Magna should pass on Chrysler

Apr 16, 2007 02:30 AM |

David Olive One of the few sources of unqualified support for the potential tie-up of Magna International Inc. and troubled automaker Chrysler Group is Linda Hasenfratz. The CEO of Linamar Corp., a Guelph-based auto-parts maker that operates in the shadow of its larger rival, hinted in a television interview last Thursday that she anticipates exploiting the turmoil that Magna is certain to endure as it copes with what it has bought.

CEO Frank Stronach's straightforward motive is to protect the 15 per cent of Magna revenues derived from Chrysler by playing a part-ownership role in its future. Stronach hasn't met the venture he hasn't believed he could handle, from short-lived dalliances with restaurants and magazine publishing; stillborn initiatives like a luxury airline and a huge theme park in his native Austria; and a string of racetracks, Magna Entertainment Corp. (MEC), that has lost close to $200 million (U.S.) in the past two years.

Yet "it's hard to imagine that Magna can manage a company so much larger than itself and its own business at the same time," investment banker Douglas McIntyre wrote on his AOL Money & Finance blog last Friday, the day Magna confirmed its interest in playing a role in Chrysler's rescue. With sales estimated at more than $70 billion, Chrysler is more than three times the size of Magna.

Without Stronach's eclectic mind, there would be no Magna – one of the world's largest auto-parts firms, and the first to master complete vehicle assembly, which it does for Chrysler, Mercedes and BMW AG, among others. But this is one opportunity begging to be passed up.

# Damaged goods. Walter Percy Chrysler's firm has flirted with ruin perhaps more often than any other major automaker. If Lee Iacocca's turnaround couldn't stick, and the $200 billion (U.S. sales) DaimlerChrysler AG – one of the world's oldest and largest vehicle manufacturers – couldn't fix the No. 3 North American automaker after a nine-year effort, what realistic shot does Magna have?

Magna has no experience in consumer preferences, marketing, vehicle financing or dealer relations. Neither do the proposed financial partners in a Chrysler acquisition with which Magna is most frequently linked, the Toronto-based merchant banker Onex Corp. and Ripplewood Holdings. Nor do any of the other three potential bidders, all buyout firms like Onex and Ripplewood, in itself a powerful statement about Chrysler's parlous condition. There are about two dozen major Western automakers, and not one of them will be among the three potential buyers meeting with DaimlerChrysler executives in New York this Thursday for a scheduled negotiating session.

There is no market segment that Chrysler dominates. After two restructurings under DaimlerChrysler, the most recent of which seeks to eliminate 13,000 jobs, a cost-bloated Chrysler is still in need of another rough pruning. The firm suffered an operating loss of $1.5 billion last year – which, by coincidence, is the sum total of Magna's cash hoard. Chrysler's unit sales slipped another 4 per cent in the first quarter, due in part to buyer uncertainty about Chrysler's future.

Chrysler has been one of the great wealth destroyers of all time. Purchased by the then-Daimler-Benz AG in 1988 for $36 billion, it is expected to fetch no more than $6 billion. The Stuttgart-based DaimlerChrysler signaled its willingness in February to end its foray in North American mass-market vehicles under pressure from its shareholders. They are convinced that, like Studebaker, American Motors and Britain's Rover Group, Chrysler is circling the drain and that no amount of genius, sweat and luck will save it.

# The looming import threat. A poor third in North America, its only substantial market, Chrysler is behind the curve on fuel-efficient technology. And it is increasingly bested in small-car marketing by General Motors Corp., Toyota Motor Corp., Honda Motor Co. and Hyundai Motor Co. – not a good state of affairs when your traditional strength is the low-price end of the market.

And on the horizon is the next wave of interlopers, from China and India, whose automakers already are using Eastern Europe, Africa and the Middle East as a testing ground for an assault on North America. China imposes stricter fuel-economy standards than does the United States on domestic automakers. And 80 per cent of India's annual output of 1 million vehicles are tiny fuel-sippers designed for congested urban areas – likely to be one of North America's fastest-growing segments by 2012. The ultra-low production costs of these newcomers, which enable Indian manufacturer Maruti to offer its flagship Alto model at $4,500, will be a challenge even for lean producers like Toyota and Honda, but a nightmare for high-cost makers like Chrysler.

# Backseat driver. Joint ventures are tough to manage at the best of times, never more so than when you're the caboose on the train, where Magna would find itself in a Chrysler rescue. Magna's buyout partner or partners would raise most of the takeover funds. And so they would call the tune. That's a problem, since conflicting agendas would abound.

Strictly speaking, any Chrysler deal would not be an acquisition but a financial restructuring, in which the buyout firms haggle with Stuttgart about how to apportion Chrysler's $15 billion in unfunded pension liabilities, among other burdens. Magna is along for the ride given its expertise in running plants. It would have no substantive role in the dealmaking.

The preoccupation of the buyout firms kicking the tires at Chrysler is to extract a quick return on their investment. That would require dropping slow-selling models, closing plants, further payroll reductions and selling assets. Chrysler would be loaded up with debt to make the deal as self-financing as possible, starving the firm of funding for R&D and new-product development.

Part of the brutal streamlining would be a reduction of Chrysler's parts orders, as well as pressure from Chrysler on its suppliers to cut their prices. That works against Magna's principal goal of protecting its Chrysler-related revenues.

As the junior partner, the one putting the least money in the pot, Magna would also have to accept second-guessing from its financial partner or partners on everything from proposed model line-ups to the size of factory and dealer networks. Naturally that would apply to another of Stronach's longstanding vanity projects, his desire to get a Magna-designed vehicle into production.

Stronach's goodwill in seeking to restore Chrysler's health is genuine. Building, and not asset-stripping, has been his lifelong M.O. Not so the buyout firms, which will have the deciding voice in Chrysler's fate and whose fixation is with exit strategies.

"Does anyone really expect Blackstone Group, Centerbridge Capital Partners or Cerberus Capital Management to rebuild Chrysler and run it for the long term?" veteran U.S. auto-industry observer Alex Taylor III wrote in his blog last week. "Not when they can sell it and reap 20 per cent of the profits for themselves."

# Overtaxed. Longtime Stronach friend Dennis Mills, a former MP who has put in many stints at Stronach companies, has watched Stronach agonize over the stalled progress of the comparatively small MEC, which has run into balky gaming regulators at almost every turn since its inception, and failed to retain any of its CEOs for more than two years.

At 74, does Stronach really want to take on the almost insurmountable woes of Chrysler, refereeing disputes among its suppliers and dealers; becalming Magna clients such as GM, Toyota, Ford Motor Co. and other Chrysler rivals; and ceding autonomy to a buyout firm? And at the same time continuing to oversee one of the world's largest auto-parts firms at a time when two of Magna's other biggest clients, GM and Ford, are in rough shape? And all the while struggling to transform his Pimlico and Santa Anita racetracks into "family entertainment centres"?

There is another option, which is to just walk away. Let someone else slice-and-dice Chrysler, off-loading its lucrative minivan and Jeep franchises – to which Magna would continue to be a supplier. And selling its modern Brampton vehicle-assembly operation to Toyota or another transplant in need of additional North American capacity. Let buyout pros more experienced with organized labour than Stronach wring concessions out of the United Auto Workers and the Canadian Auto Workers, and take on the politically charged process of downsizing a dealer network that needs to be cut by about one-third.

Ideally, the industrial legacy inherited by the Stronach children, Belinda and Andy, will be a robust auto-parts maker which, like Linamar, can feast on the woes of the half-dozen or so North American auto-parts makers that have hit the wall in recent years.

With the loss of some, but not all, of its Chrysler business, Magna will have that much more incentive to exploit its formidable talent at designing innovative parts and hyper-efficient, state-of-the-art factories; building on its recent Russian joint-venture success in exploiting new geographic markets; and snapping up rival parts makers at distress prices. The choice seems starkly clear: Leave behind a global auto-parts supplier of reliable and growing profitability, or an untested hybrid almost certain to be a drain on cash.

Before her announcement last week that she will soon quit politics to rejoin Magna as executive vice-president, Belinda Stronach held the shadow-cabinet post of Liberal competitiveness critic. If Belinda really does understand the virtue of playing to one's strengths, and if Frank Stronach is serious about granting his daughter a measure of real authority at Magna, the deciding vote in avoiding the potential ruination of Magna might well be cast by her.