A Disastrous Deal
October 11th, 2008The New York Times is reporting that GM and Chrysler are discussing combining operations (see GM Said to Seek Merger).
G. M. executives approached Ford about a possible merger in July, but Ford rejected the idea and ended the discussions last month, these people said.
After Ford decided to remain independent amid an increasingly difficult auto market, G. M. turned its attention to Chrysler. For the last month, it has been in preliminary merger talks with Chrysler’s owner, the private-equity firm Cerberus Capital Management.
People with knowledge of the talks described the chances of a deal as “50-50.”
It’s a pretty straightforward deal: an oligopolistic play in an industry burdened by overcapacity. By coming together, the two firms figure that they can rationalize operations, reduce industry capacity, and gain some pricing power.
This type of strategic rationale can work, as there is no quicker way to gain market share and increase pricing power than to remove a direct competitor. However, I’ve never been a big fan of combining two failing firms in the hopes of creating one healthy one. You generally end up with managerial attention diverted to a complicated integration, and away from what they should be doing in the first place - managing the individual businesses to make them healthy.
According to the WSJ, GM expects $10B in benefits by combining with Chrysler (see GM had Talks with Chrysler).
Pray, do tell, how?
Unless GM is expecting to shut Chrysler down and pocket their nearly $11B in cash reserves, $10B in benefits seems improbable to me.
Their best bet would be to get rid of half the products of the combined GM-Chrysler, keeping only the best-in-class product from each firm (e.g., the Jeep brand for SUV’s and the Chevy brand for the mass market). Their product portfolios overlap almost exactly, so the thinking has to be that by rationalizing operations, GM-Chrysler would be able to do so while effectively combining Chrysler’s 11% U.S. market share with GM’s 24% market share.
But again, I am skeptical. Do Chrysler and GM truly believe that they will be operationally improved after combining operations? This integration will cost far more than either can imagine, at a time when there is little room for error on either side. As the WSJ astutely points out:
A GM-Chrysler deal would be a highly complicated maneuver, which would involve the rationalizing of more than 100 automotive plants and about 190,000 employees in North America. It would also likely force a streamlining of 11 automotive brands — from Chrysler to Cadillac — and more than 10,000 auto dealers in the United States, Mexico and Canada.
So if you are GM, why not wait until Chrysler goes bankrupt? That accomplishes the same thing without the trouble of the integration. You get to capture Chrysler’s market share (or at least split it with Ford), without having to assume responsibility for its operations. Unless, of course, GM is worried that it might be the first to go…
In the end, the whole thing reeks of desperation. And sadly, the only firm this deal benefits is Cerberus, providing them an exit from an ugly, ugly deal.
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October 17th, 2008 at 4:40 pm
Cerberus and GM are both better off putting Chrysler into Chapter 11, shedding all its debt and pension obligations and closing its unnecessary plants, and then selling the remaining good assets (Jeep, minivans, Mexico, the brands) to GM. The banks (who are pushing the merger) and the unions won’t like it, but reality is reality.
October 17th, 2008 at 9:56 pm
I totally agree!!!
October 21st, 2008 at 12:09 pm
Excellent post. This deal makes no sense at all; what Big Three manufacturers need to focus on is making good cars at affordable prices, which is the only thing that will pull them out of the hole they dug themselves in.
One remark: you say the only firm who benefits is Cerberus. I have another usual suspect: JPMorgan, who AFAIK is the biggest holder of Chrysler (now junk) bonds and is advising Chrysler on the deal, and other banks. The banks are pushing GM and Chrysler to do this to reduce their exposure to Big Three junk bonds at a time when they’re scrambling to clean up their bloated balance sheets (and generate some much-needed M&A activity in a downturn), and the hapless managements there are listening because… well, because they’re so desperate.
I’m pointing this out because, if the deal goes through and it has the consequences it is so likely to have, it will be an excellent case study on how putting stakeholders (in this case, creditors) before shareholders destroys value every time.