Chrysler deal a key test for private equity

The deal that gives control of auto giant Chrysler Group to private equity firm Cerberus Capital Management may be a defining moment for the new “masters of the universe” -- the buyout chieftains who are sweeping large chunks of corporate America into their portfolios.

How Cerberus handles Chrysler also could shape, or reshape, the public image of buyout firms at a time when their growing power has raised concerns about their long-term effect on the health of the U.S. economy.

Chrysler “is such an icon, it’s going to be the clearest test yet” of the idea that private equity buyers know best how to focus companies for long-term success, said Colin Blaydon, director of Center for Private Equity and Entrepreneurship at Dartmouth College.

By shelling out $7.4 billion for an 80.1% stake in Chrysler, Cerberus Chief Executive Stephen Feinberg and his team are betting that they have the answers that Germany’s Daimler couldn’t find in nine years of trying.

When “the solution is private equity” for a global brand such as Chrysler, “that’s a powerful statement on how big a part of the financing and [acquisition] landscape private equity has become,” said Mario Giannini, chief executive of Hamilton Lane, which helps institutional clients pick private equity investments.

The deal for Chrysler is the latest in a wave of takeovers by private equity firms in recent years. Flush with cash from investors such as pension funds and wealthy individuals, and using borrowed money on top of that, private equity firms worldwide have announced buyouts worth $355 billion this year, up from $163 billion in the same period of 2006, according to Dealogic.

The goal is to buy companies that aren’t living up to their full potential, transform them into better businesses in a matter of a few years and then sell them or take them public again at a handsome profit.

The struggling auto industry has become a natural target for private equity investors because of the potential for a hefty longer-term payoff -- if the buyers can rejuvenate the companies.

That makes Detroit a high-stakes experiment for these investors.

Josh Lerner, a professor of investment banking at Harvard University, said that although Cerberus faced major hurdles with Chrysler -- particularly with the high cost of its labor force compared with Asian rivals -- “you also can say this is a classic private equity situation.”

Chrysler, Lerner said, “is really an underperforming company, with a board that is paralyzed by factionalism and the sense that they don’t know how to handle the situation.”

By contrast, Cerberus’ expertise is in spotting the potential in distressed securities and companies, said Kelly Deponte, a partner at Probitas Partners, a San Francisco-based firm that helps private equity firms raise money.

Cerberus, founded in 1992, is no stranger to the auto industry. The portfolio of companies the investment firm has accumulated in recent years includes auto parts firm GDX Automotive as well as a majority stake in General Motors Corp.’s GMAC financing unit. Cerberus also owns the parent company of Alamo Rent A Car and National Car Rental.

In March the firm agreed to buy beleaguered auto parts maker Tower Automotive Inc.

Cerberus Chairman John W. Snow, a former Treasury secretary in the Bush administration, said Monday that the company pursued Chrysler because it “believes in the inherent strength of U.S. manufacturing and of the U.S. auto industry.”

In the case of companies that need extreme makeovers, one argument in favor of private equity ownership over the public-company model is that the financial reward for private equity managers is directly tied to their success in revamping the business.

“Because of the financial incentives, it makes private equity buyers more flexible in how they deal with the issues and what kind of solutions they might find,” said Antoinette Shoar, an associate professor of economics and finance at Massachusetts Institute of Technology.

But a key question is what cost private equity managers will exact from workers in the battle to boost a company’s bottom line.

Concerned about private equity investors’ growing clout, some unions are trying to pressure the firms to preserve jobs and let workers partake of the financial benefits of successful restructurings.

The Service Employees International Union, which represents certain government and healthcare workers, is scheduled to testify Wednesday before Congress about the effect of the private equity boom on companies and workers.

“You have a relative handful of companies that have extraordinary influence on the lives of literally millions of workers,” said Stephen Lerner, an organizer at SEIU. “There’s a choice for private equity, which is to say, ‘Yes, we do have a broader responsibility to makes things better,’ or they can say, ‘All we care about is making money and tough luck’ ” for those who get hurt.

Yet some experts say that if private equity investors weren’t willing to take a chance with struggling companies, failure and liquidation might be the only alternative.

The history of private equity investors “is not perfect, but over the last few years they’ve given a new lease on life to a number of companies and industries,” said David Stowell, an associate business professor at Northwestern University.

tom.petruno@latimes.com

walter.hamilton@latimes.com

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Back story

Name: Cerberus Capital Management

Founded: 1992

Headquarters: New York

Chief executive: Stephen Feinberg

Other executives: Former U.S. Treasury Secretary John W. Snow is chairman. Former U.S. Vice President Dan Quayle is head of the firm’s global investment section.

Notable acquisitions: Remington Arms Co., Option One Mortgage Corp., Tower Automotive Inc.

Origin of name: In Greek mythology, Cerberus is the three-headed dog that guards the entrance to hell.

Scott J. Wilson

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Source: Times research