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Fiat Investors Impressed By Speed Of Chrysler Plan Pursuit

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“But as the Chrysler strategy unfolds, we realise there is a bull case and we may end up looking too cautious”

Fiat is relentlessly pursuing its plan to make the acquisition of Chrysler the centrepiece of its future, and investors are split between admirers of the speed of implementation, and those that fear the fundamentals just don’t add up.

Fiat is now the largest Chrysler shareholder with 46 per cent (the UAW has 45.7 per cent) and will increase this by five percentage points later this year when it fulfils the pledge to provide an economical small car to Chrysler. Fiat also said it will buy the 6.6 per cent stake held by the U.S. government after the bankruptcy and government bailout and more UAW shares raising its stake to as much as 76 per cent. The share purchases so far mean that Fiat will start reporting Chrysler’s sales and profit as part of its own financial statements beginning on June 1. Chrysler also arranged $7.5 billion in new financing to repay expensive government bailout loans, saving it more than $300 million a year in interest costs.

Deutsche Bank auto analyst Jochen Guehrke said one ramification of the decision to perhaps raise Fiat’s stake to up to 76 per cent is the increasingly unlikely Initial Public Offering of shares to the public which had been expected later this year or early next.

Bernstein Research analyst Max Warburton asked the question “Can Chrysler save Fiat?”, and came up with an equivocal answer.

“Fiat is in a race against time to consolidate Chrysler, with its potentially strong cash-flows from a U.S. auto market recovery and high margin SUV/pick-ups before Fiat Auto’s Brazilian profits crack and expose large European losses. Fiat Auto remains very fragile and Chrysler is far from fixed – but it may be the case that the American business will ride to the rescue just in time,” Warburton said.

Can it work?
Warburton said Fiat-Chrysler CEO Sergio Marchionne is arguably trying to weld together Europe’s weakest manufacturer with America’s weakest, and he wondered “Can it be made to work?”

Warburton pointed out the poor track record of big automotive mergers, like BMW-Rover, Daimler-Chrysler, Ford-Volvo and questioned the lack of operational integration at Renault-Nissan.

“The logic (of Fiat-Chrysler) is quite simple. Synergies between Chrysler’s and Fiat’s product ranges will be limited and will not transform Fiat. But simple profits and cash-flows from Chrysler may be enough to subsidise Fiat Auto. Chrysler certainly has greater profit potential than Fiat Auto. The reasons for this are simple and can be highlighted with two simple figures,” Warburton said.

He compares the €20,000 average revenue per car sale at Chrysler with Fiat’s €13,000.

“Chrysler makes big, more expensive vehicles that can generate much higher gross margins. Fiat makes small, cheap vehicles that cannot generate decent margins, almost irrespective of volume and cost structure. It’s hardly a beauty parade, but Chrysler is definitely a higher potential business than Fiat Auto,” Warburton said.

Commerzbank auto analyst Sascha Gommel agreed that the two product lineups have little in common, and pointed to troubles ahead in Europe.

Headwinds in Europe
“The pace of Chrysler’s refinancing and Fiat’s stake increase is ahead of schedule. However, we believe the difficult part of the integration is yet to come. Compared to, for instance, Renault’s B platform and VW’s MQB, the amount of scale effects for Fiat-Chrysler is limited as the model lineups are poles apart. While Fiat builds small cars in Italy, Poland and Brazil Chrysler builds pick-ups and SUVs in the NAFTA region. In addition, the company is facing headwinds in Europe,” Gommel said.

Gommel wasn’t skeptical enough to recommend that investors sell Fiat shares. They should hang on to them, Gommel said.

For all of Bernstein Research Warburton’s doubts, he still saw Fiat as a possibly attractive investment with these strong points

  • Hugely profitable Brazilian operations.
  • Potential for turnaround and full consolidation of Chrysler.
  • Ferrari

But potential negatives for Fiat included

  • Unlikely to ever make Europe profitable.
  • Little new product near-term or in the longer term.
  • Next two years, European market share likely to slide.
  • Brazilian market share, pricing under attack.

“At present we are neither sufficiently convinced by the Chrysler strategy nor sufficiently comfortable with the outlook for Brazilian profitability to recommend (Fiat). But as the Chrysler strategy unfolds, we realize there is a bull case and we may end up looking too cautious,” Warburton said.

Neil Winton – May 28, 2011

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