Under the Hood of a GM-Chrysler Merger


BusinessWeek has learned details of the proposed merger between GM and Chrysler. The rewards are huge—but so are the obstacles

As top executives at General Motors (GM) and Chrysler owner Cerberus Capital Management continue to talk about a merger, the most popular scenario at this point would still have all three companies joined at the hip.

Talks between the two companies continue, and while a deal is far from certain, the two sides are narrowing in on a merger structure that both think could work, BusinessWeek has learned. The basic outcome has GM folding Chrysler's auto business into its own while Cerberus would merge lending arm Chrysler Financial Services and GMAC Financial Services. Cerberus owns 51% of GMAC while GM owns the rest.

If that deal goes through, GM would end up owning a minority piece of the merged finance company and Cerberus would still have a stake in GM. While many analysts have figured that Cerberus would retreat from the car business, the private equity firm would remain deeply in the game. If the deal ends up working this way, every company involved has a vested interest in seeing the other succeed. It would still behoove Cerberus to run the combined lender so that it helps sell more GM and Chrysler cars.

Such a deal would give GM the chunk of revenue from Chrysler's estimated 1.4 million customers and the $11 billion in cash on Chrysler's books. Meanwhile, Cerberus would acquire the merged lending business it has wanted since it acquired Chrysler from Daimler (BusinessWeek.com, 5/14/07) more than a year ago.

A Win-Win

Sources close to both companies say that if the two lenders and two automakers are combined, all would have better balance sheets. Then they can weather the storm and get to 2010, when executives on both sides think a new health-care deal with the United Auto Workers will save money, and auto sales will rebound from today's dismal levels.

But there are many hurdles to getting a deal done and making the synergies work. Both sides need to agree on what the traded assets are worth. Even if they do, there are issues to be worked out with the unions, who will be fearful of massive layoffs. One source close to the talks says that GM Chairman and CEO G. Richard Wagoner Jr. is keen on the merger but is moving very cautiously. He does not want to forge such an historic tieup if the risk of failure is too great.

The merged car company would have a dizzying 11 brands to manage and more than 10 million vehicles in global sales a year with automotive revenue of roughly $220 billion.

GM executives think they can benefit from Chrysler's cash and revenue, while cutting thousands of headquarters jobs and overhead to create a profitable revenue stream. One source close to the talks said that GM "will save billions at the start and many billions more in the future" if they do the deal.

Clock Is Ticking

But with both companies burning cash, they will have to race to get those savings. "The classic merger arguments don't apply because they don't have the time to realize them," says Sean McAlinden, chief economist at the Center for Automotive Research in Ann Arbor, Mich. "If the recession is as deep as everyone thinks, GM could run out of cash next year."

As for the combined lending company, in the past GM has rebuffed the idea of merging them for fear of diluting the company's ownership in GMAC. When Cerberus bought Chrysler from former parent Daimler (DAI) in May 2007, the private equity giant had to carve Chrysler Financial out from Daimler's lending operation and rebuild some of the back-office and loan-approval operations.

If Cerberus can merge GMAC and Chrysler Financial, they could save millions in back-office costs. In the long run, the merged financial company could boost margins. Since Chrysler Financial doesn't have mortgage operations and had limited exposure to its leasing, its total portfolio has fewer problems. With cost savings and Chrysler Financial's stronger balance sheet, the combined lender might be able to raise more capital for loans.

GMAC recently told dealers that it will only loan money for car buyers with credit scores of more than 700, which means nonprime and subprime borrowers must go elsewhere. GM has even offered its dealers incentives to get those buyers financed with banks and other lending sources.

Funding Shortage

GMAC's problem is that the finance company doesn't have enough funds to do much more than give dealers financing to buy cars from GM and make loans to prime-credit buyers.

So merging the two finance companies could be a way to save money, fix the problems at both, and raise their credit ratings.

For GM's part, the company would have an even smaller stake in the lender that it relies upon for car loans. But company executives say privately that Cerberus already controls GMAC and can call the shots with its 51% ownership stake.

Getting synergies from merging two financiers is easy to see, but it would be much tougher for GM to make Chrysler work, says Maryann Keller, an auto industry consultant who sits on the boards of rental-car company Dollar/Thrifty (DTG) and dealer Lithia Motors (LAD).

Too Sprawling?

Keller and other critics of the deal say that GM would have its hands full trying to consolidate product lines and close plants. Plus, the merged automaker would have more than 10,000 dealers—far more than it needs for the roughly 5 million cars the combined company would sell every year in the U.S.

GM would also have to deal with the incredible complexity of designing cars and marketing for 11 different brands. Dumping any one of them means getting rid of the dealers who have invested in franchises to sell those brands.

Plus, Chrysler may need more repairs. Sales are down 30% this year and analysts say the company has a dearth of new product coming. "Just looking at the future of Chrysler's product lineup, there's very little of any significance in the near term," says Eric Noble, president of The CarLab, an auto industry consulting firm in Orange, Calif.

Labor Concerns

Then there's the union. United Auto Workers President Ron Gettelfinger has already said he doesn't favor any merger that means cutting more jobs. Unless GM decides to keep every Chrysler product line and all of the workers and factories who make them—which would negate the reason for doing the deal in the first place—management would have to negotiate painful cuts with the UAW and buy out workers. In the past few years, GM has bought out thousands of workers at a cost of about $100,000 each.

It could do the same with Chrysler's workers. But they are younger and may not be ready to take an early-retirement package. The union has so far not accepted mandatory buyouts.

GM would have an even tougher time cutting brands and managing such a big and complex company. And that's another reason the company hasn't cut a deal yet. This would create a giant. GM doesn't want to create a behemoth that takes a long fall.


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