Cerberus Takes Biggest Auto Gamble Yet

Target: Chrysler unit of DaimlerChrysler

Price: $7.4 billion

Sponsor: Cerberus Capital Management

Seller: DaimlerChrysler AG

In its most recent move in the troubled automotive sector, Cerberus Capital Management has agreed to pay DaimlerChrysler AG $7.4 billion for an 80.1 percent stake in Chrysler, the third largest domestic automaker.

But this deal is bigger than simply another play on a distressed corporation. The name Cerberus may soon be synonymous with the car industry, and the firm’s performance handling the struggling Chrysler brand could well influence the private equity industry’s reputation.

Cerberus’ holdings in the automotive sector now far outdistance its investments in other industries and, if the Chrysler deal closes as expected in the third quarter of 2007, the firm would be the unquestioned king of Detroit among buyout firms. Last year, Cerberus bought GMAC, the lending arm of General Motors.

In taking control of Chrysler, Cerberus will be responsible for all the manufacturer’s pension liabilities, estimated at $18.9 billion. The gravity of the pension obligations weighed so heavily on Chrysler parent DaimlerChrysler AG that it was willing to suffer a “negative cash outflow” of $650 million in the deal to let Cerberus take over Chrylser. In exchange, the renamed Daimler AG will emerge debt-free; the German conglomerate paid $36 billion for Chrysler in 1998.

Although Cerberus is paying DaimlerChrylser $7.4 billion, most of that is earmarked for working capital and for investment in Chrysler’s lending unit. In turn, the parent company is going to cover losses of an estimated $1.6 billion in negative cash flows before the deal closes. DaimlerChrysler is also lending the newly minted Chrysler Holdings $400 million.

Much of the success of the deal hinges on a new four-year labor contract that Cerberus will have to negotiate with the powerful United Auto Workers union this summer. Chrysler’s negotiations will be part of a three-way pact with General Motors and Ford Motor Co. The leadership of the UAW has signaled its approval for the Cerberus takeover, but it’s still unclear if that will lead to smooth negotiations, or whether rank-and-file members will sign off on a collective bargaining agreement.

Winning the auction for Chrysler, Cerberus beat out Canadian car parts maker Magna International, which had teamed with Canadian buyout firm Onex Corp., and a second team consisting of The Blackstone Group and Centerbridge Partners.

Cerberus Chairman John Snow predicted at a press conference announcing the deal that the private sector would shield Chrysler from unwanted scrutiny, allowing it to achieve a turnaround “outside of the quarterly reports, outside of the analyst reports.” Snow struck a gentle note in a prepared statement, saying, “We welcome Chrysler into the Cerberus family of companies and believe Cerberus will be a good home for Chrysler.”

Cerberus’s current automotive-related investments include Vanguard Car Rental Holdings, the holding company for Alamo Rent-a-Car and National Car Rental; GDX Automotive, a maker of sealing parts for cars ; and Peguform Group, a German manufacturer of interior and exterior plastic parts for the automobile industry. It has also agreed earlier this year to buy Tower Automotive, builder of suspension systems and other vehicle body parts, and the firm owns a few bus makers. Cerberus has been involved in talks to bring auto supplier Delphi out of bankruptcy, but the firm has reportedly dropped out over a disagreement with the UAW.

Cerberus is no stranger to daring or complex deals. The GMAC deal required one of the largest equity checks every written for a company, at $7.8 billion. The 15-year-old firm, which has roughly $23.5 billion under management, also put over 200 analysts and investment professionals on the deal.—M.C. & J.H.