Chrysler deficit even bigger - is VW in the wings?
According to a report in the Wall Street Journal, Chrysler president Robert Nardelli now puts Chrysler’s loss for this year at an anticipated $1.6 billion.
Chrysler’s turn-around plan calls for the company to break-even next year, and make a profit the year after. But all automakers are now predicting relatively poor sales for 2008, especially in product lines which are not very new. The only new Chrysler product for 2008 is the Ram pick-up.
In short, Chrysler may be facing the classic conundrum of the undercapitalized: not having enough money to be able to spend in the short term the money needed to save even more money long term.
This is leading to speculation that Chrysler may be sold again, perhaps to Volkswagen. Some auto industry observers have advocated VW’s purchase of Chrysler. As they see it, VW is trying to build its presence in North America and Chrysler already has one. Chrysler and VW already have a deal under for Chrysler to build vans for VW.
At bottom, these observers believe the auto industry is poised for a new round of mergers. To compete with the production economies which their size gives GM and Toyota, other companies will need to achieve similar levels of production. That will require consolidation.
Oddly, the deal GM struck with the UAW may be the ultimate salvation for Chrysler, though not for its new owners. That deal set a pattern which was followed at Chrysler. As a consequence, Chrysler workers will soon cost $10 an hour less than VW’s West German workers. Factor in the cost penalty for European production created by the exchange rate of the Euro to the dollar and it becomes obvious that the best way to make a profit selling cars in North America is to build them here.
VW has said it want to increase United States sales to 1,000,000 vehicles annually. Worldwide, it plans to invest $14.1 billion in the next three years to increase production capacity and introduce new products, including a new plant in the U. S.
But, what if it just bought Chrysler?
Two factors might put Chrysler into the hands of Volkswagen.
First, Porsche has gained control of Volkswagen. It owns enough Porsche stock to run the company, and is now setting policy at VW. That policy is very aggressive.
Second, Cerberus – the equity firm that bought Chrysler – is having trouble with several of its other investments, which were players in the subprime mortgage market. One has gone bankrupt; one may. Cerberus cannot inject further capital into Chrysler.
Porsche has already flexed its muscle at VW. The aggressive plan to increase VW sales is driven by Porsche, which has invested heavily in VW with the specific goal of VW overtaking Toyota in world-wide sales. Porsche’s strategy at VW emphasizes expansion of sales rapidly enough to overtake Toyota. To do that, VW will much more production capacity, soon. The fastest way to get it is to buy it. In North America, the fastest way to do that would be to buy either Chrysler or Ford. Ford is publicly held and acquisition would require a lengthy and expensive tender offer process. Chrysler could be bought with one check payable to one owner.
That owner may soon want to sell. Cerberus cannot pump more money into Chrysler because it doesn’t have it and can’t get it. That means it could be faced with the choice of selling out at a loss now to someone with more funds or holding on, only to be forced later to sell out for even less, or even risk bankruptcy reorganization.
Cerberus does not have a free hand at Chrysler, even though it is the controlling owner. There are still the bondholders. Cerberus borrowed a great deal of money to buy Chrysler, and about half of the bonds issued to buy it are still held by Wall Street investment banks. If Chrysler cannot meet the payments on those loans, those bondholders have legal rights which include taking possession of the Chrysler production facilities. This gives them an ability to exercise enormous control over the company.
Moreover, there is a way for Volkswagen to pull off the acquisition of Chrysler at a bargain basement price.
Volkswagen can simply buy all of those bonds currently held by the investment bankers. Their face value is about $12 billion. But VW could certainly get them for much less. The banks long ago gave up any idea that they’d make money on this deal. Now, they’re just trying to cut their losses, with no luck. Since the Cerberus/Chrysler deal closed, these investment banks have twice attempted to sell off some of their holdings. First it was $10 billion, and then it was $4 billion. There were no takers. A buyer who is willing to purchase something for which there is no market would be in a pretty compelling position.
Holding that much of Chrysler’s debt would give Volkswagen enormous leverage over both Chrysler and Cerberus. Bondholders cannot ordinarily make a credible threat of taking over the production facilities of a carmaker – what would they do with them? VW could. In the event of a default by Chrysler on the bond payments, VW could take over the entire company and know exactly what to do with it. Moreover, the fact that such a high percentage of the company’s debt was owned by VW would likely eliminate any possibility of selling Chrysler to anyone else.
Granted, buying the bonds isn’t buying the company. Cerberus would still own the stock and Nardelli would still be running Chrysler. But, Volkswagen’s influence would be enormous. In the end, it would likely be easier for Cerberus to accept an offer from VW for outright ownership than operate with VW constantly watching over its shoulder as Chrysler’s biggest creditor.