There’s a popular canard among Detroit’s many critics that the auto industry can sell anything just by flexing its marketing muscle — never mind the Edsel or its more recent equivalent, the Pontiac Aztek. But as employees and media gathered in the auditorium at Chrysler’s sprawling corporate headquarters on an early August morning in 2007, that truism was about to be put to the test.
Only a few months earlier, the long-struggling automaker had been unceremoniously jilted by its one-time partner, Daimler AG. The “merger of equals” had collapsed, unceremoniously, with Chrysler being sold, at a sizable loss, to Cerberus Capital Management, and though John Snow, the former Treasury Secretary and now chairman of the New York private-equity giant, was promising to practice “patient” capitalism with the sickly automaker, Cerberus was a company best-known for hunting down the quick score, rather than the nurturing acquisition.
As the sale was about to be finalized, Cerberus’ sincerity was being stretched even thinner by the news of the day. In the preceding weeks, the Chrysler rumor mill was overwhelmed by the debate over who would take charge of the automaker. Far and away, the favorite choice was Wolfgang Bernhard, the one-time chief operating officer under German control. Smart, dapper, and an avowed aficionado of Chrysler products, he had been spotted prowling the Chrysler Technical Center and was rumored to have locked down a lucrative new contract. Just the evening before the Monday morning news conference, Chrysler’s normally well-connected public relations department was making the final tweaks to a presentation introducing Bernhard.
But in the hours before the conference began, the team, led at the time by the ever-resilient Jason Vines, realized they were going to have a far bigger sell job than they might’ve imagined. Bernhard wasn’t anywhere near Detroit. And he wasn’t going to be. In a last-minute shuffle, the German executive was brushed aside, Cerberus instead extending the contract to Bob Nardelli. Characterized as aloof and, at times, irritable, Nardelli was the one-time heir apparent of GE’s legendary Chairman Jack Welch. But when he was unceremoniously bypassed, Nardelli packed up and moved on, landing at Home Depot. Despite a strong initial performance, sales eventually tumbled, along with the big-box hardware chain’s stock price, and Nardelli was ousted — with a mind-bending $210 million compensation package as his consolation prize.
“We knew we were going to have a tough challenge making this look good,” recalls one of several Chrysler PR officials who’ve left, in frustration, since the Cerberus acquisition. Yet, early on, the smoke, mirrors, and pixie dust seemed to work much better than expected. After some initial coverage that focused on the wrath of Home Depot stockholders over Nardelli’s parting bonus, he began to receive some unexpectedly good press. It helped that Chrysler had just won a breakthrough contract from the United Auto Workers union, which promised to radically improve its financial situation. Even some of the CEO’s initial moves to cut production, trim plants, and reduce the workforce were hailed as the much-needed steps of a no-bull leader determined to nurse Chrysler back to health and prove Cerberus was, indeed, a patient and willingly entrenched player in the challenging automotive world.
It helped to know that Chrysler wasn’t the only bet the New York firm was making in the industry. Over the past few years, Cerberus had plunked down billions in hard cash on an array of transportation industry investments, including bus manufacturer Blue Bird and a number of aftermarket parts manufacturers. In Michigan, one could feel the equity firm’s presence in a variety of quarters, notably Tower Automotive, a supplier best-known for producing frames and other big, bent metal parts for OEMs such as Chrysler. Snow and company had even made a bid for the bankrupt Delphi Corp., though it fell through at a late hour. Closer to its core competency, Cerberus also purchased a controlling 51 percent stake in General Motors’ captive finance subsidiary, General Motors Acceptance Corp., which made it one of the nation’s larger lenders in both the home and automotive markets.
In a curious way, notes David Cole, chairman of the Center for Automotive Research in Ann Arbor, Cerberus seemed to be following the model laid out nearly a century earlier by William Crapo “Billy” Durant. The one-time Flint buggy manufacturer transformed an assortment of small automakers and parts makers into what would become the world’s largest automaker, General Motors Corp. In the early years, that “vertical integration” made unarguable sense. Henry Ford had followed a similar model, though growing organically. In its heyday, his Rouge River complex took in sand, iron, and coal at one end, and spat out fully assembled automobiles at the other. In recent decades, the concept had been discarded, in large part to shift costs away from the OEMs. But Cerberus managers were often quick to boast that they knew a better way to do business. Might they be proving that in Detroit? And might they really be ready to stick around, rather than grab for the quick buck?
The Reluctant General
Cerberus? The equity firm was named after the three-headed dog that, in both Greek and Roman mythology, guards the gates of Hades. Considering the current fiscal crisis, especially the meltdown at Chrysler, it soon seemed an inadvertently apt moniker. Yet for investors who’d bet big on Cerberus in earlier days, the firm often seemed heaven-sent. Though it’s been known to walk into some hellish situations, Cerberus developed a reputation — make that a legend — for finding ways to routinely turn around distressed companies and deliver returns that often ran 20 percent or better.
The company was founded in 1992 by Stephen A. Feinberg, the Bronx-born son of a steelworker, who graduated from Princeton and originally aspired to a career in politics. But there was just one impediment to his avocation: Feinberg is notoriously publicity-shy — to the point of paranoia. In fact, since Cerberus was formed, he’s granted a total of one interview — to The New York Times — and has participated in only a handful of news conferences, including one marking the acquisition of a 51 percent stake in GMAC. Lest one think he’s simply too busy managing his money, Feinberg wrote a letter to his investors last February, complaining that, “We despise all the public attention we are getting.”
Feinberg quickly demonstrated a magic touch with money, first as a trader at the legendary junk bond firm, Drexel Burnham Lambert, then as a player in the dog-eat-dog distressed debt market and, finally, partnering with fellow financier William L. Richter to form Cerberus. In 1992, the pair had a grand total of $10 million under their management. In recent years, Feinberg’s annual compensation has run significantly larger than that — and while he prefers a frugal lifestyle that includes drinking domestic beer, driving an old pickup, and taking weekend hunting trips, it’s at odds with reality. In 2003, Feinberg and his wife, Gisela, bought a four-story townhouse on East 67th Street in New York for $19.75 million, but according to a report in The Wall Street Journal, after five years the remodeling costs went from an estimated $5 million to $15 million. Further, the Feinbergs’ feuds with contractors became the stuff of legend, even by New York standards. But one place Feinberg is loose with the checkbook is in his support of the Republican party, an affiliation that has proved useful in numerous ways.
Among other things, it helped connect the now 48-year-old Feinberg to the more publicity-savvy John Snow, the second of three secretaries of the Treasury to serve under outgoing President George W. Bush. Born in Toledo, Ohio, in 1939, Snow spent the majority of his career in the railroad business, most recently as CEO of the massive CSX Corp. — which created a media stir a few years back by selling its vast port holdings to Dubai Transport. After his stint in public service, Snow signed on with Cerberus, becoming the public face of the otherwise very private equity giant. (Notably, Cerberus officials declined to be interviewed, despite repeated requests over several months.)
Today, Feinberg, Snow, former Vice President Dan Quayle, and numerous other employees manage a widely diversified portfolio more than 2,000 times larger than when Cerberus was formed. With an estimated value of $27.5 billion, and generating annual revenue of more than $100 billion, the dogs of hell have significant holdings in real estate, aerospace, banking, and retailing, among other industries. Cerberus’ geographic profile is equally impressive, spanning North and South America, Europe, and Asia.
“I think they’re brilliant deal guys,” says a senior Tower Automotive executive who was deeply involved in the parts maker’s bankruptcy — from which it emerged through the sale to Cerberus. “They’re willing to take risks that [others] won’t,” adds Kimberly Rodriguez, principal of Grant Thornton Advisory Services Automotive Platform in Southfield.
Cerberus boasts an enviable track record, scoring impressive returns by hedging most of its bets. Its signature is a deal that seems to put it ahead, no matter how things come out overall. In 2004, Cerberus and other investors purchased Mervyns, a clothing and housewares retailer, for $1.25 billion from Minneapolis mega-marketer Target Co. On the surface, it seemed Mervyns was a poor investment on Cerberus’ part, considering the department store filed for Chapter 11 protection last July and finally liquidated in October.
But Cerberus split the Mervyns deal into two separate transactions: one for the retail operations company and one for a property unit, commonly known as an “opco-propco” structure. Since it was the retail side that filed for bankruptcy, the property company avoided the subsequent liquidation. That move netted Cerberus and its partners more than $250 million, as many of the store locations were sold back to the mall owners where the chain’s stores were located, according to court documents. In fact, Cerberus and others shared $58 million in deal fees upon closing the initial transaction, according to the filings.
Riding Out the Perfect Storm
Yet even the best make mistakes, and the whiz kids at Cerberus nearly got nailed when they agreed to acquire United Rentals in 2007 for approximately $4 billion. But at the last minute, the private-equity firm had second thoughts about its target, which rents power tools and construction equipment. Cerberus claimed its initial projections of United were “overly aggressive,” so it wanted out of the deal, which required it to pay United a $100-million breakup fee. But the rental company wasn’t ready to walk away and sued Cerberus, hoping to force it to complete the deal. Lawyers for United argued that Cerberus had failed to invoke a material adverse-effect clause, a commonly negotiated loophole permitting a buyer to back out. After some nasty wrangling, the courts ruled in Cerberus’ favor, but observers contend that the contract was so ambiguous, it could’ve easily gone United’s way.
Today’s business deals are so complex, it’s often argued that it’s impossible for the average jury to comprehend the subtle legalese. Indeed, nearly two years after DaimlerChrysler and Cerberus agreed to terms on Chrysler, few outside claim to have a truly comprehensive grasp of the deal’s details. The Economist estimates that beneath the polished prose, Cerberus negotiated another can’t-lose deal, with the Germans giving up in excess of $700 million to make the troubled U.S. side of the company go away. But Daimler AG didn’t go away completely, keeping a 19.9 percent stake while agreeing to pay some debt over time. (As of late December, the two sides were feuding over the details of Cerberus buying Daimler’s remaining share of Chrysler. With Cerberus contending it wasn’t given a clear picture of Chrysler’s situation, the talks have stalled, and some observers say a resolution may come only through the courts.)
Although it posted strong returns during the early days of the “merger,” at one point propping up the vaunted Mercedes-Benz during a rare downturn, Chrysler’s fortunes soon started sagging. Never truly seeing their American counterparts as equal partners, the Germans couldn’t wait to sever their trans-Atlantic ties. Yet despite its obvious problems, some industry observers began to bet that the worst was over, as Chrysler emerged from the broken marriage.
It helped to have a precedent-setting labor contract that effectively offloaded most of Chrysler’s hefty health-care costs into a union-managed trust. And the agreement with the UAW resulted in numerous changes and concessions, including the creation of a two-tiered wage structure that, by 2010, was expected to shave about two-thirds of the production cost gap between Detroit and the transplant assembly lines operated by competitors such as Toyota. That can add up to thousands of dollars per vehicle.
Even before that happened, Chrysler had taken steps to sharply improve factory-floor productivity. According to the latest Harbour Report, an annual measure of auto-plant efficiency, Chrysler achieved the seemingly impossible last year, matching the productivity of Toyota’s industry benchmark.
No wonder, then, that Cerberus chairman Snow seemed willing to invest “patient capital” into an acquisition that Feinberg, in a rare public comment, described as an “American icon.”
Then the perfect storm came ashore. It was bad enough that basic commodities like rubber, steel, and the rare metals for catalytic converters were soaring to record highs. But so were gasoline prices, which had a disproportionate impact on an automaker where pickups, minivans, and SUVs accounted for roughly two-thirds of all sales. The ensuing credit crunch only worsened the situation, making it near-impossible for even the vaunted Cerberus to access the capital Chrysler needed to keep its empire operating. The sales slump that all those factors triggered is the worst the American market has seen in decades, with October and November volumes coming in at seasonally adjusted levels of just over 10 million vehicles. For the first half of the decade, the industry enjoyed steady annual sales of around 17 million.
But while even Toyota has been feeling the heat — reporting a rare slump in U.S. sales and earnings — Chrysler has been hit much harder than just about anyone else. Its dependence on light trucks is a major factor, especially as the automaker readied an all-new version of its full-size Ram pickup truck. Like its crosstown competitors, Chrysler has been making a renewed foray into the passenger-car market, which has long been dominated by Asian imports such as the Toyota Camry and Honda Accord. But with a few rare exceptions, such as the now-aging Chrysler 300 sedan, it’s thrown nothing but duds, at least by buyers’ standards. The latest iteration of the compact Sebring sedan and convertible, developed in partnership with longtime Japanese ally Mitsubishi Motors, has been slow to move out of showrooms. It hasn’t helped to have independent arbiters, such as Consumer Reports magazine, label Chrysler products’ quality among the industry’s worst.
The credit crunch is also compounding problems unique to Chrysler. Like many mainstream automakers, it has long relied on subsidized leasing to prop up volumes and keep factories running. But the crash of the truck market has crippled used-car values, and that means Rams and Jeeps coming back off lease are worth far less than originally estimated, running up countless millions in unexpected costs. The consortium of banks that used to annually rubber-stamp a $30-billion loan decided to force the automaker to give up its leasing program. As a result, many normally loyal return-buyers are facing sticker shock. Forced to buy, they can’t afford to stick with products such as the Jeep Grand Cherokee when their monthly notes might more than double — unless they’re willing to stretch what might’ve been a two- or three-year lease into a five- or six-year purchase.
And the list of complications only gets worse. One of Chrysler’s long-nagging problems has been the lack of a solid international network, on the order of GM’s Opel or Ford of Europe, both of which have often provided some profits to offset downturns in the North American market.
“I think if [Cerberus] knew what they were getting into, they wouldn’t have done it,” says one Wall Street source, who, like many of those who have — or who may eventually work with Cerberus — asked not to be identified. “Even before all this [market upheaval], they didn’t get what they thought they were buying.” To some, that’s an almost benign way of looking at what’s happened. “There was a fundamental lack of respect and understanding for what the auto industry was about, and the depth of the problems it was facing,” Grant Thornton’s Rodriguez contends. Meanwhile, David Cole walks the middle ground, suggesting that “they just didn’t know the business well enough, and didn’t see the economic downturn coming. I think they thought the turnaround was a lot closer, but so did I.”
More Than Chrysler
If things were limited to Chrysler alone, Cerberus might not be so worried. But now its options are slipping away. Take GMAC. For years, the finance arm was a cash cow; in fact, it was not uncommon for it to provide significantly more profit to the GM bottom line than the automaker’s car-making operations. Now, however, it’s simply struggling to survive. Like other home lenders, it’s paying a stiff price for its dalliance with the subprime market, with a reported $9.1 billion in losses over the last two years.
On the auto side, GMAC is so cash-constrained, it’s limiting loans to only the most prime borrowers, those with credit scores above the 700 level. Among the options Feinberg and Snow are exploring is to convert GMAC into a bank, which would provide significantly greater access to government funds. But that option, one of several that sources confirm are under consideration, might force the private-equity fund to give up control of its precious holding. Federal guidelines, passed as part of the government’s economic rescue plan, would subject anyone controlling more than 33 percent of a bank-holding company to the government’s strict banking regulations. Cerberus currently holds 51 percent of GMAC, and had been hoping to acquire the remaining stake held by General Motors.
That was one of the reported goals of now-abandoned negotiations that also would’ve merged Chrysler into GM. It was a proposal that few outside the bargaining room could make sense of — and neither could most of the automaker’s board members, who ultimately told CEO Rick Wagoner to pull the plug. “While the acquisition could potentially have provided significant benefits, the company has concluded that it’s more important at the present time to focus on its immediate liquidity challenges and, accordingly, considerations of such a transaction as a near-term priority have been set aside,” Wagoner said.
But Cerberus has shown it can make gains in the auto sector. Take Tower. The long-struggling supplier pulled off an against-the-odds turnaround that nearly collapsed when a first round of financing fell through and the supplier almost failed to come through its bankruptcy. When Cerberus stepped in, a slimmed-down Tower emerged with a significantly lower cost base. Now the company is doing fairly well, all things considered, and its exposure to the Detroit Three is between 30 percent and 40 percent. Cole is cautiously optimistic about Tower, noting that it’s a war of attrition among metal-benders. “A lot of their competition has been drained away,” he says, “so once we get back to a reasonably high [vehicle market] again, those stampers who survive will be fine.”
Given time, perhaps Tower’s success will carry over to Chrysler. For the moment, Nardelli is left to keep hacking away. Over the last few years, Chrysler has been forced to eliminate tens of thousands of jobs, close numerous parts and assembly plants, and curtail promising product-development programs. As 2008 drew to a close, the company had around 56,000 employees, barely half what it began the decade with, and there’s no choice but to keep cutting. According to numerous well-placed sources, virtually all product programs, except for the replacements of the 300 sedan and Jeep Grand Cherokee, have been either scrubbed or put on hold.
Many of those who witnessed Nardelli’s speech are gone, and the once-crowded CTC is starting to resemble a ghost town. Many of the employees who remain walk around with the uncertain gaze of those waiting for the ax to fall. Perhaps it’s good there aren’t so many around to hear the increasingly rancorous debates between Nardelli and his top lieutenants, notably former Toyota USA chief Jim Press, now Chrysler’s vice chairman and capo of sales and marketing.
After the initial resurrection of his reputation, Nardelli has once again become the target of frequent criticism in the Detroit and automotive media. He’s also taken his fair share of abuse in Washington, where he and the other Detroit Three CEOs went pleading for a $25-billion cash bailout in November. At this writing, they’ve been told to come back — by commercial, rather than corporate jet —with a workable plan for survival. Says one frustrated Chrysler source, “That’s not going to be easy.” It’s an especially difficult sell for Cerberus, which doesn’t provide the sort of public financial guidance of Chrysler’s crosstown rivals, GM and Ford.
In his appearance before Congress last November, Nardelli attempted to persuade lawmakers by suggesting he’d take a $1-a-year salary, and also by offering that Cerberus would consider forgoing any profits from the eventual sale of Chrysler — a proposal that assumes, of course, 1) that the automaker would survive, and 2) that somebody would eventually pay a premium to acquire it.
Another option left to Cerberus would be to sell off Chrysler, either in whole or in chunks. Despite the downturn in the light-truck market, its Jeep brand is still considered the corporate jewel, and in spite of the fall-off in the minivan market, there are numerous players envious of the continuing demand for models like the Chrysler Town & Country and Dodge Caravan. Who’d cough up the money? “I don’t think today” anyone could, “with the finance markets still disrupted,” says Carlos Ghosn, CEO of the Euro-Asian Renault-Nissan Alliance. Ghosn has often said that he’d like a third, North American leg to his alliance, but while “we’re very open,” he warned, following a speech at the recent Los Angeles Motor Show, in its current condition, Chrysler just isn’t worth spending money on.
If anything, Cerberus could find recent history repeating itself. It might eventually have to pay a potential suitor like Nissan a significant chunk of money to take Chrysler off its hands (recall Daimler recently wrote down its 19.9 percent stake in Chrysler to zero).
Despite the depth of its automotive problems, it’s unlikely a worst-case failure at Chrysler and GMAC would do much more than hurt some of Cerberus’ investors. The company’s policy is to limit its stake in any single investment to no more than 5 percent of the value of one of its funds. Industry reports indicate that Chrysler and GMAC, combined, come to less than 7 percent. But even if those automotive ventures pull through, it’s hard to say how much damage will have been done to Cerberus’ normally sterling reputation. Wall Street traders report that weary investors in buyout funds like Feinberg’s are selling their stakes for as little as 30 cents on the dollar.
“They’ve underestimated, totally and absolutely, just how hard it would be,” complains one well-regarded Detroit executive who left the equity fund’s payroll after watching “Cerberus people come in and out of meetings, not knowing what to do and giving totally different directions.”
By its very definition, Cerberus is a company that walks close to Dante’s Inferno. That’s what it takes to win the big payouts. But whether it can get past the dogs of hell this time is anything but certain. When money is invested in an industry entering its worst downturn in decades, it often pays to recognize the first rule of business — caveat emptor. Cerberus might simply not have been wary enough.
Sources:
http://finance.google.com/finance?q=OTC:ACEAF.html
http://www.aceaviation.com/en/investors/documents/2004_ar.pdf
http://www.cbc.ca/news/background/mergers/cerberus.html
http://www.atwonline.com/channels/dataAirlineEconomics/article.html?articleID=1477
http://www.aozorabank.co/ <http://www.aozorabank.co
http://www.ynetnews.com/articles/0,7340,L-3169476,00.html
http://www.bluelinxco.com/home.asp
http://www.bushmaster.com/about.asp
http://michaelbane.blogspot.com
http://www.fenwaypartners.com/sel_inv.asp?id=27
http://www.manta.com/coms2/dnbcompany_jd68vl
http://www.alacrastore.com/storecontent/Thomson_M&A/Creditors_acquires_SLI_Inc-1461910020
http://www.jigsaw.com/id524408/cta_acoustics_company.xhtml
http://louisville.bizjournals.com/louisville/stories/2002/08/12/daily41.html
http://www.decisionone.com/company_profile/
http://www.gmacfs.com/us/en/about/investor/sec_filings.html
http://www.berlin-partner.de/partner-werden/?L=1&partnerId=161&letter=A-Z
http://search.ft.com/ftArticle?queryText=Cerberus+GSW&id=040526000823&ct=0
http://www.guilfordproducts.com/BriefHist.aspx
http://www.secinfo.com/dsVsf.2dWs.htm#1stPage
http://www.iapws.com/who/heritage.aspx
http://www.itjungle.com/tfh/tfh093002-story05.html
http://www.americancapital.com/
http://www.lnrproperty.com/whoweare.asp
http://investing.businessweek.com/
http://www.accessmylibrary.com/
http://www.talecris.com/talecris-about.htm
http://www.autonews.com/article/20070903/ANA/70831068
http://www.tulsaworld.com/business/article.aspx?articleID=20080605_54_E1_hFallo755008
http://www.accessmylibrary.com/coms2/summary_0286-8091191_ITM
http://www.hoovers.com/vanguard-car-rental/–ID__126450–/free-co-factsheet.xhtml
