updated 5/15/2007 1:56:37 PM ET 2007-05-15T17:56:37

The final bill came due on May 14 for Daimler-Benz' ill-fated 1998 takeover of Chrysler. After nine years of management agony and billions of dollars in losses, DaimlerChrysler  cut a deal that actually pumps a net $700 million into Chrysler as a sweetener for private equity group Cerberus Capital Management to take over the ailing Chrysler unit and its $18 billion in estimated health and pension liabilities.

DaimlerChrysler announced Cerberus will pay $7.4 billion for 80.1% of Chrysler, but as part of the deal, the German auto maker is injecting slightly more than that sum to cover Chrysler's outstanding debt and restructuring charges and recapitalize the weakened U.S. auto maker. "Daimler actually paid a dowry to unload Chrysler — it took a $700 million hit on its balance sheet. That speaks volumes about the future they saw for Chrysler under their stewardship," says Garel Rhys, professor of motor industry economics at Cardiff University in Wales.

Seeking an upbeat way to characterize the divorce, DaimlerChrysler Chairman Dieter Zetsche called it "a new start" for both Daimler and Chrysler. Daimler has spent over 15 years grappling with the costly legacy of misguided acquisitions and alliances. Many of them were part of the "World AG" strategy of former CEO Jüergen Schrempp. Chrysler was Schrempp's most costly debacle: He paid $36 billion for the No. 3 U.S. auto maker shortly before the losses erupted, calling the deal "a marriage made in heaven."

But if Chrysler's future is a question mark, Daimler's is the answer to many a shareholder's fervent wish — a return to the company's core luxury-car tradition. Analysts see the sale of Chrysler as more a leap backward for Daimler than a fresh start. The split returns Daimler to its status of the early 1990s — prior to unsuccessful acquisition binges — as a maker of luxury cars and trucks. Shrunken and chastened, DaimlerChrysler will rename itself The Daimler Group. "It's back to square one," says Rhys. "They've showed they are vulnerable. Daimler's confidence has taken a hit."

Zetsche's task now is to hone top profits and regain some of the market share lost to premium rivals BMW and Audi. "We want to be the worldwide leading maker of premium cars, and we want a culture of top performance," Zetsche said. While Daimler was struggling to fix Chrysler and Mitsubishi Motors, BMW invested heavily in a raft of hot new premium models, surpassing Mercedes in global sales in 2005. Audi is also making incursions.

And though the global market for luxury autos is growing at a healthy clip, the world has changed since the simple days when Mercedes reigned supreme in the high-end market. The price premium that automakers such as Mercedes or BMW can charge — compared with mass-market brands like Ford or Toyota — is shrinking, down by 45% in 14 years, Rhys says, as the gap in technology and quality narrows. And that shrinkage is bound to continue, putting greater pressure on upmarket brands to cut costs.

"Flawed hypothesis"
When it comes to new models, many things are going right again at Mercedes. Under Zetsche's leadership, development, costs, and quality at Mercedes have all been overhauled, and new models such as the M-Class SUV and the flagship S-Class sedan are powering profits again. Zetsche confirmed that Mercedes is on track to meet its target 7% operating margin this year, and that it should do even better in 2008 and 2009, when a new E-Class is set to hit showrooms.

One remaining problem that could undercut Mercedes' performance is the Smart minicar, a long-running, unprofitable investment. The company spent $1.2 billion restructuring it in 2005. Zetsche has overhauled Smart, and aims to introduce the 2007 Fortwo model in the U.S. in 2008. But analysts say Smart sales must hit at least 120,000 to 130,000 a year to make a profit. Last year, Mercedes sold just 82,000 of them, and analysts forecast 2007 sales at only 100,000.

"The whole car was built on a flawed hypothesis," says Rhys. Daimler believed people would pay a premium for an environmentally friendly minicar, but the Smart has now been repositioned as a mainstream supermini. "They need some pretty innovative marketing to make sure people see the value for the money — and they may need to lower the price," Rhys says.

Copyright © 2012 Bloomberg L.P.All rights reserved.


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