Fiat and GM: For richer, for poorer...

GM prepares to pay the price of ambition as Fiat deal turns sour

Act in haste, repent at leisure. When General Motors bought a 20 per cent stake in the struggling Fiat Auto five years ago, with an option to buy the whole company, it looked like a masterstroke. GM would consolidate its position as the world's number one car firm, and take a leading position in Europe too. But since then, the deal has turned spectacularly sour. Last Wednesday, talks about how to end the deal - GM desperately wants out - broke down at the end of the mediation period both parties had set. There is stalemate and the case could end up in court. The Fiat unions have called a nationwide strike to protest at the uncertainty. Whatever happens it seems likely to cost GM billions of dollars and cost many Italian car workers their jobs.

Act in haste, repent at leisure. When General Motors bought a 20 per cent stake in the struggling Fiat Auto five years ago, with an option to buy the whole company, it looked like a masterstroke. GM would consolidate its position as the world's number one car firm, and take a leading position in Europe too. But since then, the deal has turned spectacularly sour. Last Wednesday, talks about how to end the deal - GM desperately wants out - broke down at the end of the mediation period both parties had set. There is stalemate and the case could end up in court. The Fiat unions have called a nationwide strike to protest at the uncertainty. Whatever happens it seems likely to cost GM billions of dollars and cost many Italian car workers their jobs.

A lot has happened in the intervening five years since the early hopes of a happy GM-Fiat partnership. Fiat's patriarch Gianni Agnelli has died - and so has his successor, his brother Umberto. GM has acquired collapsed Korean automaker Daewoo, has closed its UK Vauxhall plant at Luton, and has suffered mounting problems at its European Opel division, based at Russelsheim, Germany. It has been forced into a costly restructuring programme that will see the loss of up to 10,000 jobs. The last thing GM wants is the new problems that integrating Fiat would bring.

However, that decision is out of GM's hands. And under the terms of the agreement signed in 2000, Fiat Group could force GM to buy its ailing car division. This is because of the so-called 'put option' - a clause in the original agreement - comes into force. The put option gives Fiat the right to force GM to buy the 90 per cent of Fiat Auto it does not own, under terms decided by Fiat. Fiat can now invoke its "put" option.

GM has known this was coming, and for the past 12 months it has been trying to engineer an escape route. And like any good American corporation, when the going gets tough it mobilizes an army of lawyers. GM's legal team argues that the original agreement has been invalidated by recapitalization at Fiat since 2000, which has resulted in the dilution of GM's initial 20 per cent stake to 10 per cent, and the sale of the company's consumer finance division.

Fiat disputes the claim, and since December 16 Fiat CEO Sergio Marchionne and his GM opposite number, Rick Wagoner have been trying to work out a solution. Legal action is seen as a last resort. Marchionne last week made conciliatory overtures to GM, saying he hoped the dispute could be settled without going to court.

"I'm hopeful that both organizations will do the best thing," Marchionne told reporters at the World Economic Forum in Switzerland. Marchionne said surrendering the put option via an out-of-court settlement would not come cheap. "The put is an incredible asset, and it cannot be bargained away for nothing", he said. Forcing GM to buy the shares would be "the ultimate draconian resolution", he added. "At the other end of the spectrum is a validation of the put at a level that satisfies Fiat's assessment of its value."

Analysts believe GM will have to offer Fiat a cash settlement to get out of the deal - and the price will be high. GM has already written off the $2.4bn it has spent on its stake in Fiat Auto, and analysts claim it will have to pay another $2bn to get Fiat to cancel the put option.

This is a lot of money - but a fraction of the cost to GM if Fiat were to exercise the put option. This is because the terms of the year 2000 deal, not revealed at the time, but recently made public on Fiat's own web site, are extremely tough. GM would immediately have to pay, in cash, all Fiat Auto/Fiat Group intra-company debt - estimated at about $6bn. It would downgrade GM debt to junk status.

On top of that, GM would be lumbered with costly and unwanted overheads. It would have to maintain Fiat Auto's global management, headquarters, engineering and R&D centre in Turin for five years. It would have to buy part's from Fiat group companies without renegotiating prices or terms for the same period, and would be unable to restructure Fiat Auto for two years without Fiat Group's approval. So while jobs are being shed in Russelsheim and Luton, workers in Turin would avoid the chop until 2007.

Indeed, GM could end up paying for the deal forever, unless it decided to ditch the Fiat nameplate, as the terms include the payment of royalties to Fiat group to use the Fiat brand. The agreement reads: "Fiat will determine...the terms for a perpetual license."

So why did GM agree to such a punitive deal? Wind the clock back to 2000. The car industry is gripped by merger fever in the wake of major deals such as Renault-Nissan, and the DaimlerChrysler merger, in turn forging alliances with Mitsubishi of Japan and Hyundai of Korea. GM genuinely saw these as a threat to its status as the world's largest auto maker.

The final straw was a $12bn cash offer for Fiat Auto, which DaimlerChrysler was shaping up to make. GM's then-chairman Jack Smith and CEO Rick Wagoner believed the only way to block the move was to offer Fiat an alliance. The wily Agnellis, seeing a solution to their loss-making car company, locked GM into the tightest of deals. Even if Fiat decides not to enforce the put option right now, it can do so any time until July 24, 2010.

Without its car-making division, Fiat Group would be very profitable. With the Agnellis gone, and a tough businessman like Marchionne at the helm, the emotional pull of the car business has been reduced. And anyway, Fiat would still have Ferrari, not part of Fiat Auto.

At the Detroit motor show, Marchionne admitted that when the alliance was signed in 2000, an eventual merger was likely. Indeed, some activities - engine manufacturing and purchasing - were merged into joint ventures. But so much has changed since 2000 that a merger with Fiat no longer makes sense for GM. It needs less European capacity, not more. Its acquisition of Daewoo gives it a more effective source of low-cost technology, Korea, to pump into growing emerging markets such as China and India .

How might the saga end? Marchionne could even engineer a win-win situation by getting GM to fork out $2bn to annul the deal, and then be free to find an Asian carmaker that would buy Fiat Auto, possibly a Chinese group. After all, Fiat looks like a better beachhead into Europe than MG Rover, currently embroiled in takeover talks with Shanghai Automotive Industries Corporation - GM's Chinese partner.