Why a Fiat-Chrysler Merger Is Great News for Both

The last hurdle to a Fiat-Chrysler merger has been cleared. That's good news for both.

Jan 2, 2014 at 5:59PM

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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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Fool contributor John Rosevear owns shares of Ford and General Motors. You can connect with him on Twitter at @jrosevearThe Motley Fool recommends Ford and General Motors. The Motley Fool owns shares of Ford. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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