Can Fiat Pull It Off?

As we wait for GM (GM) to officially declare bankruptcy (see Bondholders Push GM to Brink) and a decision on Opel (Berlin Considers Buyer for GM Unit), I thought I’d share an interesting article from this week’s edition of the Economist on Fiat’s quest to create a global automobile firm (see Marriages Made in Hell).

According to the Economist:

The bold attempt by Sergio Marchionne, chief executive of the Fiat Group, to use the crisis that has overwhelmed Detroit to forge a three-way merger between Fiat Auto (FIATY.PK), Chrysler and General Motors’ European arm, Opel, has been greeted both with admiration (for his chutzpah) and skepticism (about his ability to pull it off). The skeptics say cross-border mergers in the car industry have a poor record and that Mr Marchionne is biting off much more than he can chew.

Assuming Mr Marchionne does get both [Chrysler and Opel] deals done, that is when the hard part will begin. Adam Jonas of Morgan Stanley says that although the three-way combination could make 6m cars and around $100 billion of revenue, he doubts whether it will be able to operate in a fully integrated way like VW (VLKAY.PK) or Toyota (TM) “for perhaps decades”. He also questions Mr Marchionne’s faith in scale, suggesting it is a function of success rather than prerequisite for it and gives warning that even successful mergers bring with them “many hidden cost burdens (financial and non-financial)” and that these can spiral if things do not go well.

The doubts are rooted in experience. With the partial exception of the alliance formed between Renault and Nissan a decade ago, auto-industry mergers usually go wrong and destroy rather than create value.

Personally, I think it is extremely generous to refer to the Renault and Nissan deal as a success. Let’s just say it hasn’t fallen apart, yet. But that is neither here nor there. The real point is that these types of deals generally fail.

The skepticism detailed in the Economist is entirely consistent with the views I expressed several weeks ago in the post Is Fiat Nuts??:

If it weren’t enough that Fiat is trying to expand on the North American front via its alliance with Chrysler (see Now Introducing Fiat/Chrysler), it now seems as if Fiat wants to simultaneously expand its empire closer to home (via an acquisition of Opel)…

Are they nuts??? It is hard enough to pull off one integration the size of Chrysler, but now they are going to try to pull off two? And to top it all off, we’re talking about foreign integrations, where economic, political, and cultural differences compound the complexity. Frankly, I am surprised that Fiat’s board would give Marchionne the approval to simultaneously attempt both deals. A prudent board would counsel Marchionne to eat one cookie at a time, lest he get indigestion. So much for corporate governance.

“From an engineering and industrial point of view, this is a marriage made in heaven,” [Marchionne] was quoted as telling the Financial Times on Monday.

Or [as I put it at the time] an integration made in hell.

The Economist continues:

The corporate troubleshooter [Marchionne], who, since 2004, has been responsible for a highly successful turnaround at Fiat, has reached the conclusion that volume carmakers will in future need to sell at least 5.5m vehicles a year to be viable. With just over 2m sales last year, Fiat is too small to get there on its own. The choice, he believes, is a stark one: Fiat must be either a nimble hunter or wait to be gobbled up by someone else.

I responded to that specious logic with the following:

I just don’t get it. Why the preoccupation with size? I remain unconvinced that largess is a means to success. Just ask Jurgen Schrempp and the folks at Daimler, who ran around spewing the same nonsense about scale and survival before their acquisition of Chrysler.

Size certainly leads to increased revenues, which helps justify exorbitant managerial pay. But given the organizational complexities that go hand in hand with size, size does not always translate into increased profitability.

In order to truly benefit from size, there must exist extremely large economies of scale and scope. Perhaps such economies (the ability to economize on platforms, dealerships, suppliers, etc.) exist in theory in the auto industry. However, the power of the auto unions, coupled with the structural characteristics of the countries in which Fiat, Chrysler, and Opel operate make capturing synergies very difficult.

Fiat will certainly encounter difficulties when trying to capture synergies based upon economies of scale. But the trouble with Marchionne’s logic does not end there.

The fact remains, there is absolutely nothing wrong (from a strategic perspective) with being the hunted instead of the hunter. Lest we forget, managers act in the capacity of agents for shareholders. As such, they have a fiduciary responsibility to maximize shareholder value. If maximizing shareholder value means selling to a high bidder, then so be it. Shareholders generally end up better off in cases where their firm is the target rather than the acquirer. Moreover, looking only to be the hunter can be self-serving on the part of managers - it helps enrich them, allowing them to build empires and become entrenched along the way, while ultimately destroying shareholder value.

If Marchionne is truly interested in acquiring Chrysler and Opel because he believes it is better to be the hunter than the hunted, then we must question his motivation. It could be, as I pointed out in my previous post (Is Fiat Nuts??), that:

Marchionne, aided by a board of directors that he has in his back pocket, is engaging in a form of empire building whereby his own personal interests in building the world’s second largest automaker are taking precedence over the best interests of Fiat’s long-term health and prosperity.

Nevertheless, for those of you interested, I encourage you to read the entire Economist piece. It provides a nice perspective on the proposed three-way deal. That said however, it still came across as if the authors believe that the Fiat/Chrysler/Opel deal makes strategic sense, and that if anyone could pull off such a deal, it is Mr. Marchionne.

I am less sanguine. My stance toward Fiat/Chrysler/Opel therefore remains: Guilty until proven innocent.

Disclosure: No Positions

Comments

[dfalter:]

An integration with Opel would be fairly realistic to pull off. Opel and Fiat operate in more or less the same markets covering a similar range of products, so it's easy to see where synergies would be.

It also so happens to be that the Opel deal is the only deal Fiat is actually willing to commit itself to properly - as in promising to take a majority stake and repay the government funds with the capital of the joint company after a few years.

The Fiat-Chrysler deal looks to me more like a shoot in the dark. Fiat commits no capital whatsoever and only gets a minority stake, so if it happens to work out, they have the potential of increasing their stake and trying to turn it into a proper joint venture. If it doesn't work out, they can just write off the stake they got for free and have no significant loss whatsoever. As such.. it does make a lot of sense to try it for Fiat.. they are getting a chance of entering a new market relatively cheaply at very little risk, if it doesn't work.

You can say many things about Fiat.. but two thing they are definitely not: bad at writing up contracts or crazy. Remember the last time they had an international tie-up, it ended up with GM paying them 2 billions for the privilege of dissolving it. So I'm quite sure they structured the Chrysler deal in such a way that would allow them to extricate themselves from it, if it goes pearshaped.

Such a deal is of course not going to be very advantageous for either the US government or Chrysler, if it fails to work.. but beggars can't be choosers, there was no other bidder available.

May 28 05:46 AM

[dealer 65860:]

Being the hunted doesn't always workout either. Take a
look at the Daimler-Chrysler deal. Chrysler was the
low-cost producer in the US and by most measures the
most profitable of the Big 3 at the time of the merger.
Where are they today?

May 28 08:22 AM

[speculari:]

All of this drama might make a great story for an epic Italian opera but, alas, Donizetti is dead, and I believe this "deal" is deader than the proverbial doornail. Fiat + Chrysler + Opel = 1 full Pitcher of Warm Spit.

May 28 08:53 AM

[developered:]

You seem to have forgotten that Fiat was once owned in part by at least 1 of the big 3. Also that many auto mergers have been very successful.

For example BMW bought Mini and Rolls Royce when they were on their death bed. Since that time they have done very well.

Ford took Jaguar and Land Rover and made them successful and was able to sell them off.

GM bought Vauxhaul and Opel when they were about dead and brought them back to life. Unfortunately GM hasn't managed them as well as others.

Audi bought Lamborgini and has done well

Volkswagon bought Skoda and has done well.

So, my guess is that Fiat/Chrysler might actually do quite well based on what I know of the companies..

May 29 11:29 AM