Merger and Takeover Activity Chills

Before we get to mergers and takeovers, let's take a quick look at autos. I will tie the two together shortly.

According to Standard & Poor's Ratings Services

automobile sales look set to decline in the world's three largest established markets -- the US, Europe, and Japan -- in 2008, further squeezing global car makers' margins, but said the booming BRIC nations -- Brazil, Russia, India, and China -- hold some hope for growth.

S&P expects North American industry sales to decline to the lowest level in 10 years in the uncertain economic environment, and said the severe downturn in the commercial-vehicle market shows no sign of easing.

However, the BRIC nations, which represent 20 pct of global car sales, are predicted to increase strongly by more than 10 pct per year over the medium term, S&P said.

Yet, even if demand is robust, profitability in China has already sunk to world average levels due to fierce competition, overcapacity, and market fragmentation. It therefore cannot offset the effect of persisting negative industry trends in established markets, S&P said.

Looking ahead to future job growth, the severe downturn in the commercial-vehicle market is one sign of things to come.

Housing is weak, commercial real estate is weak, financials are weak, and we are soon going to find out about retail, in what is expected to be the worst holiday shopping season since 2002.

Chrysler CEO says We're 'operationally' bankrupt.

Chrysler Corp., the troubled automaker bought by private equity just four months ago, is scrambling to sell assets amid indications of huge losses, as access to cash becomes increasingly scarce, according to a published report Friday.

"Someone asked me, 'Are we bankrupt?'" the Wall Street Journal quoted Chrysler boss Robert Nardelli telling employees at a meeting earlier this month. "Technically, no. Operationally, yes. The only thing that keeps us from going into bankruptcy is the $10 billion investors entrusted us with."

To raise money, Chrysler is looking to sell over $1 billion in land, old factories, and other holdings, even if it has to let those properties go for under book value, the Journal said.

Chrysler's owner, Cerberus Capital Management, is now facing serious subprime-related losses from GMAC Financial Services, which it bought from General Motors (GM) for $12 billion, and is also trying to walk away from a now pricey deal to buy United Rentals Inc., (URI) the Journal said.

Cerberus bought Chrysler from German automaker Daimler in a deal that closed in August.

In the arrangement, Daimler (DAI) essentially paid Cerberus to take the automaker, which fell to No. 4 in U.S. sales behind Toyota Motor (TM) in 2006, in an effort to get out from under a $1.5 billion loss from last year, along with continued obligations to union members and retirees

Damage Control by Cerberus

Attempting to undo damage from the above statement, Cerberus issued this statement on Chrysler.

First and foremost, it is important to note that Chrysler is not only meeting, but, in many cases, exceeding its financial targets heading into 2008.

Importantly, Chrysler has ample liquidity.

We are very excited about the new products coming in 2008. These include the legendary Dodge Ram pickup truck, the Dodge Journey crossover, the relaunch of the historic Dodge Challenger -- which has already generated 8,851 customer orders -- and two, all-new, large hybrid SUVs, the Chrysler Aspen and the Dodge Durango, demonstrating our support for the environment and more fuel-efficient vehicles.

I remain unconvinced. Both Cerberus and GM were not thinking clearly. GM had the chance to unload all of GMAC and failed to do so. Cerberus made a huge mistake with GMAC. Cerberus also made a huge mistake in agreeing to buy United Rentals. It can thank its lucky stars they backed out of it. A judge just ruled United Rentals Can't Force $4 Billion Cerberus Buyout.

United Rentals Inc., the largest U.S. construction-equipment rental company, lost a bid to force a $4 billion takeover by Cerberus Capital Management LP when a judge ruled the agreement allowed the buyer to pull its offer.

United Rentals fell 17 percent, after reaching a one-year low of $17.32. More than 10.1 million shares were traded, almost four times the three-month daily volume.

Delaware Chancery Court Judge William B. Chandler III ruled today that United Rentals officials should have known that Cerberus executives believed they had a right to pull out of the deal at any time as long as they paid a $100 million fee.

"There's some clarity here for the private-equity firms that if you have an agreement, you're protected," Steven Kaplan, a professor at the University of Chicago Graduate School of Business, said in a phone interview. "For United Rentals, part of this can't be recovered because it was predicated on debt markets that no longer exist."

United alleged Cerberus's RAM Holdings buyout entities agreed in July to pay $34.50 per share for United Rentals' stock, and reneged on the deal in November amid weakened U.S. credit markets.

The judge concluded that the contract was "ambiguous on account of its conflicting provisions" and involved "a deeply flawed negotiation" process.

Cerberus made a $100 million mistake. I cannot comprehend a proposal to buy a construction-equipment rental company in the midsts of a housing collapse and the start of a decline in commercial real estate. Clearly this collapsed deal as well as GMAC and Chrysler calls into question the overall strategy and management at Cerberus.

Other Buyouts Collapse

Other buyouts have collapsed as credit investors balked at buying bonds and loans committed to fund the transactions. Kohlberg Kravis Roberts & Co. and Goldman Sachs Group Inc. in October abandoned their $8 billion purchase of Harman International Industries Inc.

Investors led by J.C. Flowers & Co. walked away from their $25.3 billion deal to buy SLM Corp., the biggest U.S. education lender, after the Reston, Virginia-based company refused to consider a lower offer.

A suit over Flowers' decision to renege on the offer is pending in Delaware Chancery Court.

The agreements that have fallen apart threaten to "chill" merger activity, said Roy Behren, who helps manage $2 billion at Westchester Capital Management in Valhalla, New York.

Dog Days at Cerberus

BusinessWeek is taking a look at Dog Days at Cerberus.

The bad news for the investment powerhouse keeps coming—and it goes deeper than Chrysler and GMAC.

Cerberus Capital Management sweated for months over its $7 billion bid to buy the construction equipment leasing company United Rentals (URI). With the financial markets in turmoil, the investment management firm pushed hard to renegotiate the price. When that failed, Cerberus abandoned the deal on Nov. 14, just days before it was set to close.

In hindsight, Cerberus' bets on housing, financials, and autos look perilous. It bought GMAC Financial Services, which owns a mortgage lender, as the real estate bubble was bursting.

It's unclear just how much work it will take to fix GMAC, the financing arm of General Motors (GM). A Cerberus-led group paid $14 billion for a 51% stake in September, 2006. Cerberus wasn't exactly an industry newcomer. It had a front row seat at the subprime show with Aegis Mortgage, a lender it took control of in 1996. Yet Cerberus jumped into GMAC at exactly the wrong moment. Price defends the move: "There was one time to buy GMAC. We wanted it and took action."

The short story? Aegis filed for bankruptcy in August, and GMAC's mortgage group ResCap has been bleeding red ink.

"I don't think anyone is panicked," says one Cerberus insider. But "we sure as hell didn't expect GMAC to be what it turned out to be."

In early December, it pulled out of a deal to buy Option One Mortgage (HRB) from H&R Block (HRB) as conditions deteriorated in the housing market. Earlier, Cerberus walked away from its bid for Affiliated Computer Services (ACS), after the ACS's independent directors sought other offers.

Cerberus seems unfazed by it all—and confident that it can turn around the troubled companies. "We believe at the other end of the current deep, dark valley is a sunny one from which we'll emerge with a bunch of great companies," says Price. "We do well in good times and bad."

A rising tide of financial insanity kept the Cerberus boat afloat. What seems to be keeping that boat afloat now is fortunate timing of collapsed deals right before settlement.

Heading forward, those who keep throwing caution to the wind are going to regret it. It's far too early to be bargain shopping.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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