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A New Model for Automakers

Prepared by: Lee Hudson Teslik
May 22, 2007

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The headlines announced that the private equity firm Cerberus Capital Management would cough up $7.4 billion to purchase Chrysler from its German parent company, DaimlerChrysler, but the fine print of the May 14 deal revealed a slightly different story. The deal was a “sale” only nominally—in fact, DaimlerChrysler couldn’t give Chrysler away. Daimler agreed to cover Chrysler’s outstanding debts, to issue a $400 million loan to the new company, and to absorb Chrysler’s losses until the deal’s completion. All told, the Economist estimates Daimler is paying Cerberus roughly $670 million to take Chrysler off its hands.

In exchange, Daimler sheds Chrysler’s astronomical healthcare and pension liabilities, which tally over $18 billion and weigh heavily (NPR) on the firm’s profitability. Perhaps more interesting is Cerberus’ calculus. The terms of the deal mandate Cerberus to honor healthcare and pension obligations to Chrysler’s workers, and despite the private equity firm’s reputation for slash-and-burn corporate turnarounds, executives and union leaders alike promised further layoffs are not in the works (Detroit News) at Chrysler.

What, then, is Cerberus thinking? The Economist article cited above notes several factors that could help Cerberus rev up Chrysler’s profitability. For starters, the merger could potentially vault Chrysler’s debt rating to “BB”—the highest “junk bond” rating, above Ford’s and GM’s “B” ratings—thereby reducing the interest the company pays on its debts. An infusion of Cerberus cash might also enable new flexibility in Chrysler’s efforts to restructure its operations. So too might Chrysler’s new status as a private company, which frees it from scrutiny of quarterly reports, potentially enabling a healthier, long-term outlook.

The deal also highlights a possible new model for dealing with bloated corporate healthcare costs. As this Backgrounder notes, American companies are handicapped by a U.S. healthcare system that relies heavily on employer-based coverage. General Motors, for instance, says healthcare costs add over $1,500 to the sticker price of every GM automobile. Industry analysts are murmuring that Cerberus and the United Auto Workers union may seek to mimic a venture agreed by the tire-maker Goodyear, in which the union took over management of healthcare liabilities. Bloomberg estimates such a deal could cut Chrysler’s healthcare costs by $3-4 billion. If Cerberus pulls off this trick, GM and Ford will likely follow suit (WSJ), potentially swinging management of over $95 billion in American healthcare funds. The savings would lighten the burden on U.S. automakers, which are rapidly losing ground to global competitors, particularly in Asia, as detailed in this Backgrounder.

More broadly, the Cerberus deal sparks heated debate over the role of private equity. Barney Frank (D-MA), who chairs the House Financial Services Committee, expressed concerns that a wave of private buyouts could hurt American workers (Bloomberg). Republican committee members and business leaders rebuffed this argument, saying buyouts help save American companies and protect the overall U.S. job market, even if doing so sometimes requires targeted layoffs. Both points hold an element of truth, the New York Times argues in a recent editorial, concluding that private equity buyouts are welcome but that U.S. regulators must monitor “the line between streamlining and looting.”

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