The battered auto sector has become a hotbed of private equity investments; buying hot rods or lemons?
By Chris Isidore, CNNMoney.com senior writer
April 12 2007: 2:00 PM EDT
NEW YORK (CNNMoney.com) -- It's a sector facing staggering global competition, expensive union contracts, fickle consumer tastes and a looming burden of tougher environmental regulation.
It's a cyclical industry that's rarely produced great returns.
So the last place you might expect to find smart-money private equity investors sniffing around is the auto industry.
But there they are. There's a ton of interest in the sector right now, with many of the nation's top private equity firms looking not only at Chrysler Group, put up for sale by its parent, DaimlerChrysler (Charts), but also at auto parts makers such as Delphi and Lear.
DaimlerChrysler executives are reportedly ready to meet with officials from some of the nation's top private equity firms, including Blackstone Group and Centerbridge Capital Partners, which are teaming on a bid, as well as Cerberus Capital Management.
Canadian investment firm Onex Corp. and Canadian auto parts maker Magna International (Charts) are also reportedly talking about a joint bid, and some reports have private equity firm Ripplewood Holdings joining that effort.
And last week financier Kirk Kerkorian announced a $4.5 billion bid for Chrysler, saying he wanted to team with the union and Chrysler management to give them equity in the automaker in return for cutting labor costs.
Despite all those efforts, private equity's interest in Chrysler is almost modest compared to the push in auto parts. Management of auto parts maker Lear (Charts) has accepted a $36-a-share cash offer from financier Carl Icahn, although shareholders still have to consider the bid, which values the company at slightly below market price.
Wilbur Ross, who did well buying up bankrupt and troubled steelmakers, has moved on to buying up parts makers. And Cerberus, Appaloosa Management and Harbinger Capital Partners Master Fund are among the private equity groups that have pledged $3.4 billion in new financing to bankrupt parts maker Delphi, contingent on it reaching new labor deals with its unions.
The private equity buyers are basically betting they're buying on the cheap, and that either the break-up value of the companies or better times ahead will help them earn a relatively quick return on their money.
Whether that bet will pay off, though, is a subject of some debate.
Some industry experts think that this is a good time for private equity to be climbing behind the wheel.
"The assets involved are relatively inexpensive," said David Cole, chairman of the Center for Automotive Research. "The timing is right."
For Chrysler, Cole says he thinks the company, along with rivals General Motors (Charts) and Ford Motor (Charts), will soon win significant cost savings from the United Auto Workers union when their current contracts expire in September. For the auto parts makers, many have already won cost savings and now stand to benefit as their customers trim the number of suppliers they use.
"Things will soon restructure to the point where they're profitable," said Cole. "The private equity guys see this happening. That tells them this is the time to move, before it becomes obvious. Sometimes they guess wrong, but I don't think they are."
But other experts say there's still plenty of risk involved for buyers kicking the tires.
Kevin Tynan, auto analyst with Argus Research, said while he thinks the auto parts sector has some bargains, he's got doubts about whether Chrysler can be turned around. He thinks the only way Chrysler makes sense for private equity buyers is if they break up the company to sell off the more valuable parts, such as the Jeep brand or the company's state-of-the-art vehicle design center.
"The parts of the company are probably worth more split up than there is an upside potential of trying to resurrect all three brands," he said, referring to Chrysler, Dodge and Jeep. "To fix it, you are being asked to do a lot on both the product side and the cost side. To execute both of those things, I'm not sure it can be done."
Tynan said he doesn't believe Chrysler or any Detroit automakers, for that matter, will get nearly enough from the United Auto Workers on health care costs and flexibility that they need to compete with Toyota (Charts) and other Asian automakers.
"Where they need to be and where the union will be willing to go in terms of concessions, I don't think there's a happy medium between the two points," said Tynan. "I'm not sure they can afford a strike, so I don't know if they can push that hard to get what they need."
But Cole believes union leadership recognizes that concessions are needed, even if they're unpopular with the rank-and-file. He's expecting some kind of deal to cut much of the high costs hanging over the Big Three. "The union cannot afford to take anyone down. They'd be taking themselves down at the same time," said Cole. "The equity bidders knows that."
Erich Merkle, director of forecasting at IRN Inc., an automotive consulting firm serving suppliers and investment firms, among others, said he doesn't think the outlook is as tough as it appears.
He said that if the winning bid is less than $5 billion "that's buying Chrysler at a pretty deep discount.
"Things are not as bad as the Germans would make them appear," he said. "When you look at where they are today and where they'll be 12 to 24 months from now with the new product they have in the pipeline, I think it's crazy for them to unload Chrysler at this point. I certainly think the UAW will have to give something in terms of concessions."
Merkle said he thinks it's possible DaimlerChrysler will decide that none of the bids for Chrysler provide a fair return on its $37 billion purchase, and that it will decide to hang on to the unit it bought in 1998. But others believe a sale is inevitable.
"I think Daimler wants Chrysler to be gone," said Cole. "It's pretty easy to split apart. That means the assets might be available at a lower cost."
