Diversion stuns Chrysler

The $22bn bid for the car-maker may prove hard to finance and be badly timed. William Kay in London and David Usborne in New York explain why
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IN RECENT months, the folks at Chrysler have been all but deafened by praise. "The parade keeps coming," the chairman, Robert Eaton, observed to journalists in January as he looked back at 1994 - the company's best year ever. Even the Japanese were impressed. They had disassembled Chrysler's newest small saloon, the Neon, to understand what innovations had been used to put it together.

Arguably, however, the biggest accolade of all came last week with the stunning bid for the company by Kirk Kerkorian, the billionaire investor who already has 10 per cent of Chrys- ler's stock. By offering $55 (£34) a share for the company, Mr Kerkorian was declaring his belief that the company was grossly undervalued by the stock market. At close of trading on Tuesday, immediately before the announcement, Chrysler stock was priced at just $39.25.

The compliment has not, however, been taken kindly at Chrysler headquarters in Detroit. Though Mr Eaton has promised that the company board will properly consider the offer, his personal response is that the "For Sale" sign is not out front now nor is it likely to be in the future. He is backed by Chrysler's workers. They seem unnerved by the offer, even though it features as a co-investor Lee Iacocca, Mr Eaton's predecessor and the man who navigated Chrysler out of virtual collapse in the early 1980s.

No wonder Mr Eaton is alarmed. He only need glance over his shoulder to be reminded of the terrifying roller-coaster ride the company has taken over the last 15 years. "We don't want to put Chrysler at risk," he said last week. "We've worked hard to build this company's financial strength, to increase shareholder value and to build the confidence of customers, employees, dealers and suppliers. We have no desire to reverse the process."

Founded by Walter P Chrysler, a master mechanic at Buick, in 1925, the Chrysler Corporation emerged as one of America's big three car-makers alongside General Motors and Ford in 1929. It achieved early popular success with the launch of the De Soto and Plymouth models and later acquired Dodge Brothers Inc, maker of rugged all-terrain vehicles that were famous for being able to drive into the Grand Canyon and out again.

In the Second World War, the manufacturer diversified heavily into the defence sector, making tanks and, after the war, missiles, including the Jupiter rocket. It has no UK interests.

The modern era of Chrysler began with the hiring in 1978 of Mr Iacocca as president. He was elected chairman the next year. Mr Iacocca's arrival coincided with perhaps the darkest days of Chrysler. He revived it, with the help of federal loan guarantees. But by the end of the 1980s, Chrysler was on the skids once more. Mr Iacocca had taken the group on to what was later seen as an ill-advised diversification spree, and the Japanese were gobbling up market share. By 1990, Chrysler stock had collapsed to a mere $9 a share compared with $48 in the mid-1980s, prompting Mr Kerkorian to take a tenth of the company at a bargain-basement price in 1993. Like GM and Ford, Chrysler was struggling through huge losses and undertaking painful restructuring when Mr Iacocca was asked to leave by the board at the end of 1992 and succeeded by Mr Eaton. The story since then has been one of another dazzling corporate turnaround.

Several factors have contributed to the comeback. The company moved swiftly to dispose of non-core assets, including a stake in Mitsubishi, its components companies and a stake in Lamborghini. The strategy provided new cash for intensive investments in new production techniques and new models. The factory innovations bore fruit with much-improved productivity and increased quality in the cars. Perhaps most important, though, has been Chrysler's success in turning out models that Americans have wanted.

Part of the company's salvation has rested on its series of minivan - or "people carrier" - models, typifed in Europe by the Renault Espace. Chrysler pioneered this type of vehicle in the mid-1980s under Mr Iacocca's reign and established an invaluable niche for itself.

More recently, American buyers have been drawn in droves to other Chrysler products such as the Jeep Grand Cherokee - a vehicle designed to be all- terrain but more likely to be used for a visit to Saks Fifth Avenue than the Grand Canyon - the LH series of upscale and stylish executive sedans and the much cheaper Neon. By the end of 1994, its US market share was 15.3 per cent, against 12.4 per cent three years earlier.

That is why the group has produced recent profit figures that are a virtual negative photographic image of the losses suffered earlier in this decade. In 1994, Chrysler earned $3.71bn, the biggest profit in its history and a world away from the $2.55bn loss registered in 1993. The company's pension liabilities are fully funded for the first time in recent memory. Mindful of the past ups and downs, it also amassed a generous cash cushion of $7.3bn.

Enter Messrs Kerkorian and Iacocca. The 77-year-old Mr Kerkorian, who proposes to make his bid through his Las Vegas-based Tracinda Corporation, complains, with reason, that the stock value of Chrysler does not reflect its financial renaissance. He has spent $676m in acquiring Chrysler stock and received only $95m in dividends. While his stock was valued at $1.4bn before his bid announce- ment on Wednesday, that is profit on paper only - selling his shares would doubtless have sent the price tumbling.

Mr Kerkorian meanwhile argues that while he has faith in current management, the swerve towards financial conservatism has gone too far. Chrysler may need money for the rainy day that will surely come, but $2bn would be enough, he says.

Now Mr Kerkorian is proposing to scoop $5.5bn out of that reserve to help fund his putative takeover, which he has pitched at $55 a share, valuing the company at $22.5bn. In addition, he is proposing to raise up to $12bn in new debt from the banks and $3bn from outside investors interested in taking new equity. The remainder, about $2bn, would come from the stakes that Mr Kerkorian and Mr Iacocca already hold in the company.

Such a deal, according to Mr Eaton, would amount to a leveraged buy-out, with a strong whiff of the smash-and-grab corporate raids of the 1980s. Mr Eaton neither wants to see so drastic a depletion of the cash reserves - which he considers vital for Chrysler to ride out the next recession - nor does he want the company burdened with so much new debt. Many auto industry analysts sympathise with his concern. "There is an odour of slime about the deal," Ted Stolberg, of Stolberg Partners in New York, suggested. "It does not make sense to put on the new debt. It is not good for the country, not good for Chrysler, not good for the employees and not good for the suppliers".

By the weekend, the early trickle of anxiety had developed into a torrent of opprobium. Mr Kerkorian has made his move, moreover, just as signs are starting to multiply that the tracks at Chrysler are beginning to turn down again.

On Thursday, Mr Eaton announced a 37 per cent drop to £592m in first- quarter earnings compared with the same period in 1994. The decline reflects several negative factors, including a decided softening in domestic demand, problems in Mexico and charges related to a backdoor latch-replacement programme for some of the older minivans. The company has also spent heavily on the development of a 1996 version of the minivan. Sales of the Neon have proved disappointing, and competitors are catching up fast on the Jeep Cherokee. And analysts continue to express concern about Chrysler's relative weakness abroad. Only 6 per cent of Chrysler's production is for export, making the company heavily dependent on domestic sales.

Observers question whether Mr Kerkorian's offer is for real. The cynics smell an attempt at greenmail, whereby Chrysler, to stave off the offer, would be obliged to buy back Mr Kerkorian's stock at a premium, thus giving him the profit on his investment that otherwise cannot be realised. That in itself would be a costly exercise, however, and would have to be funded from the famous cash reserve.

Another theory is that Mr Kerkorian is trying to flush out a different buyer for Chrysler, perhaps a foreign car company. Speculation has been rampant, touching almost any European mass manufacturer you might mention - Mercedes, Volkswagen, Peugeot, Volvo, Fiat.

If Mr Kerkorian is serious, however, how likely is it that he can raise the financing he needs? There has been puzzlement that he did not line up more of the funding before making his approach public. His first task will be to find the outside investors to provide the $3bn in fresh equity. As far as we know, he has got nowhere on this and finding takers may be very difficult. Only then could he turn to the banks for loans. As many as 100 banks could be involved and the negotiations would take weeks.

Until Mr Kerkorian lines up his plan more convincingly, Chrysler can probably sit tight. At some point, however, the battle will have to be joined.

Few people, either in Motown or on Wall Street, do not believe that the fight will weaken the company - at the very moment when it seemed finally to have made itself secure.