Daimler minus Chrysler = Very Expensive Relief
Did anyone read the DaimlerChrylser Investor Relations (Press) Release published on the DaimlerChrysler website on Monday? The title of the IR is: "Cerberus takes over majority interest in Chrysler Group and related financial services business for €5.5 billion ($7.4 billion) from DaimlerChrysler".
The headline should have been: "DailmerChrysler pays US private equity group Cerberus Capital Management LP €1.15 billion to take Chrysler off its books".
I want to walk you through the exact wording of the press release and then interpret it for you.
Here's the basic structure of the transaction: A new entity, Chrysler Holding LLC, will be formed by Cerberus Capital Management, LP and DaimlerChrysler AG. Cerberus will make a capital contribution of €5.5 billion to the new entity in return for 80.1% equity interest. DaimlerChrysler will hold a 19.9% equity interest in Chrysler Holding LLC.
Why 80.1% divested? That's a legal and accounting move. In order for Daimler to get rid of the unfunded pension liability from its financial statements, it has to own less than 20%. If it owned 20% or more, it would still be required to recognize its prorated portion of Chrysler's liabilities. The Germans want to distance themselves from the albatross of Chrysler. Do you blame them?
DaimlerChrysler AG will transfer the industrial business of the Chrysler Group to Chrysler Holding LLC in the form of two new entities: Chrysler Corporation LLC and Chrysler Financial Services LLC. Chrysler Holding LLC will own 100% of these new entities.
The press release says that of the €5.5 billion "purchase price", €3.7 billion will be contributed to the capital of the new Chrysler Corporation LLC to "shore up" the capital base of the industrial business and €800 million will go to strengthen the equity base of the Chrysler Financial Services LLC. The remaining €1 billion will be distributed to DCX.
Definition of an LLC: An LLC is a limited liability company. It is a pass-through entity like a partnership but it has the legal protection of a corporation. Owners of an interest in an LLC are called "members" (not partners) and a member can be any form of entity from another LLC to a foreign corporation to an individual.
LLCs do not pay income taxes. They pass through profit or loss to the members. Eventually someone or some entity reports the income or loss on a tax return.
Corporations use LLCs to pass through income or loss to entities that can absorb the income to avoid taxes. For example, if Chrysler Corporation LLC loses money, its losses flow to Chrysler Holding LLC, another pass-through entity. Chrysler Holding LLC will pass its losses to its members -- Cerberus and a US holding entity owned by Daimler AG. Daimler AG will use the losses to offset profit from its US Mercedes-Benz car unit. The US government and the US taxpayers will be the loser in this transaction as the losses from Chrysler over the next few years will likely wipe out the US profit of Daimler's US Mercedes-Benz car unit.
But DCX won't keep any of that €1 billion! First, DCX will grant a loan of €300 million to Chrysler Corporation LLC. There is no detail given at to the terms of that loan or its expected repayment date (if ever).
Next, the press release states that the transaction is scheduled to close in the third quarter of 2007 and that during that time, the Chrysler Group is expected to have negative cash flow of €1.2 billion -- all of which is born by DCX.
Let's do some math.
|
1. Net cash distributed to DCX:
|
€1.0 billion
|
| 2. New Loan to Chrysler Corporation LLC |
[€0.3 billion]
|
| 3. Negative cash flow to closing |
[€1.2 billion]
|
| Net cash OUTFLOW (according to DCX) |
€0.5 billion
|
But I don't think the "cash outflow" stops there.
According to the agreement, DCX will transfer all the assets of the Chrysler Group to their new holding entities free of debt. Short term accounts payable aren't part of what is defined as "debt" -- only long-term liabilities are considered "debt".
The press release states that this will result in "prepayment compensation" of approximately €650 million. Ha ha ha ha! Prepayment compensation? That's a nice way of saying that DCX is paying Cerberus to take this mess of its hands!
Oh, and how about this line: "The usual transaction costs will also be incurred." That means the lawyers, accountants and investment bankers all get paid huge fees to make this happen. There is no disclosure as to how much DCX will pay to these consultants; but you can be sure that "fees" will easily exceed €100 million.
So as I read the press release, the transaction will cost DCX more than €500 million:
| 1. Net Cash Outflow -- Per DCX |
€0.500 billion
|
| 2. Prepayment Compensation (Payment of long-term liabilities) |
€0.650 billion
|
| Total Cash Outflow (according to me) |
€1.150 billion
|
The assumed dollar/Euro exchange rage in the press release is €1 = $1.35. That means this transaction will cost DCX around $1.553 billion plus professional fees. Cerberus, a US-based private equity group will, in effect, be paid more than $1.5 billion to take 80.1% of the Chrysler Group, once valued at more than $30 billion (80% of $36 billion), off the hands of the Germans.
What does all this mean to Cerberus? Recall that of the original €5.5 billion "sales price", €4.5 billion was a direct equity investment in the new, debt-free Chrysler Group rather than direct compensation to DCX and its shareholders. So that payment directly benefits Cerberus' investment.
By its own admission, Cerberus will transfer only €1 billion to DCX. However, that wasn't cheap enough for Cerberus. DCX desperately wanted to eliminate all liabilities with respect to Chrysler and Cerberus was happy to let the Germans foot the bill. Accordingly, the deal is to be "debt free" -- that is free of long-term debt. At no cost to Cerberus, DCX agreed to pay off all long-term debt related to the transferred automotive and financial services businesses -- a whopping €650 million -- and pay all transaction costs related to this debt relief.
And if that wasn't good enough to sweeten the deal to ditch Chrysler, at the time of closing, the new Daimler will immediately loan Cerberus (not a cash poor company) €300 million for the continuing money-losing operations of the (debt-free) Chrysler Group. As far as I can tell, Cerberus only had to let go of €50 million and got way more than that in terms of loans, debt reduction, hard assets, enhanced equity and brand value. The Jeep brand alone is probably worth more than its €4.5 billion direct equity investment.
Here are some more interesting factoids:
1. As soon as the transaction closes, in the fall of 2007, DaimlerChrysler AG will change its name to Daimler AG. [Too bad it won't go back to Daimler Benz AG -- I liked the old name better!]
2. Daimler expects the new Sprinter work van to enjoy continued success in the US market. The press release is silent as to how this will happen; however it's implied that the Sprinter will continue to be manufactured by the Mercedes van group and distributed and sold through Dodge dealers in the US. That's good news for Dodge dealers.
3. Since 2002, DaimlerChrysler has invested more than €7.4 billion ($10 billion) in new production facilities and technologies. [Apparently these investments have little or no value as there is no payment to DCX for these investments.]
4. Since 2001, Chrysler has introduced 34 new models. [Who knew?]
5. DCX says that its financial obligations for the Chrysler Group pension and healthcare benefit plans are "significantly over-funded" at the present time. Those plans (and their future obligations) will remain with the new Chrysler Group. [This is interesting. The press release doesn't say just how over-funded these obligations are. This is another way to transfer cash and other assets to Cerberus without any compensation to DCX shareholders.]
6. Daimler and Chrysler will continue to jointly develop conventional and alternative (hybrid) drive systems. The separate companies will also work together for purchasing, sales and financial services outside the NAFTA region. Such "mutual benefits" are one proclaimed reason for Daimler retaining a 19.9% interest in Chrysler.
The business community is spinning this transaction as a big gamble for Cerberus due to the long-term unfunded pension obligations estimated at $18 billion. However, what they don't focus on is that these costs don't exist on the books of Chrysler; it's a footnote to the financial statements. These unfunded costs are directly related to future pension and healthcare benefits costs. It's widely expected that Chrysler's new owners will do everything possible to dramatically reduce these future obligations. That will mean major concessions by the United Auto Workers.
Here's my spin: Cerberus will expect current workers and both current and future retirees to shoulder most of the burden of reducing costs. As we learned in February, Chrysler is cutting at least 13,000 UAW jobs from its shrinking North American operations. I expect that number to increase as costs are cut further.
It's no secret that the first thing that happens in any American-style take over is for employees to be fired and pensions terminated. I also think that the UAW will eventually do what it should have done many years ago and give wage and job concessions. This time around however, the UAW won't have much leverage with management. And new management won't be worried about the short-term effect of a strike. Frankly, if the UAW were to strike Chrysler, it would be a while before the products pipeline would empty as the inventory is so high!
If management can get new and desirable product on showroom floors, Chrysler will enjoy growth and profit again. Cerberus will need to bring some talented management into play here. And perhaps that's the role of new board member Wolfgang Bernhard. He knows the company and certainly had a role in the development of the Chrysler Group's last hit products -- the Chrysler 300 and Dodge Magnum -- when he was Chief Operating Officer. But we are told that he isn't going to be an executive, just a board member. Hmmm... Who is going to kick start the development new, desirable product? I'm sure we will learn more over the summer as the sale comes to a completion.
