Dark Days at Daimler: Should Zetsche spin-off Chrysler from DCX?

[nadepalma]

From BusinessWeek Online

Source: http://www.businessweek.com/magazine...7001_mz001.htm



Dark Days at Daimler

Jürgen Schrempp leaves behind a Mercedes beset by quality and profit woes. Now, Dieter Zetsche must take drastic measures to save the marriage with Chrysler -- or engineer a breakup

When employees arrived at Chrysler's Auburn Hills (Mich.) headquarters on July 28, they were greeted with astounding news: Dieter Zetsche, the affable, 52-year-old CEO who had led the auto maker's resurrection, was headed back to Germany to head the ailing parent company. A wave of excitement swept through the headquarters as employees realized that an executive who really values the American carmaker would run the transatlantic auto giant. And if anything, the buzz back in Stuttgart, where DaimlerChrysler (DCX ) is based, was even better, as shareholders and executives breathed a collective sigh of relief. Finally CEO Jürgen E. Schrempp was on his way out, and the company would get someone with the wherewithal to repair Daimler's tarnished crown jewel: Mercedes-Benz (DCX ). "Zetsche is well respected on both sides of the Atlantic," says Joseph S. Philippi, principal of auto consultant AutoTrends in Short Hills, N.J. "The board obviously thought he was the right guy to get the whole company back on track."

Maybe so, but he faces formidable challenges. In the past seven years, DaimlerChrysler has experienced a reversal rife with irony. Who would have predicted that in 2005, Chrysler would be the healthy part of the empire -- and Mercedes the laggard? But it's true. Beset with humbling quality problems, a money-losing small car business, and high production costs, Mercedes has gone from being the global benchmark for quality and one of the most profitable auto makers in the world to a money-losing shambles. For the first half of 2005, the premium carmaker lost $1.1 billion. Clearly, Zetsche will have his work cut out turning Mercedes around.

But fixing the luxury brand is only one part of his challenge. Nearly seven years after Schrempp brought together Daimler and Chrysler, with the promise of building an auto maker with sufficient size to compete globally, the question that has dogged the merger from the beginning remains: Does this marriage make sense? Schrempp sold investors on the idea of an historic merger of mass with class. Together, Mercedes and Chrysler would have the money, clout, and knowhow needed to produce next-generation engine technologies. They would produce a series of small cars for the world's emerging middle classes. Chrysler would tap into Mercedes technology, and Chrysler would give Mercedes the ideal hedge in case the luxury car market plateaued. Synergies and cost savings would proliferate. Later, Schrempp spent $2.1 billion adding a stake in Mitsubishi Motors to his visionary empire, hoping to get needed exposure in Asia as well as help Chrysler with small and medium-size cars. And he encouraged the growth of the Smart division at Mercedes as a way into the market for small, affordable cars in Europe.

Nothing worked out as planned. Far from being the perfect hedge, Chrysler proved to be a massive rescue job that sucked up billions and absorbed German management for years. Mercedes has lost share, reputation, and now is losing money. Synergies have been few and far between. Mitsubishi Motors? Daimler ditched the alliance after the deal proved the lemon of all lemons. The Smart car? It's looking anything but. And the merger certainly hasn't helped the stock: Before the announcement sent the share price soaring 10%, DaimlerChrysler's market cap hovered around $38 billion -- just $2 billion more than Daimler paid to acquire Chrysler in 1998. Marrying mass and class has been far tougher than anyone ever imagined.

With Schrempp leaving, Zetsche has the unenviable task of proving the wisdom of the original vision. That will not be easy. Even though Chrysler has made a remarkable comeback under Zetsche -- it produced a third of the group's operating earnings during the first half -- merger critics fret that the turnaround is not sustainable. They point to the continuing onslaught from Asian carmakers and Chrysler's history of rebounding, only to stumble anew. Most important, the Germans have not proved they can manage a steadily profitable, mass-market carmaker while recapturing and maintaining the 7%-plus margins that a premium brand like Mercedes should produce year in and year out. That's the kind of profit posted by rival BMW -- and one that Mercedes, too, might be sporting, given more astute management.

The upshot: Even before he starts work in Stuttgart, Zetsche is facing mounting pressure to prove that the merger makes sense. The new CEO has two basic choices. He must either make a much more successful go of Schrempp's strategy by ramping up the technical and manufacturing collaboration between Mercedes and Chrysler -- and producing much better financial returns in the process. Or he must run the two companies as separate entities, laying the foundation for a possible sale of Chrysler in the future.

Having just turned Chrysler around, Zetsche would be loath to unload the auto maker now, analysts and company insiders suggest. Still, in Germany, bankers and private-equity players are already talking about the possibility of buying DaimlerChrysler outright or at least taking a stake and pressuring management to sell off pieces. Dumping Chrysler and the Smart minicar unit, say proponents, would allow Zetsche to focus on restoring Mercedes to the high-margin premium auto maker it once was.

Many argue that such a divorce would be a boon for investors, because an unshackled Mercedes would sport much higher returns and therefore earn a much better valuation in the market. "A breakup would be the most value-creating route for Zetsche to take," says analyst Stephen Cheetham of Sanford C. Bernstein in London. Based on the multiples for comparable businesses and including a discount for Chrysler's pension and health liabilities, he estimates the breakup value of DaimlerChrysler at $72 billion to $96 billion -- nearly double its current market cap of roughly $51.5 billion.

Such a scenario, unthinkable a week ago, is now a real possibility. For years, Schrempp could afford to fend off angry investors because he had in his corner the company's single largest shareholder, Deutsche Bank (DB ). But on July 28, Germany's biggest lender sold down its 10.4% stake to 6.9%. Amid rising international competition, German companies and banks have been unwinding their traditional cross-shareholdings for several years, but the fraying of the Daimler-Deutsche partnership is a powerful signal that Germany's once-cozy business culture is increasingly untenable. Now the path is clear for any investor to take a large stake and push for a restructuring. Even a hostile bid led by Germans close to the establishment would not be stopped, bankers say.

For now, fixing Mercedes has to be Zetsche's top priority, regardless of whether the merged company is destined to stay together or split. That's because Mercedes is beset by a swarm of problems, from poor quality to high labor costs and increasingly competitive rivals. If Zetsche can't turn Mercedes around, no amount of dealmaking is going to secure his legacy as CEO.

How did Mercedes manage to go from one of the world's most-admired premium brands to a quality has-been? One reason was that it rushed out too many new models, say analysts. Under Schrempp, Mercedes expanded up and down the value chain, from small cars such as the A-Class and Smart to luxury limos like the $450,000 Maybach. Not all the models made decent margins -- and some lost money.

BOOM AND BUST

But it was the merger with Chrysler that diverted management attention from controlling costs and quality at Mercedes. Starting in 1998, troops of managers started flocking to Auburn Hills on a corporate jet. Soon the Germans discovered that Chrysler, which has a long history of boom-and-bust cycles, was in much worse shape than they anticipated. It spun deeply into crisis in 2000, racking up $4.7 billion in operating losses the following year alone. Mercedes had to make the ultimate sacrifice, squeezing its own costs to pump out better profits for the group. Analysts say Mercedes demanded lower prices from suppliers and allowed them to cut corners on quality. By July, 2003, Mercedes had fallen to near the bottom of J.D. Power & Associates' reliability survey.

Mercedes is still reeling from a series of embarrassing recalls of its prestige sedan, the E-Class, which starts at $50,000. In May, 2004, the company suffered a spate of problems with its electronic brake control system, and it recalled 680,000 cars for inspections. This year, in late March, Mercedes announced the biggest recall in its history -- 1.3 million cars with faulty fuel pumps made by supplier Robert Bosch. Software bugs and the complex interfaces that allow the myriad electronics systems to talk to each other are to blame for many Mercedes defects. Getting such bugs out is a fiendishly hard job and can often take years. The problems have also pushed up costs and hurt profits. Last year Mercedes spent some $600 million to cover warranty costs, analysts say.

Much more to read here: http://www.businessweek.com/magazine...7001_mz001.htm

[balthazar]

DCX should sell-off mercedes and kill-off maybach & smart (the "some lost money" non-dynamic duo). Chrysler is focused & diversified enough product-wise to stand alone again. The "merger" with mercedes gained them nothing tangible. Let mercedes flounder & flop about on their own.

[T-Type]

Originally Posted by balthazar

DCX should sell-off mercedes and kill-off maybach & smart (the "some lost money" non-dynamic duo). Chrysler is focused & diversified enough product-wise to stand alone again. The "merger" with mercedes gained them nothing tangible. Let mercedes flounder & flop about on their own.

You forget the power structure here. Mercedes will not be sold off. It's like saying a successful Daewoo should sell off GM (not the best example, but you get my meaning).

[s113]

I'm all in favor of seeing Chrysler become its own company again. Sounds like it would help both it and Daimler Benz.

[SobeSVT]

Damlier would never spin off Chrysler as a whole but rather sell it in parts, Jeep here, Dodge there. One of the rasons why Eaton sold off to Daimle Benz was to maintain the integrity of Chrysler in view to the Kerkorian menace. A very sad situation indeed.

[balthazar]

Originally Posted by T-Type

You forget the power structure here. Mercedes will not be sold off. It's like saying a successful Daewoo should sell off GM (not the best example, but you get my meaning).

Oh, but it was a "merger of equals", remember?

[T-Type]

Originally Posted by balthazar

Oh, but it was a "merger of equals", remember?

LOL Oh yea, I forgot about that.

[plane]

It would be good to bring Chrysler home again.

[AJR]

Hey, I like where this discussion is going.

[SobeSVT]

I wish that Eaton and Lutz had included a clause protecting the integrity of the Chrysler Group in case of a spinoff or sell.

[Phillip]

It might help if Mercedes stops trying to be all things to all people. They're worse than Volkswagen when it comes to pursuing every niche in the market...

[regfootball]

chrysler cannot survive on its own.

[asim]

I don't have time to read the whole thing, so i read the title. For some reason I don't think it would be a wise choice to have Chyrsler split up with DCX.

[macphisto]

My uncle works at the Jeep plant in Toledo. Every since Zetsche was named as the nest CEO there has been excitement mainly due to rumors that Chrysler was going to become American owned once more. Most all of the American Chrysler workers despise the German management (calling them Nazis), which has gone to great lengths to get workers to quit and be replaced by cheaper workers who would later be forced to quit when they got too expensive. Morale has been in the dumper for Chrysler division employees and many feel that the Germans are now holding the company back. Many feel that they are completely out of touch with American automotive heritage and are tying the hands of the company.

I'm not sure I agree on all the counts, though I am an advocate of Chrysler becoming All-American once more. The only problem is that I see some muddled up brands.

The Chrysler brand is kind of luxurious, but seems only half-hearted in it's position.

Dodge is more performance oriented and, for a while, was going to have all it's cars killed off.

Jeep isn't muddied up, but that one is easy.

Plymouth was killed off. I still think this is a shame because the Plymouth brand could have been a major success if utilized properly. It suffered from the same problems GM has had - rebadging with no original vehicles of it's own except the Plymouth's were cheaper.

If I were to be in charge of Chrysler then I would have a multi-pronged approach.

1: Bring back Plymouth as the Everyman's car solution. Kind of like Chevy but without the trucks. Plymouth dealerships would (hopefully) be teamed with Jeep, who would provide trucks and SUVs at the dealership different from what Dodge would provide.

2: Dodge is the power and performance brand. Their cars look different, drive different, and are oriented towards performance. I'd hope to see more RWD and/or AWD across the car lineup. They might offer a second SUV as well as the RAM and Dakota, which I might want to return to being a true midsize Truck. I would drop the caravan from Dodge's lineup, giving that to Plymouth and Chrysler only.

3: Make Chrysler a real luxury brand delivering luxury for good value. The 300 is a step in the right direction here.

4: Jeep is Jeep, though they'd add a truck, possibly a midsize and a fullsize.

[paul3230]

Chrysler becoming American again? Wow..the return of the big 3! Somehow, I just don't think it will happen anytime soon..Zetsche is going to try his best to save everything since he put his a ss on the line to save Chrysler