NEWS ANALYSIS

A VW-FCA deal would be risky, reasonable

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Talk about intriguing.

Is Volkswagen really in discussions to buy Fiat Chrysler Automobiles?

Now there's a deal that would reshape the global automotive landscape -- and quickly. And consider the consequences for Sergio Marchionne's resurgent Chrysler Group, which has just embarked on a strategy to radically grow sales by the end of the decade.

If it happens -- and the parties do deny the report by a German magazine -- it's because the fixations of Ferdinand Piech may line up perfectly with the needs of the family that controls Fiat Chrysler.

A source inside the VW supervisory board chairman's inner circle says Piech has a grand plan that goes beyond his success in building Europe's No. 1 automaker. He envisions a global giant second to none and wants to revive the fabled German brand Auto Union as the name of the holding company.

He also wants to do it sooner rather than later. But with VW battling head-to-head with Toyota and General Motors to be No. 1 in the world, the obsessively driven 77-year-old needs a shortcut.

Acquiring the Agnelli-Elkann family's 30 percent controlling stake in FCA would give Piech his Auto Union. With more than 14 million sales a year, it would leave Toyota and GM fighting for second place, 4 million units behind.

Analysts swung into action last week after Manager, the German business magazine, reported that VW has held talks with Fiat Chrysler's owners about purchasing the Italian carmaker.

"The simple deal logic is straightforward," London-based analyst Arndt Ellinghorst of ISI Group wrote in a note to investors. "Chrysler -- better Jeep and Dodge -- could fix VW's U.S. problems; Alfa could replace the ailing Seat brand; Fiat Europe is basically the 500 product family plus LCVs; Latin America could be sold, potentially to a Chinese buyer."

How does the deal look from the Italian side? The Agnelli-Elkann dynasty, now comprising about 150 descendants, probably faces a tough call.

Should the family put its trust in the highly ambitious Fiat Chrysler relaunch plan that calls for five years without dividends -- betting on a brighter future made possible by the rapid global expansion of Alfa, Maserati and Jeep?

Or does it take $5 billion or $6 billion now -- and keep the crown jewel Ferrari, which not only makes fantastic cars but delivers more than $475 million in operating profit a year?

VW, Fiat and Exor, the family unit that is Fiat Chrysler's controlling shareholder, all denied the report.

And analysts see many risks. But they also cite compelling reasons why an agreement would make sense for both sides.

For starters, it is a doable deal. VW had $24 billion in cash at the end of March. Paying a 20 to 50 percent premium to buy Exor's controlling 30 percent stake in Fiat Chrysler -- roughly $5 billion to $6 billion -- is easily manageable.

The pros


•  VW's scale problems in the United States would immediately be solved, as would its weakness in light trucks. With a combined 1,308,196 sales in the first half, VW-Fiat-Chrysler would be the second largest U.S. automaker behind GM, at 1,455,868, and ahead of Ford, at 1,265,357.

• The world has a growing appetite for SUVs of any size, so for VW, it might be better to own Jeep than compete with the record-breaking brand.

• VW never has made money with minicars. Its alliance with Suzuki turned sour three years ago, and an arbitration court in London is ruling on the conditions of the divorce. Getting Fiat, a global leader in making profits with small cars, could be crucial, particularly as stricter global emissions standards force all automakers to build more small cars.

• For Chrysler, the idea may stir up memories of its last unhappy go-round with a German carmaker. But Alfa Romeo and Jeep could get a boost, and Ram might have a broader scope, supplying VW-badged pickups where needed.

• Conventional wisdom has it that premium brands are the future, and an Auto Union array would include Alfa, Audi, Bentley, Bugatti, Lamborghini, Maserati and Porsche.

The cons


• After r&d costs grew more than planned, Volkswagen recently announced a plan to boost profitability at the VW brand by cutting $6.8 billion in costs a year starting in 2017. But the cost of relaunching Alfa -- using Fiat's numbers -- alone would wipe out one year of those savings.

• Serious antitrust issues would arise in Europe, as well as in the United States. And they look almost insurmountable in Brazil, where, historically, Fiat is No.1 and VW No. 2.

• And face it, Piech's Auto Union might have an unmanageable level of complexity.

Ellinghorst says he would be concerned if VW bought Fiat Chrysler. The risks of integrating Italian plants and managing a U.S. business are huge, he said, and "we do not believe that the potential benefits justify the risks."

But Max Warburton, analyst at Bernstein Research in Singapore, has a positive view.

"A deal would clearly upset VW shareholders with its upfront cost and dilution -- and then they'd worry about the ability of a Teutonic company to integrate and run an Italian-U.S. business," Warburton said. "But it could arguably satisfy both sides' long-term objectives."

You can reach Luca Ciferri at lciferri@crain.com.

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