Why a Fiat-Chrysler Merger Is Great News for Both

With Fiat's help, Chrysler products such as Ram pickups have become strong contenders -- and Chrysler's profits have helped carry Fiat. A full merger stands to benefit both. Photo credit: Chrysler

Happy New Year, Chrysler enthusiasts: Italian automaker Fiat (NASDAQOTH: FIATY  ) has made a deal.

Fiat opened 2014 with a bang, announcing on Wednesday that it had completed a deal to acquire a 41.5% stake in Chrysler from a United Auto Workers health care trust. 

The deal will cost $4.35 billion and it's structured in a way that's very favorable to Fiat. It will give the Italian company full ownership of Detroit's third-largest automaker.

Fiat investors liked the news, and the stock was up more than 15% in Milan for much of Thursday. I think they're right to be happy, and I think Chrysler fans should be happy, too. Here's why.

Chrysler wasn't cheap, but was still a bargain for Fiat
On its face, the deal values Chrysler at about $10.5 billion. A skeptical investor could argue that's a little bit rich given Chrysler's heavy reliance on two models -- Ram pickups and the Jeep Grand Cherokee -- in just one market, North America. 

Local rivals Ford (NYSE: F  ) and General Motors (NYSE: GM  ) have somewhat higher valuations, but they're vast global businesses. Chrysler isn't.

But Chrysler's value to Fiat makes this look like a great deal, especially given the structure of the deal that Fiat was able to strike with the UAW trust -- a deal in which profitable Chrysler, and not cash-strapped Fiat, puts up a big portion of the required cash.

But make no mistake, both Chrysler and Fiat needed this deal to happen. Like Chrysler, Fiat is a regional automaker that has to compete with global rivals. Europe's dominant player is Volkswagen (NASDAQOTH: VLKAY  ) , a global colossus with economies of scale that Fiat can't match.

CEO Sergio Marchionne's plan all along has been to merge Chrysler into Fiat to create a truly global automaker. A lot of the groundwork has already been laid given that Marchionne and Fiat have been running Chrysler since 2009. 

Working together, Fiat and Chrysler did an excellent job of overhauling Chrysler's product lineup. The profits from that overhaul have helped offset Fiat's losses in Europe, where auto sales have been mired near two-decade lows.

But Fiat has always said it needs a true merger with Chrysler to fully realize the advantages of the matchup, to share finances, and make long-range investments in products as a single company. A long-running dispute between Fiat and the UAW trust -- one that looked likely to be resolved by a Chrysler IPO for a while -- had the potential to derail the alliance.

But Fiat and the UAW trust were able to strike a deal after all. This deal means that a true Fiat-Chrysler merger is coming. And that will put Fiat -- and Chrysler -- in a much better position to compete globally.

Fiat-Chrysler can now join the ranks of global automakers
Over the last couple of decades, the auto business has become globalized. The "One Ford" plan, where the company bet all of its chips on a small number of global models rather than a large number of regional ones, transformed Ford -- but it wasn't a big innovation. Toyota (NYSE: TM  ) and Volkswagen, among others, have been operating that way for years.

What Ford got out of its plan was what Toyota has always had: massive economies of scale. With fewer models to invest in, Ford could invest more in each. Ford's vehicles became more competitive -- and Ford became more profitable. GM is consolidating its own global product line in a similar way now and it is already paying off for the General.

Separately, Fiat and Chrysler each lack the scale to do anything like that. Fiat is strong in Europe and has a presence in South America; Chrysler is strong in North America and has very little presence elsewhere. Fiat is strong in small cars; Chrysler is strong in trucks, SUVs, and larger cars.

Separately, they lack scale, but they're very complementary. Put them together -- and remember, Fiat and Chrysler have spent the last four-plus years showing that they work very well together -- and you have something resembling a global automaker. 

I say "something resembling" because neither has a major presence in China, at least not yet. But between them they have several brands -- Jeep, Alfa Romeo, Maserati -- that could do very well in the world's largest auto market.

Fiat and Chrysler are already making some investments in China, but uncertainty over their alliance held them back. With this deal, which is structured to be affordable for Fiat, the mashed-up Italian-American automaker should be able to make good progress in China and find a whole lot of efficiencies elsewhere. 

The upshot: a good thing all around
To be blunt, Chrysler and Fiat didn't have much chance of thriving long term on their own. The dispute with the UAW trust that looked likely to lead to a Chrysler IPO was intriguing to some investors, but it wasn't good news for either company.

The merged company will still face big challenges. It's under heavy pressure in Europe, it doesn't have a commanding position in the U.S., and it's way behind in China. But together, Fiat and Chrysler have a good opportunity to carve out a profitable global niche that neither could have managed on its own. Already, 2014 is looking like a pretty good year for both.

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Read/Post Comments (7) | Recommend This Article (4)

Comments from our Foolish Readers

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  • Report this Comment On January 02, 2014, at 7:41 PM, LouisTewl wrote:

    Thanks for the news, John! A couple of questions for you-

    1. You say, "On its face, the deal values Chrysler at about $10.5 billion." I am assuming that's an extrapolation from the actual $4.3 B they are paying for the remaining 41.4616% they don't already own-which has been characterized as a real coup for Chrysler- and with Fiat's stated portion to be by Fiat out of paid by cash on hand. Yes, Fiat does have a fairly high debt ratio-and they also have a lot of cash on hand.

    2. You also say, "Fiat is strong in Europe and has a presence in South America." Are you unaware that Fiat has also operated in India for years, and has already had plans, with Chrysler, to expand that presence? Perhaps a quick look at this interview from July 29th, 2013 with the head of Fiat Chrysler in India will help clarify things for you:

    http://www.thehindu.com/business/Industry/the-market-is-ther...

    Apparently they were unaware of their inability to resemble a global automaker.

    Other than that, with the understanding that TMF, and you, must cast every story against your long positions in Ford and GM, your reporting is fairly accurate, but, somewhat short on prognostication, so, I'll do that here, and say (again) that FIATY will outperform both, as a stock, this year, as well as over the longer term.

    Thanks for the timely article.

  • Report this Comment On January 02, 2014, at 8:46 PM, TMFMarlowe wrote:

    1. Yes. Hence the "on its face". If you pay $4.35B for 41.5ish% of a company, it seems fair to say that you're valuing the company at around $10.5B. And I do think that seems a little rich for Chrysler -- unless you're Fiat, in which case it's a bargain, as I think I explained.

    2. I am aware that Fiat has something like an 0.5% share of the (still very small) Indian auto market, selling just over a thousand vehicles a month in recent months. (Market leader Maruti Suzuki has lately been selling around 90k a month, second place Hyundai 30-35k a month.) I'm not sure why you'd think that would be worthy of mention, or what that has to do with my real point -- that Fiat/Chrysler needs to get going in China.

    To your larger point, owning F and GM doesn't predispose me either way toward FIATY's chances in 2014 and beyond. Having loved both Fiat and Chrysler products in the past, as a car enthusiast I emphatically hope the merged entity succeeds. But

    as an investor, the picture is more complicated. The whole company is basically living off Rams and Grand Cherokees right now, and that's not sustainable. I'll dig into it in more detail soon, and look forward to your comments then.

    John Rosevear

  • Report this Comment On January 03, 2014, at 10:46 AM, LouisTewl wrote:

    Fair enough, JR-I think we can agree to disagree, except that, in India, as in my above-referenced interview article, they are rebuilding their dedicated Fiat dealership network, and, after the merger Fiat-Chrysler will be the 7th largest auto manufacturer in the world, just above Honda in size, and, Fiat is already in plans to again bring the Alfa Romeo back to the U.S., which will further help their Italian plants-of course none of this includes the JV Fiat is already involved in with the Chinese in...(wait for it)..China!

    My point is that, in my opinion, the pieces are in place, and it's really not that complicated. I am optimistic, and I will look forward to your further work on my favorite investment.

  • Report this Comment On January 04, 2014, at 3:43 PM, SkepikI wrote:

    <as a car enthusiast I emphatically hope the merged entity succeeds. But

    as an investor, the picture is more complicated. The whole company is basically living off Rams and Grand Cherokees right now, and that's not sustainable.>

    For decades I was a Chrysler guy. I admired Lee I. more than nearly anyone in business. Chrysler is a two time loser. I will NOT stick around as an investor of buyer for a third round. If you ignore the warnings and do, I have no sympathy. So will Fiat perform well in the short? Maybe. Do I care NO. too risky and too clueless.

  • Report this Comment On January 04, 2014, at 3:45 PM, SkepikI wrote:

    Though I disagree with your kind treatment of Chrysler and the deal, JR, its an interesting article that I read twice to be sure I understood the deal. Well worth a read, and the commentary is interesting as well.

  • Report this Comment On January 05, 2014, at 4:26 PM, LouisTewl wrote:

    My comment above about your assumed extrapolation of the full valuation for Chrysler paid by Fiat is because the previous 58%~ of Chrysler already owned by Fiat was purchased in stages according to the agreement already in place, and I would argue that it is logical to assume that Fiat paid more to acquire this final 41%~ in one fell swoop, and therefor your valuation of $10B~is overly simplistic and an expression of a knee-jerk bias against F/C, which I have already mentioned in my comments above.

    Further, re India, and the potential of that market for F/C, Fiat also already supplies the diesel engines for both Suzuki and Tata vehicles there.

    The one final comment I wanted to make, JR, is that many of the positive actions F/C has been taking have been very much under-publicized by F/C while they were in their parallel process of negotiating the lowest purchase price for the remainder of Chrysler, and that these strategic actions will become much more apparent after this transaction is finalized.

    The full NYSE listing is expected this year, with a possible convertible offering at that time to reduce Fiat's debt ratio, and, in my opinion, all systems are go.

    Thanks again.

  • Report this Comment On January 09, 2014, at 4:09 AM, masaerati123 wrote:

    SkepikI,as an investor,I think you are wrong in not investing in Chrysler/Fiat at this time.I actually think this is the best time to invest.The Cherokee,Maseratis,Feraris,Rams and 500's are doing very well.If a company can do what Chrysler/Fiat did in 4 years after coming out of bankruptcy,repaying the government debt,then paying 4 billion plus to buy the remaining shares,this is really awesome.It does not matter where the funds are or where they will come from,the point of the matter is that it was done,now the two companies can move ahead with what good car companies do,make good cars.You must also remember Chrysler had many old dead stock,and to get the Ram and Jeeps to this position is truly remarkable,just imagine what they can do now.

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