With the announcements this morning that Cerberus Capital Management LP, a $24 billion investment firm, will buy 80.1% of Chrysler for $7.4 billion, it's officially a trend that private equity is in the driver's seat. Cerberus already owns 51% of General Motors Corp. (NYSE: GM)'s GMAC -- the Finance unit -- and Ford Motor Co. (NYSE: F)'s founding family wants to sell out. Why does private equity find the automobile business so appealing?
There's an interesting side issue going on here: founding families are realizing that now is the time to sell. This topic is being covered in excruciating detail [subscription] with the proposed merger between News Corp. (NYSE: NWS) and Dow Jones & Company Inc. (NYSE: DJ).
Founding families have it great. They can clip million dollar annual coupons and spend their time riding motorcycles and playing tennis. But selling out means giving up on that lifestyle. So the willingness of founding families to sell spells trouble for public equity investors. Here's why:
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Unstoppable business and stock slowdown. In the automobile and newspaper industries, new management, new strategies, and restructuring have all failed to revive sick companies with stagnant stock prices. For investors, this means that unless you can find a company in the industry that is bucking the trend -- such as Toyota Motor Corp. (NYSE: TM), you should get out.
- Realization that takeout prices can only go down from here. Founding families are realizing that the availability of equity and debt to finance going private is so high that they will likely never be offered a better price to take their money and run. Given the deteriorating condition of the companies that finance those dividend checks, many founding families are beginning to recognize that now could be the best time to get out.
As far as why private equity finds the automobile industry appealing right now, there are a few possibilities:
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Private cost cutting. According to Bloomberg News, Cerberus -- which is buying an operation that lost $672 million last year -- expects to profit on its investment by reducing wages and paring pension expenses.
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Resolving founding family conflicts. If a private equity firm offers a high enough price, the generational conflict between the founding families' aged parents and their children -- such as the one facing Ford -- could be resolved. Unfortunately, the higher the price, the harder it is for the private equity firm to make an attractive return.
Thus private equity might be best off buying bonds and seeking to control the company out of bankruptcy. And ultimately it is the threat of bankruptcy that could focus the minds of both generations. With private equity in the driver's seat, the future does not look good for public shareholders in the automobile industry.
Peter Cohan is President of Peter S. Cohan & Associates, a management consulting and venture capital firm. He also teaches management at Babson College and edits The Cohan Letter. He has no financial interest in the securities mentioned in this post.
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