DaimlerChrysler Deleveraging as Private Equity Ramps Up

Reuters reports that DaimlerChrysler's CFO Bodo Uebber has announced that the company will significantly reduce its use of corporate debt. At a time when private equity group Cerberus is using enormous debt to leverage its commitments to Chrysler, DaimlerChrysler is moving in the exact opposite direction.

Just how much does DaimerChrysler plan to reduce its reliance on commercial paper? Almost completely. The company will not issue bonds "in the quarters ahead". Daimler AG, as the company will be known once the Chrysler sale is complete, is making a strange decision.

The price of corporate debt is quite low and doesn't appear to be rising in the near term. Companies that engage in leveraged buyouts, like Cerberus and KKR, are on a tear making investments in otherwise uninspiring companies based almost entirely on their observation that those companies are under-leveraged.

MBA students around the world have long learned how to calculate the appropriate balance between equity and debt that maximizes the profits of shareholders, yet companies have consistently been far more financially conservative than those calculations suggest they should be. Of course, their are other costs associated with taking on excessive debt that cannot be expressed in purely financial terms. Many wealthy individuals are uncomfortable with taking on significantly more risk by increasing the debt of their businesses.

Still, the rewards of leverage remain clearly visible in the new leveraged buyout firms that are remaking the business world. DaimlerChrysler is making a decision to reduce its risk profile at a time when much of the smart money is betting in the opposite direction. Only time will tell who is right.

Chrysler Buyout Saga Continues

Reuters reports that private equity firm Cerberus Capital Management LP is now DaimlerChrysler AG's preferred buyer for its Chrysler assets. This significant information, from people willing to talk to the Detroit News, suggests a shift in interest from the formerly preferred Magna International, a Canadian auto parts maker. The shift is significant because until recently, one of the primary differences between the competing bids was that Cerberus was willing to give the current management and employees a large ownership stake in the firm. Yet just on Thursday, Magna indicated that it was also willing to make similar concessions.

Since no official announcement has been made, this shift might be only the outward reflection of negotiations that occurred quite a while ago or even a complete fabrication designed to somehow influence the strength of the competing bids.

Nonetheless, one unmistakable view of the shift away from the traditional auto business buyer to a private equity concern is that DaimlerChrysler is responding to the continuing weakness of the American automakers. Private equity has recently taken on the role of buyer of last resort in the larger equity markets, snapping up companies that otherwise look sickly to industry insiders. If the Germans have come to the conclusion that management is sufficiently unable to right the ship at Chrysler, they must see the ability of private equity concerns to create additional value by dramatically increasing the leverage of Chrysler as a big plus.

The important thing to remember is that private equity concerns like Cerberus lack the industry specific knowledge of players like Magna have. They also tend to adopt a decidedly mid-term view, planning to sell the company in about five years. Running an organization the size of Chrysler is less akin to driving a lawnmower and more akin to driving a battleship in terms of its turning radius. It might take five years to turn the business around under the best of circumstances.

Last quarter Chrysler was the only major American automaker to keep its head above water. Ford and GM are in free fall and Toyota is seemingly unstoppable. Yet just a recently as 2005, Toyota recalled more vehicles than it sold. The American auto consumer is a fickle beast and winning today is no guarantee of winning tomorrow.

Are Labor Unions going Extinct?

The NYT reports that the National Labor Relations Board charged that Starbucks, everyone's favorite coffee joint, broke the law 30 times as it tried to discourage union activity at four locations in Manhattan. But the story is not about an evil corporation taking advantage of hapless workers. Rather, the focus of attention is the overwhelming anti-union sentiment at private businesses in general and do-gooder concerns like Starbucks and Whole Foods in particular. Anecdotal evidence seems to suggest that "accusations of union-busting and poor pay" simply don't matter in one of the most liberal cities in America.

Business owners aren't just expressing a mild preference for fewer unions. Whole Foods' CEO John Mackey is extremely hostile to unionization. He has gone so far as to say that unions are "highly unethical and self-interested".

Why is a socially conscious leader like Mackey getting away with being so down on unions? The easy answer is that most people are opposed to unions these days. The last twenty years have witnessed a collapse in organized labor. And if government workers are excluded from calculations, less than 8% of employees belong to a union.

The article credits the trend toward political activism via conspicuous consumption that has brought us such wonders as the Prius and compact fluorescent light bulbs. And while this cultural movement no doubt has some impact, other factors seem more significant. The trend toward the service sector at the broad expense of manufacturing, fewer government restrictions on anti-union efforts, increased competition from abroad, and better market institutions all seem more likely to negatively influence unions more.

But unions will likely be fixtures in certain sectors of the economy for many years to come. For example, Hollywood, grocery stores, and professional sports are all likely to remain highly unionized for the foreseeable future.

The real question mark is the fate of unionized automakers. In a very real sense, the Big Three automakers are tied to unions in a manner their foreign competitors will never be. If GM, Ford, and Chrysler continue to crash and burn while Toyota and the other Asian automakers grow without significant union presence, it could spell the end of unions in their most high-profile instantiation.

Today, things don't look good for the unions.

Kerkorian Takes on Chrysler

Forbes reports that things are really heating up at the Chrysler firesale. Billionaire investor Kirk Kerkorian has offered $4.5 billion for Chrysler. This is significantly less than DaimlerChrysler's hopes of $8 billion but the mere presence of another bidder may force Cerberus and Blackstone to significantly raise their own bids.

The personal drama of Chrysler's crackup and subsequent firesale is really heightened by the addition of Kerkorian. His investment company lost a lawsuit against DaimlerChrysler in 2000 based on his assertion that management duped investors into supporting the merger with Daimler Benz. According to the article, he still has an appeal pending that seems to put the due-diligence probe that typically occurs after a bid of this magnitude underwater before it gets off the ground.

Kerkorian is enormously interested in American carmakers. He invested in General Motors and tried to convince management to form some sort of combination with Nissan and Renault in order to jumpstart growth. He made his personal fortune in other areas - gambling and plastics - but if Kerkorian succeeds in his titanic investments in automakers, he could remake the industrial landscape of America.

Kerkorian is a brilliant investor, but this investment strategy just doesn't look promising. Chrysler is hemoraging cash and marketshare at frightening rates. The company needs a fundamentally different strategy if it is to get more customers into its cars. Ultimately, the increased financial leverage applied under almost any conceivable acquisition of Chrysler may only increase the risk of catastrophic collapse. Lenders with billions of dollars in loans coming due will simply not tolerate continued losses, and the way for any American carmaker to achieve even modest profits is still unclear.

Is a Chrysler Buyout in the Cards?

Bloomberg reports that at least two serious bids have been made for DaimlerChrysler AG's Chrysler unit. One of the bids is from Canada's largest auto-parts supplier and the other is a joint bid by private equity giants Blackstone Group LP and Centerbridge Capital Partners LLC.

Nobody close to the deal is saying what the likely price will be, but $6 billion is a number that has been tossed around by analysts. That's a lot of money considering Chrysler lost $1.5 billion last year. Its market share is also in freefall, dropping to 12.9 percent.

The real story here seems to be that the nine-year-old merger between DaimlerBenz AG and Chrysler Corp has been an unmitigated failure. The Germans were unable to take a struggling Chrysler back to its former glory, in spite of the fact that in most regards Chrysler has been the most vigorous of the Big Three Detroit automakers. This failure is particularly galling in view of the concommittent rise of Toyota. None of the Detroit automakers has been able to avoid enormous losses and even most foreign automakers like Honda are really just treading water. Only Toyota has moved to significantly increase its marketshare while remaining profitable.

The global auto industry is definitely a growth business worldwide over the next few decades. None of the Detroit automakers looks particularly well leveraged to take advantage of the rise of a new consumer class around the world. American management has failed spectacularly to lead the way and our German friends likewise appear stumped. Canada's largest auto-parts supplier looks to be doubling down and maybe that's their only hope to keep their jobs, but if I were one of those private equity concerns I'd rather invest in the only auto company worldwide with proven leadership - Toyota.