Preface

In 1998, two of the world’s most profitable automobile manufacturers, Daimler-Benz AG and Chrysler Corporation, embarked on a venture to merge their businesses as equals. This monumental merger, valued at an astonishing $35 billion, stood as the largest industrial merger of its time. However, a mere nine years later, this ambitious endeavor was abandoned. By paying just $7.4 billion for Chrysler, the private equity group Cerberus showed that the creation of DaimlerChrysler was one of the most unsuccessful mergers of modern times. This paper aims to delve into how a merger that initially inspired such unwavering confidence and optimism unraveled so profoundly within a span of less than a decade.

Situation of the two giants

The Mercedes Star

During the baby boom era, Daimler-Benz was thriving. However, the 1979 oil crisis significantly impacted the industry, revealing its susceptibility to business cycle fluctuations and overcapacity issues. Recognizing these challenges, CEOs Werner Breitschwerdt and his successor Edzard Reuter initiated a strategic shift. Throughout the 1980s, Mercedes-Benz, a division of Daimler-Benz, ventured into aviation, electronics, and software services. This diversification included acquiring a majority stake in MTU, an aircraft engine manufacturer, and merging with Germany’s largest aerospace company, MBB. Then, Daimler acquired AEG in electronics, Fokker in aviation, and a share in Gemini for software development, becoming a diversified industrial conglomerate. However, problems occurred in the strategy. The commonality in these M&As is that the target companies often possessed unique corporate cultures that were challenging to integrate into the conglomerate. Minority shareholders also posed obstacles, hindering the conglomerate’s business decisions. Additionally, the conglomerate did not undertake significant restructuring.

Conglomerates were in vogue, and diversification had the endorsement of top management consultants such as McKinsey. Furthermore, major U.S. automobile companies were simultaneously pursuing a similar strategy during that period. However, some executives at the time believed that due to the losses incurred by the newly acquired companies, the budget for the Mercedes-Benz automotive division was reduced, resulting in the inability to execute plans for increased R&D or factory upgrades.

In the 1990s, Daimler-Benz faced a market rejection of its new S-type and an economic downturn, resulting in a loss of over DM2 billion by 1993. Despite doubling sales, its market value halved, and about DM100 billion in capital was lost by 1995. Daimler invested heavily in new acquisitions, further straining finances. This period marked a disconnect between German CEOs and stock price concerns, with Daimler’s shareholders and stock value largely ignored, reflecting deeper issues within the company’s strategy and vision.

Thus, after the next CEO, Jürgen Erich Schrempp, took charge, the company made changes. First, he started by cutting the head-office staff from 1,200 to 300 and announced a profit warning. Then, Schrempp became a passionate advocate of shareholder value, and because of the emphasis on profit, he sold a bunch of companies that didn’t make a profit. Through these drastic strategies, by mid-1998, the stock price of Daimler-Benz was three times higher than in 1995. Schrempp had made the crucial discovery that a strong share price is the most powerful weapon in a company’s strategic armory. It gave him the currency for doing a deal.

The Great Chrysler

In the 1980s, similar to Reuter’s experience with Daimler, Lee Iacocca, the CEO of Chrysler Corporation, used the remaining cash to embark on an acquisition spree that diverted the company away from its core automotive business. Iacocca even established a holding company structure, dividing the business into four divisions: automotive, aerospace, financial services, and technologies. Unfortunately, this diversification led to a lack of investment and attention in the automotive sector. In hindsight, Iacocca redeemed himself with one significant acquisition: the $800 million purchase of American Motors Corporation, the manufacturer of the Jeep and the fourth-largest automotive company in the United States. This move positioned Chrysler for years of prosperity in the fast-growing sports utility vehicle (SUV) market, which the company came to dominate in the 1990s.

However, during the 1980s, the company’s success was not particularly notable. Chrysler’s market share and net earnings declined in 1989, 1990, and 1991, and its stock price also plummeted. Some of its debt went from being considered investment-grade to junk status, and this recession related to the market was an extremely crucial point when it faced the merger. In 1995, Bob Eaton, the CEO after Iacocca, took charge. In 1996, the return on sales was more than 6 percent, significantly more than Ford or General Motors, and return on capital was 20 percent, more than double the industry median. Profits and sales per employee—the best measure of productivity—were the best in the industry. Chrysler was strongly cash-generative, on track to spend $23 billion on new products and plant expansion in the next five years. Dividends were running at $1 billion a year. It had a fully funded pension plan for the first time in forty years.

Nevertheless, the stock price was not good at all. This was mainly because there was a likelihood of recession in the U.S., and investors feared that Chrysler’s profits would crumple as they had always done in the past. Eaton’s strategy was to hold cash on hand to deal with the economic downturn, but the biggest shareholder, Kerkorian, thought that the company was sitting on too much cash. A hostile takeover was about to begin, and Kerkorian started to make moves.

As the conflict continued, Helmut Werner of Mercedes-Benz read about Kerkorian’s approach to Chrysler, and a crazy idea grew in his mind. It was possible to him that Chrysler might want to work together to fight against the unfriendly approach. After calling, Eaton was not sure yet about the proposal. However, he couldn’t forget the idea. It was the beginning of the great merger.

Background before the merger: the purpose

After Schrempp took charge, Daimler-Benz sold a lot of companies and tidied up the holding structure of the group. The most famous and profitable company, Mercedes-Benz, returned and became an independent but wholly owned subsidiary of Daimler-Benz. This made the whole vision clear: Daimler emphasized and looked for full control over the auto industry again. During that period, all market research teams in Daimler, as well as the analysts of Goldman Sachs, ended their investigations with a similar conclusion: the process of consolidation in the auto industry would continue and become more and more crucial. In such a background, every auto company worked with each other, and a lot of mergers appeared. Because of the rapid growth in stock price caused by the good decisions Schrempp made, the Daimler group became a very popularly considered partner of its competitors. The hidden problem was that Deutsche Bank held 22% of Daimler-Benz shares, making it troublesome since it had huge power in deciding which company to be involved in the game. Also, Daimler had tried to work with several Japanese firms, but had not yet found any partner that fit their merger needs.

Daimler was not urgent in seeking an alliance compared to other auto companies, though it had started trying. However, the merger of Daimler and Chrysler could be meaningful. The most significant reason is that these two companies are complementary in both product and region. Also, since Mercedes focuses on high-end vehicles, opening the market in growing economies such as Asia, South America, and Africa is an unrealistic fantasy. With the technology of Chrysler in economy cars, the world automobile industry would see a strong force emerge, aiming to take over the global market. Moreover, the industry has a phenomenon of “first come, first served.” Once a company undertakes a reasonable expansion first, it establishes a competitive advantage through economies of scale, making it challenging for other companies to compete effectively, even if they engage in similar expansions afterward.

As Chrysler faced its crisis and Daimler observed potential advantages, the initial negotiations for a merger commenced.

Negotiation and Valuation

From 1995 to 1996, Daimler and Chrysler engaged in seven rounds of negotiations over eight months without reaching a conclusion. The talks initially centered on the percentage of cross-holding, influenced by Kerkorian’s ambition to acquire more shares. However, Kerkorian’s inability to secure financial backing ended this crisis, altering the negotiation dynamics. Despite Daimler’s struggle to boost sales in emerging markets, its efficient distribution channels presented an opportunity to market Chrysler’s products globally. The proposed solution was the creation of Q-star, a joint venture to manage operations outside Europe and North America, with each company holding a 50% share. Predicted to outgrow its parent companies, Q-star faced unresolved issues, particularly regarding market competition between the parent companies and the subsidiary in Europe and America.

After the failure of the first stage of negotiation, BMW found Chrysler to cooperate with in Brazil, and Ford contacted Daimler seeking opportunities. Little did the world know that Schrempp never gave up on Chrysler, and the negotiations between Daimler and Chrysler never really stopped.

Though at that time Chrysler was doing very well in business according to stock price and profit growth, it suffered from a lack of international strategy. Every approach that Chrysler took before had no positive results in the international market, which was a key concern during Kerkorian’s previous takeover attempt. In 1998, Chrysler’s Eaton suggested that a merger was essential for survival. Schrempp seized this opportunity, presenting a compelling merger proposal to Eaton in a 17-minute quick talk on January 12th, 1998, and it was the time that the wheels of the merger started to run.

During the process, confidentiality was key to success. Even most of the highest executives did not know about the upcoming event at the early stage. Initial talks on February 11th increased the likelihood of a merger, and subsequent negotiations on February 17th addressed critical issues such as accounting rules, tax implications, headquarters location, and share distribution. Legal experts joined the discussions to resolve these complexities.

Given Daimler’s status as Germany’s largest private company, it was agreed that the post-merger entity would remain German. However, this posed a challenge, as German company stocks were less appealing to American and Asian investors. The exclusion of the new entity from the S&P 500 was a concern for some shareholders. This situation empowered Chrysler to negotiate a higher share price as compensation for accepting the German business structure.

On April 9th, 1998, the two companies reached basic agreements such as board structure, headquarters, and expected synergies. Now, the main problem and priority was: “What will be the price?”

Chrysler rejected Daimler’s offer of paying half of the transaction in cash, arguing that an all-share cross-holding would maximize the profit of the merged company. After Daimler agreed, the stock exchange ratio thus became the largest negotiating point for both companies. During the Kerkorian crisis, Kerkorian offered a $57.5 per share price, so Chrysler wanted Daimler to offer a price exceeding this since Eaton had successfully defended against the crisis previously. Coming into the game, the Daimler team had a maximum acceptable offer: the stock price plus a 30% premium. Thus, Daimler started at 25% and ended up raising it to 28%. However, the negotiation between Schrempp and Eaton went wrong: Schrempp thought a 28% premium was the deal, while Eaton thought $57.5 per share was the deal. The stock price of Chrysler on April 9th, 1998 was $43.5, so a 28% premium would only get to $55.68. This mistake almost ruined the merger, and Daimler decided to take the risk of waiting and hoping the stock price would rise to fit their needs. Finally, six days later, the stock price rose to $45.8, making the offer after a 28% premium $58.72. Daimler then paid the sum in stock, equivalent to $37.9 billion in total.

The premium also made the merger clearer. Although both companies claimed this was an equal merger, a premium would not exist if it were 100% equal. The situation that caused the balance to tilt toward Daimler was that the shares of Daimler were significantly higher than those of Chrysler: the P/E ratio of Daimler was 26 times and that of Chrysler was 8.2, while Daimler’s market value was roughly double that of Chrysler. What caused the market to value Daimler significantly higher when Chrysler was able to earn higher profits? First, Chrysler was more sensitive to economic downturns, which investors learned from historical data. Second, companies that manufacture high-priced vehicles like Mercedes generally have a higher market value compared to those producing lower-priced cars, including Japanese companies. Third, Schrempp had just turned Daimler-Benz from losing money to making a profit; therefore, the market saw him as a capable leader with a bright future, reflected in the stock price. Last but not least, based on historical data, European automobile companies have stronger flexibility when facing difficulties, causing the general stock price of European automobile companies to be higher than that of U.S. companies.

However, Eaton thought that since Chrysler was such a profitable company, its stock price was undervalued, thus the premium was necessary. But for Daimler, they paid the premium not because of the value; it was more likely that the premium was the cost for them to take charge. The prediction of the metrics was that the new stock price and P/E should be greater than the average of the two companies before the merger. Due to the complicated laws of both the U.S. and Germany, the result was that the shares would be in only one global stock, traded mostly on the Frankfurt and New York stock exchanges.

After the decision was made and the structure established, the merger was ready to be revealed to the executives in both companies, as well as to the public.

Endgame of the Merger

After concluding the negotiations, Schrempp’s first action was to inform Hilmar Kopper, Chairman of Daimler’s Supervisory Board, about the deal. This step was delicate because Kopper also chaired Deutsche Bank’s Supervisory Board. Schrempp faced the risk that Kopper might oppose the deal or disclose it to Deutsche Bank, potentially jeopardizing the entire agreement. Fortunately, Kopper, as a friend and supporter of Schrempp’s vision for Daimler, not only agreed to the deal but also maintained confidentiality. The next step involved calling a special board meeting. The board members were initially surprised by the sudden completion of the deal. Despite some initial concerns about the complexity of the merger, the board was predominantly enthusiastic about the transformative potential it held. The third crucial step was managing the intricate details of the merger and executing them swiftly. With an increasing number of stakeholders involved, including attorneys, accountants, engineers, managers, and government regulators like the SEC, the risk of information leakage escalated. It was imperative to finalize decisions quickly and announce the deal promptly to mitigate this risk. Despite some ongoing negotiations, preparations for the announcement proceeded swiftly. The Wall Street Journal reported the deal on May 6th, 1998, a day before the official announcement, which turned out to be a manageable leak. On May 7th, Eaton and Schrempp contacted key figures, including politicians, industrialists, and journalists, starting with Reuters and Bloomberg, to communicate the merger. The announcement emphasized that it was a merger of equals, aiming to temper market volatility. Following the announcement, the media coverage was generally favorable, aiding the shareholder meetings. An overwhelming 99.98% of Daimler shareholders approved the deal in a meeting attended by over 13,300 shareholders. Chrysler’s meeting saw a smaller attendance of 140 shareholders, but a significant 97.5% approval rate was still achieved.

Deal from hell

On May 14th, 2007, the Board of Management approved the future concept for the Chrysler Group along with the related financial services business and the realignment of DaimlerChrysler. A majority interest in Chrysler was set to be transferred to Cerberus Capital Management, a private-equity firm. By August 3rd, the transaction transferring a majority interest in the Chrysler Group and the related financial services operations in North America was concluded: Cerberus acquired 80.1% of the new Chrysler Holding LLC; DaimlerChrysler retained an equity interest of 19.9%. The final purchase price amounted to $7.4 billion, with $1.35 billion going to Daimler. As part of the overall deal, Daimler injected $2.5 billion in cash into Chrysler and provided an additional loan of $400 million. Consequently, Daimler ended up approximately $1.5 billion out of pocket. As previously mentioned, the amount Daimler paid in stock equated to a cash value of $37.9 billion. The selling price was merely a fifth of the purchasing price, not accounting for the additional expenditure.

Why did the merger go so wrong in less than ten years? Firstly, the cultural clashes between employees and managerial teams were significant. This is the reason the article started with the history of Daimler-Benz and Chrysler. Daimler, with a strong sense of pride in Mercedes, had employees who believed they were producing luxury vehicles and perceived Chrysler’s products as inferior. This problem existed in the previous acquisition of Daimler’s aero industry, and it seems that Daimler never successfully managed it. Secondly, the factories did not generate the expected synergies. The production lines were not compatible with one another; Mercedes questioned the quality of Chrysler’s line, while Chrysler viewed Daimler as lacking in efficiency. Thirdly, the merger was not as equal as initially announced. It resembled more of a takeover with two CEOs at the helm. Although Eaton and Schrempp were good friends, operational conflicts, legal differences, market appetites, and governmental perspectives from the two countries led to challenges in integration, with each CEO representing their respective nation.

Chrysler’s profitability was unsteady, as indicated by the data. Daimler’s press statement highlighted that one of the main reasons for this was the volatile U.S. automobile market, coupled with a focus on large vehicles unsuited to high energy prices. Schrempp retired at the end of 2005, leaving his successor, Dieter Zetsche, to address these challenges. In the autumn of 2006, Chrysler’s deteriorating sales turned into losses, prompting Zetsche to recognize the necessity for Daimler and Chrysler to demerge. The loss was not only affecting Chrysler but was also keeping the stock price low, making it vulnerable to private equity investors. A decision was imperative to prevent the collapse of the empire.

The subsequent story of Chrysler involved collaboration with Fiat in early 2009, declaring bankruptcy in April, followed by Fiat acquiring the majority of its shares. In 2014, Fiat purchased all remaining shares of Chrysler, including those held by Daimler, becoming an exclusively invested enterprise. In 2019, Fiat and PSA merged into Stellantis, headquartered in Amsterdam, making Chrysler a complete subsidiary under Stellantis. Daimler-Benz, meanwhile, began forming alliances with Japanese firms such as Renault, Nissan, and Mitsubishi, and continues to navigate the new era of electric vehicles alongside Chrysler.

In conclusion, the DaimlerChrysler merger, initially fueled by the enthusiasm of Eaton and Schrempp for its perceived benefits, ultimately faltered due to unanticipated challenges. The envisioned synergies, market expansion, and shared expertise failed to materialize as expected. Significant cultural clashes, integration issues, and strategic misalignments outweighed the potential advantages. The ambitious merger, while pioneering, proved that even the most promising unions might struggle against deep-rooted operational and cultural barriers. The lessons learned from this unprecedented merger offered valuable insights into the complexities of large-scale corporate integrations.

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