MARCHIONNE’S MERGER PLANS: THE SPEED AND MUSCLE OF AN SRT 8, THE AGILITY OF A GIULIETTA…AND PLENTY OF FERRARIS FOR WALL STREET

5/25/13 

This weekend’s (i.e., 5/25-5/26/13’s, page B1) Wall Street Journal featured an article “Fiat Chief Pulls Out the Deal Wrench,” on a topic I’ve been dealing with extensively for at least the last month or so, to wit

CHRYSLER’S QUARTER:   HOW DO YOU SAY “POOR MOUTH” IN ITALIAN? 5/1/13

and

IMPORTED FROM DETROIT:   MARCHIONNE BETTER BE AS FAST AS A CHRYSLER 300 SRT8, 4/25/13

The Journal emphasizes the complexity of Chrysler and Fiat CEO Sergio Marchionne’s plan to merge Fiat and Chrysler and take the company public on a U.S. exchange.  Indeed, this is a complicated deal.   In grossly simplified terms, Mr. Marchionne and his colleagues must

• Buy out the voluntary employee beneficiary association’s (“VEBA”’s) 41.5% stake in Chrysler.  Estimates on the value range from $1.75 b to $4.27 b.   Not only is that quite a spread (and probably serves as a useful proxy for the bid/asked), but final determination hinges in part on an upcoming court ruling.
• Arrange financing to do the above, or use cash.  But if the company eats into its $14.4 billion cash pile to buy out the VEBA, it imperils it credit rating and strains its development budget; designing and building cars isn’t cheap.
• Merge the operations of the two companies; this step is for the most part completed
• Do an IPO of the merged company on a U.S. exchange to raise cash but, more importantly, to establish a higher market valuation (largely because U.S. car companies trade at higher multiples than European car companies) and thus afford the new company greater financial flexibility.
• Raise some money from the IPO and as a result of the heightened financial flexibility to refinance the $2.9 billion in debt Chrysler incurred to repay the U.S. government and $3.2 of other bonds.  These issues must be refinanced because they both contain covenants restricting the transfer of cash from Chrysler to Fiat.  Any debt used to buy out the VEBA would also be refinanced, presumably at or about this time.

Phew!  And that’s a SIMPLIFIED explanation.

As I have argued in my 4/25/13 post, however, at least as daunting as the deal’s complexity may be its timing.   If Mr. Marchionne moves in the very near future, he may be buying into what has been a very ebullient market for U.S. car company stocks.  (See my 5/23/13 piece, THE CAR SALES BUBBLE:  “JUST TELL ME WHAT YOU WANT AND THEN SIGN THAT LINE AND I’LL HAVE IT BROUGHT DOWN TO YOU IN A HOUR’S TIME” for further elucidation on this topic.)   If he buys rich, he will have to move very quickly to do the IPO to avoid selling cheap; to use two trite analogies, he appears to be playing a game of hot potato or musical chairs and wants to avoid getting burned or being left without a chair while holding an expensive Chrysler stake.  If many of the Street analysts are correct, however, and the U.S. car stocks are cheap, as they appear to be based on those analysts’ earnings estimates, there is no concern here.   Gulp.

Further, if Mr. Marchionne is unable to talk down the value of the VEBA stake in Chrysler (See my 5/1/13 post.) and goes ahead and buys rich, not only will he have to move quickly with the IPO, but one would think he would like to make the IPO larger than a symbolic, price establishing issue in order to reap the benefits of a rich price.   Doing so, however, would make it difficult to make the new shareholders happy.

Then we still have the issue of Chrysler’s product line; see my 1/31/13 piece, CHRYSLER’S PROBLEM:  IT’S (MOST OF) THE PRODUCT, STUPID!, which will take plenty of skill, and money, to get up to the standards set by Chrysler/Fiat’s competition.

So Mr. Marchionne’s plans require skill, speed, timing, and luck.  Doubtless Wall Street will get rich on these plans.  But enriching Fiat’s shareholders, and Chrysler’s new shareholders will strain even the formidable skills of Sergio Marchionne, the auto industry’s current man of the hour.

IMPORTED FROM DETROIT: MARCHIONNE BETTER BE AS FAST AS A CHRYSLER 300 SRT8

4/25/13

This morning’s (i.e., Thursday, 4/25/13, page B1) Wall Street Journal reports that Fiat is considering buying from the UAW Retiree Health Care Trust (“Trust”) the 41.5% of Chrysler Fiat doesn’t already own, effectively merging the companies.

The idea seems to make sense…use Fiat’s cash horde to buy out the Trust, merge the companies, do an IPO of the new company and list it in the States (presumably on the New York Stock Exchange) and get a higher valuation as a U.S. car company than Fiat does as a European car company. 

There is a problem here, though.   Fiat’s $14 billion cash horde would be run down considerably by buying the company; Fiat would be left with about $10 to $12 billion after buying out the trust.  That sounds like a lot of money, but designing, manufacturing, and marketing cars is a capital and cash intensive exercise.   The bet is that money raised in the IPO, along with being able to borrow more cheaply as a presumably more financially sound merged company, would allow Fiat to replenish its cash horde.   To win this gamble, however, Fiat would have to show especially adroit market timing.

U.S. car companies, and their stocks, are doing quite well, thank you, of late.   European car companies and their stocks are not doing nearly as well, to say the least.   And to the extent the Big Two publicly traded U.S. car companies are having problems, those problems emerge primarily from Europe, for obvious reasons.   Given that GM and F are doing well, it would seem at this juncture that Fiat would have to pay the Trust top dollar for its stake in Chrysler.   Valuations on the stake range from $1.75 billion to $4.27 billion (How’s that for a spread?) and presumably will be settled in court, but one has to think that the final price tag for the stake, should this deal go through, will be much closer to the top of that range than to the bottom.

That would be fine for Fiat since it plans to turn around and sell some shares in the IPO and establish a higher valuation.   But the new company might have to move very quickly to effectively immunize itself buy both buying and selling at high prices.  

While I’m not the expert on the car companies and their stocks that I used to be, I get the distinct impression that both profits and stock prices are being artificially inflated by what I like to call Ben Bernanke’s war on the elderly, i.e., the artificially low interest rates designed to encourage spending, borrowing, and taking financial risk to solve a problem born of too much spending, borrowing, and financial risk.   (See, inter alia, my 1/29/13 post, BEN BERNANKE VS. THE DOLLAR AND THE ELDERLY.)  What industry, other than housing, benefits from lower interest rates more than the car business?   All this talk of pent-up demand and the age of the fleet has some surface validity, but you can be sure that if money were not so cheap and readily available for vehicle financing, and payments thus so low, people would be able to satisfactorily, and perhaps happily, drive their old cars for many more miles, given how well cars are built nowadays.  In other words, if financing cars were not so cheap and readily available, so called pent-up demand would stay pent-up.

So yours truly suspects that, once (if ever?) the low interest rate punch bowl is taken away, car sales will plummet.   And such sales may fall even if we are stuck in a Twilight Zone of cheap money more or less forever; even artificially juiced demand gets satisfied eventually and, the way cars have been selling of late, that day may come sooner than later.   So if the very talented and clever Fiat CEO Sergio Marchionne is to pull off this financial maneuver, he better move quickly.   He doesn’t want to pay a high price to the Trust for Chrysler and then be left holding the hot potato when car company valuations deflate; he has to buy at a high price and nearly immediately sell at a high price and/or borrow based on the higher valuations that result from an artificially inflated price.    

Also note that Chrysler may be especially susceptible to artificial inflation and to the resultant corrective deflation in car company prices because of the relative weaknesses in its product line.   See my 1/31/13 piece, CHRYSLER’S PROBLEM:  IT’S (MOST OF) THE PRODUCT, STUPID!   This situation is like anything else; a rising tide lifts all boats, but when the tide goes out, the leaky boats sink first.

I sincerely hope that Mr. Marchionne can pull this one off; Chrysler is one of the bedrocks of American industry, has a substantial presence in my home state of Illinois, and, as I recounted in my 1/31 piece, I may be a Chrysler owner again some day relatively soon.   But if this deal is done, Mr. Marchionne will be going in at a rich price and must move quickly to get out, or established, at a rich price.