3 big questions for Detroit's Big Three
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
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
"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
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
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?"