn for Chrysler’s facilities, or around a third of what Cerberus valued the company at. The shortfall in value for Cerberus will have been partly made up by the property values, but more importantly by Chrysler’s car financing operation. Cerberus will be keen to merge this with the 51% stake it bought in GMAC, GM’s finance arm.
The remaining concern is whether Chrysler can survive in the long-term as a vehicle manufacturer. There is reassurance here too. Since there was no significant technology transfer from Chrysler to Mercedes-Benz it can be assumed that Daimler’s 19.9% remaining stake in Chrysler is not a willing investment and for the next five years it will even be liable for $1bn of that pension fund burden. The relationship does, though, secure access by Chrysler to some of the vehicle technology at Mercedes-Benz. This, of course, is reminiscent of the ownership structure now in place at Aston Martin where there is still a substantial relationship with Ford. By this same mechanism Cerberus is maintaining Chrysler as a credible vehicle producer. The next 300C will be based on a Mercedes-Benz platform, probably an update of the existing one, and it is possible that this will include the luxury Imperial model. This is one aspect of Chrysler’s existing plan to expand its model range while at the same time reducing the number of platforms from twelve to seven by 2012. The model strategy will be served by more flexible production and greater exploitation of globalisation, both through an international spread of new plants and global procurement of components.
It is in the nature of private equity that Cerberus will be looking to sell its new acquisition on at some time in the future, but only for a profit. It can do this if it puts the company on a stable long-term footing. If Cerberus can take care of the financial dramas then Chrysler can get back to the boring business of bashing out metal.