Crisis at Chrysler

Things get worse at Chrysler and this time parent company Daimler may not rule out spinning it off

Business Weekly | by Gail Edmondson and David Welch - - The news is grim enough for Chrysler. A massive pileup of unsold vehicles this year prompted a $1.5 billion third-quarter loss—the third huge earnings bloodbath at Chrysler in six years (see BusinessWeek.com, 10/18/06, "Detroit's Oversupply Problem").

Once again German troubleshooters from parent company DaimlerChrysler's (DCX) headquarters in Stuttgart are shuttling to Auburn Hills, Mich., to analyze its ailing U.S. division. But, unlike in the past, this time there are no assurances by the Germans that Chrysler can be fixed.

Chrysler's swift decline has even raised the possibility that it could be spun off, an option top executives haven't publicly discussed but also did not dismiss. Asked at an Oct. 25 conference call with analysts and reporters whether a spin-off of Chrysler was among possible future options, chief financial officer Bodo Uebber replied, "We won't exclude anything. We are looking at structural changes. We are first doing our analysis. Then we will draw our conclusions."

Future Still Unclear

DaimlerChrysler's revenues for the third quarter declined 8% to $44 billion and its operating profit plunged 50% to $1.1 billion. Losses at Chrysler and aerospace unit EADS will outweigh gains this year at Mercedes and the truck division, forcing group profit down in 2006, Uebber said.

Nearly nine years since the merger of Daimler-Benz and Chrysler, Chrysler has become a chronic source of distress for the group's German top management. Despite billions spent to restructure Chrysler and some modest gains over the past two years, its future prospects remain murky.

The U.S. automaker continues to suffer from anemic sales—down 24% this quarter—an inability to anticipate major market trends such as the shift to fuel-efficient cars, production overcapacity, and erosion of market share. Only 16% of Chrysler's vehicles are fuel-efficient four-cylinder models, compared with an industry average of 37%.

The Cost of Conscience

Chrysler has a raft of passenger cars coming, for instance the just-released Jeep Compass crossover SUV, and soon, the new Chrysler Sebring and Dodge Avenger mid-sized sedans. But with more than 70% of its business in trucks, SUVs, and minivans, Chrysler will have to work hard to establish brand credibility among passenger car buyers, many of whom flock to Japanese and Korean models.

The company suffers from another common Detroit malady: retiree costs. Like rivals General Motors (GM) and Ford (F), Chrysler is paying for legions of retirees who rely on the corporation for their pension and medical benefits. Chrysler pays about $1,400 per vehicle in health-care costs, and the United Auto Workers union has frustrated Daimler CEO Dieter Zetsche and Chrysler chief Tom LaSorda by so far refusing to give them the same concessions on retiree benefits that saved GM $1 billion a year.

Chrysler also has a $22.3 billion pension plan that is underfunded by $1.7 billion. If Chrysler can't make up the shortfall by investing the pension fund's proceeds, it will have to spend more cash to get the plan flush.

"Really Bad News"

Auto industry analysts increasingly question whether Chrysler can escape a troubling pattern of swinging between modest profits in its best years and gushing losses in the worst ones. And that scenario makes it difficult to justify hanging on to Chrysler. "It's early to say the whole thing has to be unraveled, but they cannot keep throwing good money down the drain," says Garel Rhys, professor of automotive economics at the University of Cardiff in Wales.

Chrysler is now expected to lose $1.2 billion in 2006, dragging down group earnings and casting a shadow over a recovery under way at Mercedes Car Group.

Worse, insiders at DaimlerChrysler say Chrysler is likely to post a loss in 2007 as well—an event that could seriously dent Daimler's share price and rekindle ire among institutional investors about the alliance, prompting calls for a spin-off. "If we don't see a visible improvement in 2007 at Chrysler, it's really bad news," says JP Morgan analyst Philippe Houchois.

Uebber and LaSorda, who also participated in the conference call, declined to forecast a recovery for Chrysler in 2007, noting that eight new models in the second half of 2006, and more in 2007 should help rekindle sales. By cutting production, LaSorda aims to bring unsold inventory down to around 500,000 vehicles by yearend. By the end of September, Chrysler's excess inventories were down to 534,000 from a 2006 peak of 580,000.

More Than Muddling

Beyond cutting inventory, management has launched a new initiative dubbed the "Chrysler Group Optimization Program" to study everything from product strategy and fixed costs to manufacturing capacity and quality. Seven corporate S.W.A.T. teams, which aim to slash $1,000 from the cost of building each Chrysler car, are headed by Chrysler executives but receive frequent visits from a group led by Mercedes Chief Operating Officer and restructuring ace Rainer Schmueckle.

"I don't want anyone to think we are sitting here and muddling through," said LaSorda. We are aggressively analyzing the business, including future break-even points if the market goes down."

Chrysler's third-quarter loss implies a loss of $2,600 per vehicle, Morgan Stanley analyst Adam Jonas calculated in a recent report—far greater than the per-unit loss posted at Chrysler in the depth of its crisis in 2000 and 2001. Jones now expects Chrysler to post a loss of more than $1 billion in 2007. "We cannot rule out the risk of even greater losses in 2007," Jonas says.

Guilty of Optimism

If market conditions in the U.S. remain unfavorable and Chrysler suffers another large loss in 2007, Zetsche could be forced to consider a spin-off as early as 2008, insiders say. Chrysler's double profit warning this year is an especially tough blow for Zetsche, who was hailed a year ago as the turnaround ace who fixed Chrysler when he returned from Auburn Hills to take charge of Mercedes Car Group.

A much chastened Zetsche admitted Sept. 19 to the major management blunder this year and took the blame for Chrysler's overly optimistic sales forecasts, which should have been corrected far sooner. Zetsche became CEO of the $190 billion-revenue DaimlerChrysler group on Jan. 1.

At the Paris Auto Show in September, Zetsche reiterated that the target for Chrysler's operating margin remains 5%. "When we can achieve that target is the right question," he said. "More than that, it has to be sustainable."

Back in Action

Zetsche gave the first hint of more radical solutions for Chrysler on Sept. 19 when he said he did not rule out long-term changes to DaimlerChrysler's structure. Uebber's comments on Oct. 25 seemed to confirm that a spin-off is one possible future option (see BusinessWeek.com, 9/19/06, "Turnaround Time at Chrysler—Again?").

As Chrysler veers off track, Mercedes is regaining traction. Zetsche has presided over a recovery at the $63 billion Mercedes Car Group following years of quality problems and a crisis at Smart that triggered large write-downs. Mercedes' operating profit rose 127% to $1.2 billion in the third quarter.

One-third of the profit gains came from increasing sales and higher-priced cars in the mix and two-thirds from cost-cutting. Mercedes is expected to achieve an operating profit of 7% in 2007—returning to its historic role as profit engine. Powerful profits at Mercedes could help Zetsche buy time in pondering Chrysler's future.