Cerberus wrestles to fix GMAC, defense contractor

Turnarounds are its specialty, but even Cerberus Capital Management may be feeling a little overwhelmed right now.

The New York-based firm is getting hit hard by the subprime mortgage market collapse through portfolio company GMAC Financial Services, which recently reported a loss of $1.6 billion for the third quarter, compared with a loss of $173 million for the same period last year.

The carve-out from General Motors Corp. provides automotive financing, insurance policies and residential mortgages through Residential Capital, a.k.a ResCap. In a press release, the company attributed the loss to “the effects of the global dislocation in the mortgage and credit markets on GMAC’s real estate finance business, which more than offset the continued strong performance in the company’s automotive finance and insurance businesses.”

That GMAC’s auto financing and insurance businesses are doing well is probably cold comfort to limited partners who co-invested in the GMAC deal alongside Cerberus, which is believed to have proposed unusually high fees. It is unclear what the exact terms of the co-investment are, and Cerberus didn’t respond to calls seeking comment.

One LP who saw the clouds gathering on the subprime mortgage horizon in 2006 and passed on the GMAC co-investment offer is breathing a sigh of relief. “I guess people had different views about how bad it would get with subprime mortgages,” the LP source said. “We thought it would get really bad. We’ll see how it plays out for them, but it hasn’t been playing out good so far. I’m sure in retrospect they probably wish they put more aggressive assumptions about losses. It’s definitely worse than they expected, no question about it.”

The LP source added that it’s too early to write off the GMAC deal as a failure and that Cerberus could still “do interesting things” with the company.

Last year, the New York-based buyout shop acquired 51% of GMAC Financial Services after General Motors sold the company’s commercial mortgage business to a consortium ithat included Kohlberg Kravis Roberts & Co., Goldman Sachs Capital Partners and hedge fund Five Mile Capital Partners. The $14 billion deal required Cerberus to write one of the largest equity checks ever for a company, at $7.8 billion. Citigroup and Aozora Bank joined Cerberus to buy Detroit-based GMAC.

Cerberus has 32 portfolio companies, including bus manufacturer Blue Bird Corp. and Spyglass Entertainment, a movie studio, according to Cerberus’s website. In May, Cerberus agreed to pay $7.4 billion to DaimlerChrysler AG for an 80.1% stake in Chrysler, the third largest U.S. automaker.

GMAC isn’t the only portfolio company causing concern for Cerberus. IAP Worldwide Services, a defense contractor based in Cape Canaveral, Fla., has also hit a rough patch. In late October, Moody’s Investors Services downgraded the company’s rating in light of it defaulting on its leverage covenants and insurance coverage. That downgrade confirmed an earlier prediction made by the Standard & Poor’s ratings agency, which placed IAP on its “Weakest Links” list, citing its high risk of defaulting on debt.

However, late last month, the federal Government Accountability Office upheld a protest from IAP and Contingency Management Group, another defense contractor. The two argued that they unfairly lost bids to share in the $150 billion Logistics Civil Augmentation Program. It’s one of the largest U.S. military contracts for housing, feeding, and providing other services to troops in Iraq, Afghanistan and Kuwait. IAP may have another attempt at that contract if the Army follows the GAO’s recommendation to re-evaluate revised proposals from the initial slate of bidders. —Joshua Payne