Contrary to a common market prediction, last month Fiat Auto walked away from an agreement signed in 2000 that allowed it to put the company to General Motors, with €1.55 billion in its pocket.
The pay-off is to terminate GM's 10% stake in Fiat Auto. Fiat will receive €1 billion from GM immediately and another €550 million within 90 days of the break-up of the two companies' power-train and purchasing joint ventures. GM will also have to take an after-tax charge of $840 million to account for the agreement.
This is not just a bitter pill to swallow for GM but also a major disappointment for its advisory banks. The master agreement Fiat signed with GM in 2000, which stated the put conditions, said the price that GM should pay should be determined through the average of three of the closest of four valuations prepared by four investment banks at the time the put was exercised. This is without the added fees GM's bankers could have taken home for providing the financing for GM to bail out Fiat.
The settlement struck by GM eliminates the risk that the company would have had to bail out Fiat, be embroiled in a court battle with Fiat over the issue or fork out even more cash for its bankers. However, the amount was higher than many analysts were expecting. Just a few weeks ago, GM was saying the put was unenforceable. Certainly, it would have been difficult for Fiat to follow through without sinking itself even further. If GM had taken on the company and implemented a brutal restructuring, it could have caused Fiat and its suppliers more harm than good.
GM seemed pretty confident on this point. In fact, in its 10-Q it filed in mid-2003 it was pretty bullish. "GM believes, however, that whether the Put could ever be exercised is subject to the possibilities that it could be affected by subsequent agreements of the companies, it could be non-exercisable under other provisions of the Master Agreement, it could be unenforceable by reason of actions Fiat has taken or may take, of Fiat may choose to not exercise the Put."
One upside of the deal stuck in February is that Fiat will transfer some intellectual property rights to GM on such things as diesel engine technology, which should help it make headway against competitors in the European market. The company says this accounts for around a third of the payment.
In buying their way out of the agreement, GM has decided that a protracted legal wrangle, further uncertainty and negative publicity was the last thing it wanted to contend with on top of Standard & Poor's cutting its rating to junk last October, spiralling healthcare costs and the company's inability to make a profit from selling vehicles.
Post-retirement healthcare expense at the GM is set to increase by a further $1 billion in 2005 over 2004 and the company expects net income in 2005 to come to between $2.3 billion and $2.8 billion, compared with $3.6 billion in 2004. And all of that net income is expected to come from GMAC; its automotive business is likely to only break even.
S&P saw the Fiat pay-off as neutral to the company's BBB– rating as GM has ample cash on hand to make the payment. However, Moody's, which rates GM one notch higher than S&P, placed GM's Baa2 rating on a negative outlook, saying the payout and subsequent write-down would just add to the challenges of increased competition and healthcare costs.
According to CreditSights, this also makes it unlikely that GM will finish the year cash positive. As CreditSights auto analyst Mike Ward points out: "GM clearly made an error of judgement by issuing the put option to begin with and once again is being forced to pay for its sins."