Shady car dealers sometimes "cut-and-shut," welding together two badly damaged vehicles to create a new one that looks sound but is always at risk of falling apart. Chrysler was close to the scrap yard when America's carmakers sought bankruptcy protection in the wake of the financial crisis. Fiat acquired an initial 20 percent Chrysler stake in 2009 in a deal with the Obama administration, and saved the company. Now the Italian carmaker is on course to take full control and merge the two firms into a global giant. But is their pairing an accident waiting to happen or a new model that will run smoothly for years?
Fiat was itself heading for the scrap yard in 2004 when Sergio Marchionne, a new boss, came in and turned it around. More recently the slump in Europe — where car sales are at a 17-year low — has led to big losses at Fiat. It would again be in serious trouble were it not for its stake in a newly profitable Chrysler, which it has increased in stages to 58.5 percent. Fiat's hope of salvation is to get its hands on Chrysler's cash to pay for a turnaround plan that will keep both companies running.
Much progress has been made in integrating the two carmakers' manufacturing operations. The next challenge for Fiat is to lift its Chrysler stake above 75 percent, at which point it will be able to use the American firm's cash flow to finance itself. It has tried to exercise options over the remaining 41.5 percent, which a trade-union health care trust, VEBA, acquired as part of the government's bailout plan. But the two sides are at odds over the price. The case is being thrashed out in a Delaware court.
There is no doubt that Fiat will get its hands on the remainder of Chrysler, with a deal probably struck by the end of the year, reckons Philippe Houchois of the bank UBS. VEBA needs to sell, either directly to Fiat or through an IPO, to raise money for the growing medical bills of retired car workers. What is unclear is the price: anywhere between Fiat's valuation of $1.8 billion and the $4.3 billion that VEBA wants.
Chrysler's cash — perhaps as much as $12 billion — is vital to keep Fiat going. It has been forced to scrimp on new models. Marchionne worries that he is now "cutting bone." His view is that, to keep up with rivals such as GM, Toyota and Volkswagen, the merged Fiat-Chrysler must turn out 5.5 million to 6 million vehicles a year, compared with 4.1 million now.
Will it work? Chrysler's last association with a European carmaker, an ill-fated takeover by Daimler in 1998, ended nine years later when the exasperated Germans sold it to a private-equity firm. Daimler's bosses belatedly realized that it made little sense pulling together a maker of technically complex luxury vehicles and a mass-market firm that churned out pickups and SUVs.
At first sight there is not much overlap between Chrysler's butch Dodge Ram pickup trucks and Jeeps and Fiat's tiddly 500s and Puntos. But at least both firms are mass-market operations with similar cost structures, argues Philip Watkins of Citigroup. As Chrysler owes its existence to Marchionne, its managers have given him the benefit of the doubt. His informal management style has probably helped, too.
Since Chrysler has little of its own to offer in small cars, it needs Fiat to provide platforms such as Alfa Romeo's Giulietta and its excellent small-engine technology to comply with America's increasingly strict fuel-economy standards. And building copies of Chrysler's worldwide hits, such as Jeeps, in idling Italian factories is a way to make use of spare capacity that Italy's politics make it hard for Fiat to close.
Europe's depressed car market is not the only reason Fiat needs Chrysler. Conditions in Fiat's most important market, Brazil, are getting harder. Fiat is Brazil's biggest carmaker, with 22 percent of the market. But once-fabulous margins in Brazil of 15 to 17 percent in 2005-07 have dwindled to about 8 percent. Carmakers such as Renault, GM and China's Chery are now ramping up production. This, and the slowing of Brazil's economy, mean margins will surely fall further.
The tie-up with Chrysler may help Fiat in Asia, where it lags behind other big carmakers. Though it makes money in China, a car that it launched there based on the Giulietta was a flop. Jeep's models have better prospects, but the slow start made by both Fiat and Chrysler and lack of a heavyweight Chinese partner mean that they may never be as strong there as GM.
The merged Fiat-Chrysler probably will chug along, neither attaining the dominant scale of a VW or Toyota nor the profitability of smaller carmakers like BMW and Jaguar Land Rover. And there is no obvious successor to Marchionne, a clever strategist who has saved two carmakers from oblivion but cannot go on forever. His joining of two of the world's weakest auto firms into one that stands a chance of long-term survival has been a triumph for those whose jobs depend on them.
© 2013 The Economist Newspaper Limited, London. All Rights Reserved. Reprinted with permission.