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A New Pileup in the Auto Sector?


Bankers pony up to finance the Chrysler acquisition, but a drop in demand could undermine future industry restructuring

The financing deal that will put Chrysler into the hands of private equity firm Cerberus Capital Management hit a speed-bump Wednesday. Bond buyers who were expected to belly up to buy the debt that would finance the buyout, left some $10 billion in bonds on the shelf. While disappointing, it won't be enough to derail the deal, say the executives running the transaction.

Detroit automakers are hurting as demand for pickups and sport-utility vehicles wanes and Toyota keeps gaining market share. But the cool reception to the debt offering was a result of people defaulting on their mortgages, not disinterest in Chrysler's latest models. Investors have been kept away by a wave of worry over default rates in subprime mortgages that's had an impact on the corporate bond market.

An Ominous Sign for Other Deals

A consortium of banks led by JPMorgan Chase (JPM)—including Goldman Sachs (GS), Bear Stearns (BSC), and others that were syndicating the Chrysler debt—will hold the paper themselves to get the deal done. Cerberus and DaimlerChrysler (DCX) are also going to hold $2 billion of the debt.

Daimler is anxious to unwind its ownership of Chrysler, which it bought in 1998, though it will retain a 20% stake in the automaker. On a conference call on July 25, DaimlerChrysler Chief Executive Dieter Zetsche told analysts and media that the sale of Chrysler Group to Cerberus remains on track: "As I said before, we are completely within the anticipated time schedule for the closing. We therefore expect that the closing of this transaction will take place in [the third quarter of] 2007 as we indicated at the time."

The worry over the drop in demand for the Chrysler debt is that it could undermine some of the other restructuring deals in the auto industry and elsewhere that are dependent on leveraged buyouts. Ford Motor (F) is currently shopping Jaguar and Land Rover, and the leading candidates to buy are private equity firms. Ford is also looking to sell its Volvo unit, though the likeliest buyers of the Swedish brand are other car companies—BMW (BMWG), Renault (RENA), and Peugeot Citroën (PEUP)—which wouldn't be affected much by the debt market lull in terms of making a deal.

Investors Are Pulling Back

On July 24, a debt sale to finance the buyout of General Motors' (GM) Allison Transmission unit was postponed, prompting a widening in spreads for high-yield "junk" bonds. GM agreed in June to sell its Allison unit for $5.6 billion to private equity firms Carlyle Group and Canada's Onex (OCX). That deal is to be financed by $3.5 billion in corporate loans and $1.1 billion in junk bonds. Interest in the corporate bonds was light, while the junk bonds have not been offered yet.

Investors are waiting on the sidelines to see the effect of increasing mortgage defaults on the overall debt markets, and to see whether there is a stock market correction after the new highs recently hit by equity markets.

"People have basically put the 'Closed for Business' sign out," said Shelly Lombard, an analyst at bond research firm Gimme Credit Publications in Montclair, N.J. "You never know what's going to make the market switch, but investors turned that switch off fast."

Chrysler will proceed with plans to sell $8 billion of loans for its financing division after raising the interest rate return. Investors have shown consistent interest in debt backed by auto loans because underwriting has been better than in the subprime mortgage market.

Financial Services Show Promise

Moody's (MCO) rates the Chrysler automotive division at B3, six levels below investment grade, and the financial-services unit was ranked two levels higher, at B1. Standard & Poor's ranks both units at B, five levels below investment grade.

Standard & Poor's said July 2 that it expects Chrysler to remain unprofitable into 2009. Chrysler fell to fourth place in the U.S. market last year, behind Toyota Motor (TM). (Like BusinessWeek, Standard & Poor's is a division of the McGraw-Hill Companies (MHP).)

DaimlerChrysler shares ended 1.8% higher in Europe, and its New York-listed shares were 3% higher in afternoon trading.

David Kiley is a senior correspondent in BusinessWeek's Detroit bureau.

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