Fiat Chrysler Can't Find a Buyer for Itself or Its CEO's Big Idea

NEW YORK ( TheDeal) -- Left for dead in 2008, Chrysler and its Euro-American parent are now hailed as one of the great success stories to come out of the Great Recession. So why is the company's CEO trying so hard to sell the automaker?

Fiat Chrysler Automobiles NV (FCAU), the London-based company formed by the rescue merger of Chrysler by Italy's Fiat Group, has been a sales beast in recent years. The company has increased its U.S. market share by more than 3% in the last four years and has seen its New York Stock Exchange-listed shares double in the last 12 months.

Diminutive Chrysler was largely an afterthought as the government raced to save General Motors  (GM) in 2008, with many industry watchers at the time expecting the White House to either combine it with GM or let it fail instead of pouring billions into the brand. The automaker's rebound is largely thanks to the vision of CEO Sergio Marchionne, the one-time Fiat head who championed a deal between the two mid-sized automakers and has overseen the turnaround.

Marchionne is not resting on his laurels. The executive has long been one of the industry's most outspoken advocates of consolidation, and according to auto industry sources, hopes to do a capstone deal before stepping down in 2019.

The executive came out swinging during the company's quarterly earnings call April 29, reviewing a 25-page report titled "Confessions of a Capital Junkie" that outlined the issues facing the auto industry and made the case for M&A. Marchionne earlier this month described the sector as "lethargic and unwilling to change."

The auto business needs combinations, according to the report, because of the tremendous capex and research spending required to meet emissions and safety regulations while improving the car connectivity and cockpit experience. The industry as a whole invests its entire enterprise value in product development every four years, according to Fiat, compared to an average of 20 years across all industries.

Top auto manufacturers, according to Fiat Chrysler, spent more than €100 billion on product development in 2014 alone. The result, the company said, is returns that lag well below aerospace, chemicals, packaging firms and other industrial segments.

So far, however, Marchionne's calls for consolidation have fallen on deaf ears. For Fiat Chrysler shareholders, the question is whether the lack of enthusiasm about M&A is because other executives aren't as visionary as Marchionne, or rather because Fiat Chrysler needs a deal more than the industry does.

Fiat Chrysler, despite its gains, remains a relative runt in the global auto business and is in need of a tune up. The company has made strides in paying down its debt but still is highly leveraged relative to its rivals and still suffers from performance issues and overcapacity in Europe -- especially in its home Italy market. As Fiat Chrysler notes, with automobiles becoming more technically advanced, there are increasing demands for cash and scale to invest in innovation and emissions reduction, giving a clear advantage to the world's market leaders.

Fiat Chrysler also faces oversized cash demands to refresh and redesign its brands, as well as to invest in restructuring its Alfa Romeo unit and to build the group's trailing presence in Asia. In the U.S., sales are up but Chrysler has taken some recent PR punches: It's vice president of quality resigned last October after Consumer Reports concluded that reliability at the company was on the decline, and Fiat Chrysler brands accounted for four of the bottom nine in J.D. Power and Associates' recent U.S. vehicle dependability study.

Marchionne has set aggressive growth targets, hoping to hit 7 million vehicle sales in 2018 compared to 4.35 million in 2013. Such growth seems unlikely without a deal or aggressive discounting that would cut into already lagging profit margins.

Morgan Stanley's Adam Jonas says Marchionne's desire to do a deal reflects "pure audacity, or just a very clear sense of industrial reality." Either way, he encourages other automakers to take the executive's warnings seriously.

"Sergio is the type of CEO who will show up to the Detroit auto show and present to a roomful of analysts and media on how difficult it is to achieve his cost of capital in the auto industry and how the current competitive landscape and number of players is unsustainable," Jonas wrote in a recent note. What Fiat Chrysler lacks in terms of balance sheet strength "we believe it more than makes up for in urgency, speed, adaption of the model to reposition the industrial footprint of the house at a critical time," Jonas concluded.

But while much of the industry would privately echo Marchionne's plea for reduced global capacity and stronger balance sheets, few appear likely to want to merge with Fiat. GM chief executive Mary Barra used her company's recent earnings call to talk down dealmaking, saying the automaker has a "very comprehensive plan" into the next decade and "we're not going to entertain anything that distracts us."

Ford president for the Americas Joe Hinrichs meanwhile said, "we're very happy with where we are" and that Ford does not need a partner.

The problem for Marchionne is that much of what his company has to offer is similar to what potential buyers already have. While there would be some advantages in combining Fiat and Chrysler with existing nameplates, such a move would come with huge labor and regulatory headaches that could easily outweigh whatever synergies can be achieved.

"The primary reasons to buy them are to acquire Jeep, and to slash and burn," one transport banker said. "Most automakers would love to have Jeep, but not enough to pay up for the headaches that would go along with a deal."

It's worth noting that GM and Fiat were partners barely a decade ago, with General Motors in 2000 buying a 20% stake in the Italian automaker. GM paid $2 billion in 2005 to void a clause in that deal that would have forced it to acquire the rest of the company.

Outside of Detroit, Marchionne and Fiat could turn to Volkswagen AG, a company that would benefit from Chrysler's North American operations and its SUV expertise. But such a combination -- which would easily rank as the world's largest automaker -- would create significant regulatory tension in Europe, and would have to streamline a portfolio of nearly two dozen brands. And it would also likely require significant divestitures in South America.

It seems more likely Fiat Chrysler will have to settle for partnering with a fellow second-tier company like Peugeot-Citroen Group, which similar to Fiat and Chrysler has struggled and is in need of streamlining. Another option would be to look to Japan and acquire Mazda Motor, a one-time Ford partner now on its own. Such a deal would help Fiat Chrysler cut costs or expand its geography, but would not vault the company into the ranks of the world's largest.

Some industry watchers believe most other automakers would avoid a combination with Fiat Chrysler because executives at those companies are skeptical about the automaker's turnaround. Fiat Chrysler has long been accused of boosting sales, and doubters note that the company's results have not matched its rivals'.

Sanford C. Bernstein & Co. analyst Max Warburton earlier this month wrote that Fiat Chrysler's 4% profit margin is about half of what GM generates and one-third that of Ford, the result of and uptick in hiring and heavy investments in retooling factories that were left to age while both Fiat and Chrysler struggled.

Warburton also said Fiat Chrysler appears to have been "uniquely aggressive with incentives" -- sometimes using methods that do not appear obvious in incentive data -- and warned that if the company can't find a way to generate solid margins now while demand is strong, it could suffer significant losses when the cycle inevitably turns. Chrysler dealers in the U.S. have said that the automaker has pushed harder than its rivals on programs designed to boost sales, helping Chrysler to a five-year run of monthly year-over-year sales increases.
 

Chrysler officials have denied suggestions the company is pricing aggressively to gain share, saying that it is primarily discounting nameplates that are due a redesign. Chrysler, during the recession, cut back spending on product development, but the company believes that as new designs roll off the assembly line its margins will improve.

Fiat Chrysler in its report stressed that it is making its case for consolidation not to put itself on the block, and insists that a merger is not "a matter of life or death" for the company. But the automaker and its leader are clearly looking in that direction.

One of Marchionne's favorite lines of late is to explain why, in his view, Fiat Chrysler has been unable to bring another company to the table. "One of the most difficult things to do is to get the turkey to invite himself to Thanksgiving dinner," the executive said earlier this month at the company's Amsterdam shareholders meeting.

But make no mistake: Sergio Marchionne and Fiat Chrysler are hungry.

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