Blackstone, Cerberus Collide as Buyout Firms Overrun Detroit
By John Lippert

April 27 (Bloomberg) -- The decision had been made. DaimlerChrysler AG's management in Stuttgart, Germany, weary of the struggle to keep its U.S.-based Chrysler unit in the black, was ready to sell. In March, Chrysler Chief Executive Officer Thomas LaSorda organized separate daylong briefings for prospective buyers. They continued their discussions during steak and seafood dinners at the Walter P. Chrysler Museum in Auburn Hills, Michigan -- in a gallery decorated with World War II jeeps.

LaSorda's guests weren't from Toyota Motor Corp. or General Motors Corp. They were Neil Simpkins of Blackstone Group LP and Lenard Tessler of Cerberus Capital Management LP, New York-based private equity firms that have been involved in some of the biggest leveraged buyouts of the past decade.

LaSorda threw a separate dinner for Donald Walker, co-chief executive officer of Magna International Inc., a Canadian parts supplier that entered talks with Onex Corp., Canada's biggest buyout firm, on a joint bid for Chrysler.

Private equity firms have invaded the Motor City, bringing with them piles of cash and gales of controversy. The buyout firms say they'll rescue companies like Chrysler from years of bloat and mismanagement. Their opponents say that Wall Street financial operators will dice up and sell off automakers and suppliers, after loading them up with debt, destroying jobs and hastening the demise of a once-great American industry.

A Laboratory of Finance

Detroit, the cradle of modern American industry since Henry Ford started his first assembly line 94 years ago, is now a living laboratory for the latest techniques in 21st-century finance -- potentially risky combinations of bonds, loans and derivatives complex enough to baffle the most-seasoned observers.

``Most investors I talk to are very concerned, but they're not strong enough to stop it, so the train keeps rushing down the tracks,'' says Edward Altman, finance professor at New York University's Stern School of Business and a bankruptcy expert whose book, ``Corporate Financial Distress and Bankruptcy'' (John Wiley & Sons, 354 pages, $95) is in its third edition.

Private equity and hedge funds are swarming over bankrupt suppliers such as Delphi Corp. and Tower Automotive Inc., the world's biggest maker of vehicle frames. They're buying every financial obligation these companies have -- from common stock to unsecured bonds, to bank loans, to trade receivables -- and repackaging them for sale on secondary markets.

Buyout firms borrow as much as 90 percent of the purchase price of a target company and repay the loans from the company's cash flow, says Altman, 65. ``I've never seen conditions like this in all my life,'' he says. ``The country and the world are becoming so leveraged at all levels that there's a volcano brewing. I don't know when it will happen, but the rumblings are here.''

Seven Bankruptcies

Almost all of the big leveraged buyout names are in Detroit, where seven major suppliers have declared bankruptcy in the past two years, according to Barry Ridings, co-head for restructuring at New York-based Lazard Ltd. Billionaire Carl Icahn offered $5.3 billion for Lear Corp., a maker of auto seats that has not declared bankruptcy. Wilbur Ross, another billionaire investor, rolled up auto parts companies in the U.S., Japan and Brazil into his own $6 billion industrial giant, including pieces of Collins & Aikman Corp. and Lear. David Rubenstein's Washington-based Carlyle Group joined with others to buy the Hertz Corp. car rental company from Ford Motor Co. and has invested in Tower.

And when DaimlerChrysler CEO Dieter Zetsche confirmed he was negotiating to sell Chrysler, Kirk Kerkorian of Tracinda Corp., with great fanfare, made an offer of $4.5 billion.

Billions Invested

The March dinners weren't the first Detroit forays for Stephen Schwarzman's Blackstone and Stephen Feinberg's Cerberus either. In December, Cerberus led a group that bid $3.4 billion for most of Delphi, the parts company spun off by GM in 1999 that declared bankruptcy in 2005. Delphi had $26.4 billion in 2006 revenue.

Cerberus purchased a 51 percent stake in General Motors' finance unit for $7.4 billion in cash in 2006. Blackstone bought TRW Automotive Inc., the biggest maker of vehicle safety systems, from Northrop Grumman Corp. for $4.7 billion in 2003.

Private equity and hedge funds will have invested hundreds of billions of dollars in the U.S. auto industry by 2009, says Kimberly Rodriguez, a principal in the Southfield, Michigan, office of accounting firm Grant Thornton LLP.

The invasion signals the depths to which Detroit has fallen and the heights to which the buyout firms have ascended. Private equity firms raised a record $432 billion last year, according to London-based researcher Private Equity Intelligence Ltd.

Hedging Auto Parts

Hedge funds, which have substantial investments in auto industry stocks and bonds, doubled their assets to more than $1.4 trillion in five years to the end of 2006, according to Chicago- based Hedge Fund Research Inc.

``As the damage grows in Detroit, it's claiming even bigger companies like Chrysler,'' says John Casesa, managing partner of New York-based consultant Casesa Shapiro Group LLC. ``At the same time, there's so much capital in the hands of private equity funds, there's virtually no company too big for them to buy.''

Compared with recent deals, Chrysler would be a medium-sized bite. On April 2, Kohlberg Kravis Roberts & Co. agreed to buy First Data Corp., the world's largest processor of credit card payments, for $29 billion. And that was just the second-biggest buyout offer for the year, after KKR's February $45 billion bid for Texas electric utility TXU Corp.

The First Data offer took New York-based KKR's planned spending over $100 billion for a six-month period. Meanwhile, in mid-April, New York-based private equity firm JC Flowers & Co. and San Francisco-based Friedman Fleischer & Lowe announced a deal to acquire SLM Corp., better known as Sallie Mae, for $25 billion, with JPMorgan Chase & Co. and Bank of America helping to underwrite the purchase of the U.S.'s largest provider of student loans.

Competing With Toyota

DaimlerChrysler is seeking $8 billion for its U.S. unit, which last year lost $1.5 billion on revenue of $62.2 billion. Daimler-Benz AG paid $36 billion for Chrysler in 1998.

Private equity executives say they're just what Detroit needs as it struggles to compete with the likes of Toyota, which has seen its U.S. market share swell to 15.7 percent, up from 7.3 percent in 1995. Toyota's first-quarter global sales rose 9.2 percent to a record 2.35 million vehicles, the company said on Wednesday, surpassing GM's 2.26 million. The Japanese automaker expects to overtake GM as the world's biggest carmaker this year.

``I don't know if the public company model is broken, but it's gotten a lot more challenging,'' Dan Quayle, 60, chairman of Cerberus's international unit and vice president under the first President George Bush, told an investor conference in New York in February. In an interview after the conference, he added, ``We view ourselves as very good at restructuring, at taking on challenges and working through them, whether they're management, union or equity issues.''

The New Carnegies?

Wilbur Ross, CEO of New York-based W.L. Ross & Co., likens himself and other private equity operators to the entrepreneurs who built the U.S. steel, railroad, oil and banking industries. ``You can argue that the private equity community is the new industrial community,'' says Ross, 69, speaking from his 19th- floor office above Lexington Ave. ``In a sense, we've come full circle. You had Carnegie, Fisk, Mellon, Vanderbilt, Rockefeller and people like that. You can call them Wall Street people, but they were really at the end of the day industrialists.''

Basil ``Buzz'' Hargrove, president of the Canadian Auto Workers union, says the buyout binge will only produce unemployment. ``We see private equity as cutting and slashing so they can sell the company and make a lot of money at the expense of people's jobs and livelihoods,'' says Hargrove, whose union represents 11,500 Chrysler workers. He opposes a Chrysler takeover by private equity.

Unions Fight Back

Lew Moye, bargaining chairman of United Auto Workers Local 110 at a Chrysler minivan plant in St. Louis, is concerned that a new owner will break up the company. ``We don't know if we'll wind up in a big fight if an equity fund takes part of the company, like Jeep, and splits it off,'' he says.

It's the second time around for one of the Chrysler bidders, Kirk Kerkorian. In 1995, Kerkorian, 89, made a hostile offer that Chrysler rebuffed. Jerome York, once chief financial officer of Chrysler and now a Kerkorian lieutenant, made the current offer in an April 5 letter to Zetsche.

``Tracinda intends to build and strengthen Chrysler as an independent entity by partnering with the UAW and senior management,'' York wrote.

Chrysler's current troubles are a reprise of a 1979 crisis that almost forced it into bankruptcy; the company was saved by a government loan guarantee. Lee Iacocca, Chrysler CEO from 1979 to '93, then led the company to prosperity by popularizing minivans.

Buy Fast, Sell Fast

Bo Andersson, group vice president of purchasing at GM, sees opportunities and threats in the private equity incursion. ``Hedge funds and venture capital bring money to restructure and have higher expectations of management than most other people,'' he says. ``What I don't like is they're very short-term focused; they buy companies fast and sell companies fast.'' Andersson says he's concerned that buyout firms will consolidate the parts industry and boost prices. To prevent that, he says, he has at least two sources for everything GM buys.

``I've said this to Wilbur Ross; I've said it to other people, 'You think you can hold us hostage?''' Andersson says.

Private equity funds have been prowling around Detroit since Iacocca's time. New York-based Forstmann Little & Co. bought a predecessor to Lear in 1986 and sold it to the company's management two years later. Dealmaker Roger Penske, a former race car driver, bought an 80 percent stake in GM's diesel operations for an undisclosed price in 1988 and sold it to DaimlerChrysler for $583 million 12 years later.

Profiting from Axles

Blackstone paid $650 million for American Axle & Manufacturing Inc. in 1997 and then sold its interest through public stock offerings. The stock went public at $17 a share in January 1999. It had risen to $40.76 by the time Blackstone sold its last shares in December 2003.

One 2001 buyout resulted in criminal indictments. On March 26, David Stockman, former budget director for Ronald Reagan and more recently senior managing director of buyout firm Heartland Industrial Partners LP, was charged with securities fraud. After Heartland took Southfield, Michigan-based Collins & Aikman private, the company deteriorated as the cost of materials rose and its biggest customers, GM and Ford, cut production. Stockman is accused of concealing the malaise. He and three others pleaded not guilty, while four co-defendants admitted guilt and are likely cooperating with prosecutors, Stockman's lawyer, Elkan Abramowitz, told Bloomberg News on March 26.

Delphi's Pivotal Role

Delphi's bankruptcy in 2005 opened the floodgates for the buyout crowd, says David Cole, chairman of the Center for Automotive Research in Ann Arbor. ``This was the pivot point when it became real to people inside Detroit that we couldn't escape a painful restructuring,'' Cole says. Delphi declared its U.S. operations bankrupt after failing to win concessions from unions and financial aid from GM.

Detroit is a magnet for private equity because its assets are cheap, says Thomas Stallkamp, a partner in the New York-based buyout firm Ripplewood Holdings LLC. Automotive suppliers command a premium of five to seven times earnings before interest, tax, depreciation and amortization, or Ebitda, says Stallkamp, 60, a former Chrysler president. That compares with premiums of eight to 10 times Ebitda a decade ago.

In September, Ripplewood's Asahi Tec Corp. of Shizuoka, Japan, bought Plymouth, Michigan-based Metaldyne Corp. for $1.2 billion. Both companies make engine and chassis parts.

Bankruptcy, Consolidation

Lazard's Ridings says the bumpy ride for the auto industry is just beginning. ``Detroit is going to go through two phases, and we're now in the middle of phase one, in which there are a lot of bankruptcies and restructurings,'' Ridings says. ``Then comes phase two, in which we'll have a consolidation.''

One of the consolidators is Wilbur Ross. He says bankruptcies in Detroit give investors like himself a chance to solve problems dating back a century. For plastics suppliers, he says, the issue is fragmentation. Too many companies use 60 percent of their manufacturing capacity and sell to only one automaker in just one region, he says. And too many, he adds, made pension and health care promises without figuring the cost.

``It's almost as though the managements were saying, 'I'm going to retire in five or 10 years. I'll have labor peace, and then it will be someone else's problem,''' Ross says.

Ross jumped into the parts industry in 2005, when he acquired interiors and wiring factories from Collins & Aikman and Lear. The interiors unit of his International Automotive Components Group North America LLC now has 21,000 employees in 16 countries. He's closed factories in the U.K. and Germany and shifted production to the Czech Republic and China.

$50 billion Revenue?

``We want to have facilities everywhere where it's logical for people to make cars,'' Ross says. ``They need to be relatively low cost.'' Speaking slowly, with clear blue eyes watching to make sure he's heard, he says within a few years he could boost his auto parts revenue to $50 billion from $6 billion today.

During 26 years at Rothschild Investments LLC, Ross reorganized nine of the 25 largest bankrupt companies in the U.S., including Texaco Inc. and LTV Corp. After striking out on his own in 2000, he rolled up five bankrupt steelmakers and sold them in 2005 to Rotterdam-based Arcelor Mittal Steel Co. for $4.5 billion.

Ross formed the International Coal Group Inc. in 2004 from bankrupt mines. In March, the company shut down its Sago Mine in West Virginia, where 12 workers died after an explosion last year.

Like Ross, Cerberus's Feinberg keeps an eye out for auto parts companies that go bankrupt, Rodriguez says. The buyout fund owns sealing, fabric and plastic parts companies in the U.S. and Europe, the Alamo and National rental car chains, plus GMAC LLC. In April, Delphi announced that Cerberus was considering withdrawing its bid for the company because of concerns about labor costs and Delphi's ability to grow.

Feinberg: Drexel Alum

Feinberg, 47, a trader at Drexel Burnham Lambert Inc. in the 1980s, started Cerberus with $10 million in 1992. He's built it into a $24 billion powerhouse that also owns Albertson's LLC supermarkets and IAP Worldwide Services Inc., one of the largest providers of logistics support to the U.S. Army in Iraq. He declined to comment for this article.

Feinberg has plenty of appetite for risk. One example is his pursuit of GMAC, which makes car loans for GM and runs mortgage and insurance businesses. Cerberus was a latecomer in the bidding, says Sanjiv Khattri, 42, GMAC's CFO. GM sold GMAC to raise cash after its credit rating fell to junk and it lost $10.4 billion in 2005. KKR was in a strong position to buy GMAC because it led a group that bought the finance company's commercial mortgage unit for $8.8 billion in August 2005. Cerberus also had to work hard to parry a possible bid from Berkshire Hathaway Inc.'s Warren Buffett, Quayle says.

Cerberus's 'Iron Stomach'

Cerberus moved quickly to the forefront. When one of its bank partners pulled out, Cerberus found new financing in 24 hours. The firm negotiated with GM over a weekend to transfer $20 billion of GMAC's riskiest auto leases to the automaker's own balance sheet, Khattri says.

Cerberus's trump card was its willingness to continue as exclusive financier for GM vehicles for 10 years. The risk: If GM sales continued to decline, so would GMAC's earnings. ``They do have an iron stomach,'' Khattri says.

GM's North American production did fall 15.3 percent in the first quarter of 2007, to 1.06 million vehicles. GMAC has also been hit by the subprime mortgage crisis. On March 14, GM refunded $1 billion to Cerberus to cover underperforming subprime loans that had pushed GMAC's book value below a level specified in their purchase agreement.

To minimize future losses, GMAC cut back sharply; it made $6.9 billion of ``nonprime'' loans in the fourth quarter, a 43 percent decline from the same period in 2005, the company said in a regulatory filing. Lehman Brothers Inc. analyst Brian Johnson predicts GMAC's pretax income will drop 23 percent this year to $1.7 billion on subprime losses and then grow to $4.3 billion by 2012 on auto financing and insurance.

Ex-Paratrooper

Feinberg, who has a bachelor's degree in politics from Princeton University, learned to measure physical risk while serving as a paratrooper in the U.S. Army's Reserve Officers' Training Corps. When he made his pitch for GMAC in Detroit, it was tinged with patriotism. ``Steve is a very proud American,'' Khattri says. ``He's proud of American institutions, and he considers GM to be an American institution. For him, it was more than just about making a lot of money.''

Feinberg's GMAC bet helped save GM CEO Rick Wagoner's job, a person familiar with the situation says. At the time, Kerkorian, who owned 9.9 percent of GM's shares, was pushing the board to fire Wagoner. In early 2006, after Feinberg agreed to invest in GMAC, relieving the company's financial strain, GM's board gave Wagoner a public vote of confidence.

Kerkorian has since sold his GM shares--and may have pocketed a $106 million profit, according to documents he filed when he bought and sold stock.

Tower's Rise and Fall

Tower Automotive is a good example of the financial complexity that's overtaken Detroit, Rodriguez says. The Novi, Michigan-based company was incorporated in April 1993 by Hidden Creek Industries, a Minneapolis-based private equity firm. Over the next decade, Tower made 14 acquisitions, giving it factories from Detroit to Belgium to China. Revenue rose 40-fold, to $3.2 billion in 2004. Long-term debt rose to $1.1 billion in 2003 from $70 million in 1995.

Disaster struck in 2001. Tower started losing money as Ford and GM cut production and demanded price cuts of 3-5 percent a year. When Tower declared bankruptcy in February 2005, the company reported assets of $788 million and liabilities of $1.3 billion.

Kathleen Ligocki, Tower's CEO, said in a press release that she'd been forced into insolvency by debt that was unsustainable and laced with conditions that constrained her ability to manage. Ligocki moved to Tower in 2003 after five years at Ford, where she was vice president for customer service.

Hedge Fund Loan

Among Tower's debts was a $155 million loan from two dozen hedge funds at an interest rate that reached 13.6 percent by December 2004. The funds included New York-based Xerion Capital Partners LLC. Daniel Arbess, founding partner of Xerion, says he was confident he wouldn't lose money. That's because the loan was secured by Tower's overseas factories, which are not insolvent. Moreover, several funds were then shorting Tower's stocks and bonds, a person familiar with the situation says.

Arbess, 46, who won't say whether he was short on Tower, says there's nothing wrong with investors betting against companies to which they also loaned money. ``If one part of the capital structure is overvalued while another offers an attractive return, there's no reason why we would not short the overvalued security,'' Arbess says.

Notes, Shares Plunge

At Tower, the short sellers won. The 12 percent notes due in 2012 that were issued by a subsidiary called RJ Tower Corp. sold for seven cents on the dollar yesterday, down from 93 cents six months after the bankruptcy. Tower's shares sold for five cents yesterday, down from $2.88 at the time of the bankruptcy and $28.25 in 1999. Since the bankruptcy, Tower has closed half of its U.S. factories.

Since opening Xerion in 2003, Arbess, an attorney who was trained in corporate restructurings at New York-based law firm White & Case LLP, has spent hundreds of millions of dollars buying stocks and bonds in 10 auto suppliers, including Tower. He says he and other hedge fund operators, by cutting off what he calls ``the drug of excess leverage,'' are helping impose discipline Detroit needs to face low-wage competition.

``These activist investors are forcing medicine to be taken that will lead to greater competitiveness in Detroit, and that will result in more jobs being saved,'' he says.

On March 28, Tower accepted a $1 billion offer from Cerberus for its assets. The bankruptcy court invited additional bidders to participate in a June 25 auction.

Carving up Delphi

Delphi is also being carved up. Before being spun off by GM in 1999, the company made everything from fuel injectors to oil filters to receivers for satellite radios. By the time of its 2005 bankruptcy, less than a quarter of its 185,000 employees worked in the U.S. Since then, private equity investors have bought chunks of Delphi, while hedge funds feasted on its shares and bonds.

David Tepper, 49, president of Chatham, New Jersey-based hedge fund Appaloosa Management LP, bought 52 million Delphi shares immediately after the bankruptcy for as little as 30 cents each. The shares sold for $2.57 yesterday. Tepper, who declined comment, had joined Cerberus's $3.4 billion bid for Delphi's assets. He and other investors are now looking for a new partner.

Cerberus may have dropped out of the bidding for Delphi partly because of the hard stand its workers are taking. To obtain UAW agreement for the 1999 spinoff, Delphi agreed to match the pay of GM factory workers. This averaged $73.26 per hour in pay and benefits last year. Most longtime Delphi workers have since taken buyouts.

Fight Over Wages

The union has agreed that unskilled workers hired since 2004 will earn $27 an hour and $42 by 2011, a person familiar with the situation says. Cerberus told the union it wouldn't pay that much, since it's double the pay at other U.S. parts companies, the person says.

A fight could also be brewing at Delphi's interiors unit, which the company agreed in February to sell to Ira Rennert's New York-based Renco Group Inc. for an undisclosed price. The unit, which makes auto cockpits and door parts, had revenue of $1.3 billion last year.

A Brooklyn native, Rennert, 72, earned an MBA from New York University in 1956. He built Renco in the 1980s and '90s by buying up companies and funding the purchases through issuance of $1 billion in high-yield bonds. From 1996 to '98, five Rennert companies sold $975 million of bonds, and Renco collected $311.5 million of the proceeds in the form of dividends, according to the securities' prospectuses.

Humvee Stake

Renco now has revenue of more than $2 billion, according to its Web site. This includes a stake in AM General Corp., which makes Humvees for the U.S. military, and WCI Steel Inc., which emerged from bankruptcy last year.

In February, the Pension Benefit Guaranty Corp. sued Renco, seeking corporate assets including Rennert's 29-bedroom Sagaponack, New York, mansion, to cover pensions for employees and retirees of WCI. Renco settled the dispute by contributing $95 million to the pensions; the company said in a statement it should be given credit for owning up to its responsibilities.

``Rennert's a corporate raider; he has no morals,'' says Mark Sweazy, president of UAW Local 969 at a Delphi door lock factory in Columbus, Ohio. Sweazy cited the WCI pension as evidence. ``Rennert might want to slice and dice our contract, but he might be in for a shock when he comes to Columbus,'' Sweazy says. ``There's the old thing about holding your ground.'' Dennis Sadlowski, one of Rennert's attorneys, didn't return calls seeking comment.

Buyout Poster Boy

Workers at Delphi's steering components unit are more enthusiastic about their prospective buyer, Beverly Hills-based Platinum Equity Holdings LLC, headed by Tom Gores. He offered to buy the unit, which has 10,000 employees in 22 factories and took in $2.6 billion in revenue in 2006, for an undisclosed sum in January.

Workers in Saginaw, Michigan, have the buyout baron's photo posted everywhere inside their factory, says Erica Malicoat, 23, who makes metal shafts and housings for steering columns. The photo shows a hairy-chested Gores with his shirt open, a two-day growth of beard and an earring dangling from his left lobe. Gores, 42, is an Israeli Christian whose family moved to Flint, Michigan, when he was five. Since 1995, he's acquired 72 companies, mostly in software, telecommunications and logistics. ``We're very impressed with management in Delphi's steering business,'' says Mark Barnhill, a Platinum senior vice president. ``We believe we can work with them to build a business that's profitable and positioned for growth.''

`We Sweat, Run'

Malicoat hopes Gores succeeds. She started at the Saginaw plant in July, one of 2,200 replacements for longtime workers who took buyouts. She says the six workers in her group make as many shafts and housings per day as 12 of the longtime workers. ``We sweat, we run, we work hard every single day,'' she says. ``We do not want our jobs to leave this place. This is our home.''

Workers such as Malicoat shouldn't place their hopes for salvation in private equity, NYU's Altman says. ``Would Blackstone have a viable program for Chrysler that's any different from what's there now?'' Altman asks. ``Probably not. The only thing they could do is move more aggressively to sell the company to someone else.''

Stuart Gilson, a restructuring professor at Harvard Business School in Cambridge, Massachusetts, says buyout and hedge funds are sweeping through Detroit so rapidly and with such a complex array of new investment tools that it's too soon to tell whether they'll be healthy or harmful. ``I wouldn't want to bet money either way,'' he says.

In the Balance

Hanging in the balance once again is Chrysler--the living symbol of the rise and fall of the U.S. auto industry. Walter Chrysler founded the company in 1925 and expanded it in 1928 when he bought Dodge Brothers Co. from investment bank Dillon Read & Co. Since the 1970s, the company has weathered near-bankruptcy, a government bailout and a disastrous merger with the Germans. Its fate will now likely be in the hands of people whose idea of engineering is inventing a new kind of debt -- not a new way to make a car.