3 big questions for Detroit's Big Three

3 big questions for Detroit's Big Three http://money.cnn.com/2007/05/15/news/companies/chrysler_questions/index.htm?postversion 07051513
NEW YORK (CNNMoney.com) -- Despite this week's big bet by a big private
equity firm that it can turn around Chrysler, major questions remain for the troubled automaker - and the answers could shape the nation's auto industry for years to come.
DaimlerChrysler (Charts) announced Monday it would pay about $650 million to dump 80 percent of its money-losing Chrysler unit, undoing the industry's most expensive and least successful merger. The buyer, private equity firm Cerberus Capital Management, is investing about $7.4 billion in all, but most of that is new financing for Chrysler and its finance arm going forward.
Daimler was willing to pay to walk away from Chrysler because it wanted to end its exposure to the automaker's massive losses - and future retiree health care costs estimated at $18 billion. The extent of the losses came into clear focus Tuesday when Chrysler reported a loss of about $2 billion for the first quarter, compared with earnings of $857 million a year earlier.
The first-quarter loss topped the $1.5 billion Chrysler lost for all of 2006. Those numbers were reported on Feb. 14, Valentine's Day, when Chrysler also sent a love letter to its employees, announcing plans to cut 13,000 jobs and close several North American plants. That was also the day DaimlerChrysler put Chrysler Group up for sale.
The charges from the cuts amounted to $1.2 billion in the first quarter. But that leaves another $800 million in operating losses, from weak sales and stiff competition from the likes of Toyota (Charts) and Honda (Charts) as well as Chrysler's cross-town rivals in Detroit, General Motors (Charts, Fortune 500) and Ford (Charts, Fortune 500).
All of which gives rise to the first and most important question facing the U.S. auto industry. When will auto losses end?
Of course Chrysler isn't the only U.S. automaker that's bleeding.
GM, despite record global sales, reported another loss in its core North American auto operations in the first quarter. Ford's loss in autos in North America jumped 39 percent to $614 million in the first quarter, and the automaker doesn't expect a return to profitability in North America until 2009.
All three automakers are still working on the difficult, expensive job of cutting capacity. But growing competition, record gas prices and the changing tastes of American consumers - who are back to buying cars rather than the pickups and SUVs that Detroit lived on for years - will make it tough for the automakers just to break even - though breaking even won't be enough.
"They scrape by year after year and are not building up the type of profits to invest in the new products they need," said Bob Schnorbus, chief economist for J.D. Power & Associates, the auto research and consulting firm.
Many experts say they fear that even if none of the automakers are facing the kind of immediate crisis that prompted worries about a bankruptcy filing at GM only a year ago, they are all facing the death of a thousand cuts unless they can overhaul the business of making and selling cars.
"I still believe that there is going to have to be a real rationalization of the industry," said Kevin Tynan, auto analysts for Argus Research. "It has to be more serious than every few years closing some plants here and there. It has to be torn down much further."
And the biggest change Tynan and some other analysts are looking for is on the huge costs from benefits promised to employees and retirees such as pension and especially health care. That leads to the second big question for the auto industry: Will the union agree to big changes?
All three automakers have labor contracts with the United Auto Workers union that run through September. The union hasn't been opposed to granting the automakers some concessions. Both GM and Ford won unusual mid-contract changes to their retiree health plans that are already saving them billions.
But union leaders face rank-and-file members who oppose more givebacks, and the UAW has so far refused to grant Chrysler the savings it's granted GM and Ford, putting Chrysler at about a disadvantage that amounts to about $600 a vehicle.
And even with the changes from the union, GM and Ford still have a competitive disadvantage compared to nonunion rivals like Toyota and Honda. And GM agreed to let the current retiree health care deal run past September, so it's unclear how much more savings it will be able to win there.
While analysts agree that big changes needed, many say it's way too soon if the companies will get what they need.
"Now is the time for a very serious hard look at the competitive structure," said Schnorbus. "My fear is they'll only get the minimum amount necessary to get them through the next contract, that it will be a more marginal gain than the jump they need to get on a competitive footing. But until we get into negotiations and see how cooperative the unions will be, it's impossible to say."
The union faces big risks too. More jobs will be lost if the automakers can't get competitive. And there fears that the purchase of Chrysler by a private equity firm will lead to more cuts and plant closings down the road. Which raises the third important question. Who ends up with who?
While Cerberus Capital Chairman John Snow talked about how his private equity firm could take a longer-term perspective than a public company, it's also true that private equity firms rarely hang onto their investments for too many years. They're interested in buying distressed companies, making changes, and then selling for profits, often a piece a time.
Many in the industry say that at Chrysler, the world-famous Jeep line will be sold to a rival, perhaps GM, and quickly.
Others look at last summer's failed talks by the Nissan-Renault alliance to join with GM and say the two overseas automakers run by Carlos Ghosn could get into the U.S. market, and gain critical mass, by buying all or part of Chrysler.
"I think Chrysler is going to have to have a partner who builds the same kind of cars and trucks," said David Cole, chairman of the Center for Auto Research. "But does Jeep get sold off, who buys it all or the rest, those are all good questions at this point."
Some question the common wisdom that splitting up Chrysler makes the most sense when Cerberus looks to sell at a profit.
"Breaking up Chrysler would be easy on paper, but it's really an integrated operation," said David Healy, auto analyst with Burnham Securities. "It would be an unwieldy type of thing to do and who wants the bad parts?"

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