Will Chrysler Save Fiat?

For longtime Detroit-watchers, the last few years have been almost surreal. First, Ford (NYS: F) hocked everything it had to finance an audacious, wildly improbable turnaround plan. Then, after some last-gasp gestures from its old guard that seem almost hilarious in retrospect, General Motors (NYS: GM) collapsed into bankruptcy, followed by a bizarre game of managerial musical chairs -- and lately, an almost shocking display of something that looks suspiciously like competence.

Meanwhile, Chrysler was being passed from the blundering hands of Daimler (OTC: DDAIF.PK), which had starved Detroit's smallest and scrappiest automaker of desperately needed product-development resources, to a gang of well-intentioned (maybe) but clueless private-equity whizzes, only to end up (with some help from the U.S. government) in the eager hands of Italy's Fiat (OTC: FIATY.PK).

And that is where the story got really interesting.

The most unlikely of turnarounds
Ford was seriously ill when its founding family hired CEO Alan Mulally and empowered him to overhaul the company back in 2006. And General Motors was being crushed by immense legacy costs when it ran out of spoons and entered bankruptcy in 2009. But as bad as things were for both of those companies, both had strengths that could be built on -- namely, the talent and global resources to create top-notch products once long-standing impediments were removed.

Chrysler didn't have that. Frankly, Chrysler didn't have squat -- no German operation that could adapt its great small cars for the U.S. once gas prices soared (like Ford), no huge presence in Asia to give it the volumes needed to justify the high development costs of a truly world-class vehicle portfolio (like GM), not even a base of promising models to build on, which both GM and Ford could claim.

Chrysler had had promising models, way back in the 1990s, but after Daimler had starved its product-development efforts and laid off scores of its engineers, very little was left by the time Fiat came calling. Dodge, Chrysler, and Jeep had been reduced to a small lineup of models that weren't just uncompetitive with Toyota (NYS: TM) and Honda (NYS: HMC) , but so bad that most would have taken "worst in class" accolades from Consumer Reports, had the magazine bothered to offer them. Fleet sales and a dwindling group of diehard brand loyalists had kept things going, but the end was in sight.

That's why, when Fiat essentially got Chrysler for free, many observers thought that it wasn't worth the price. But when Chrysler reported its earnings last week, it showed that its partner's surprising efforts to revive it were bearing fruit.

Another profitable quarter, surprising sales gains
Chrysler made $212 million in the third quarter on revenues of $13.1 billion, a nice increase over the $84 million loss it posted in the year-ago quarter. The story behind that gain is simple and good: The company is selling a lot more cars and trucks, because the cars and trucks have gotten a lot better -- and they did so in a hurry.

Fiat CEO Sergio Marchionne's plan to overhaul Chrysler's sad product portfolio on the fly drew heavy skepticism when it was first presented, but the results have been impressive. The bones of Chrysler's current lineup are mostly traceable to the same cars and trucks it was selling in 2008, but the details and execution have been given huge upgrades. Refined handling, drastically upgraded interiors, and styling that received -- in the absence of funds for proper from-the-ground-up redos -- a series of very artful makeovers have turned Chrysler's old vehicles into a suddenly competitive group of products.

Add in the increased global reach afforded by Chrysler's global parent -- which is selling some Chrysler products through its dealers in Europe and Latin America -- and the upshot has been significant sales growth. Global sales in the third quarter were up 24% to 496,000, led by a 26% gain in the U.S. That momentum shows no signs of stopping, either -- Chrysler just posted a 27% year-over-year increase in U.S. sales in October, making it the company's best October since 2007.

The details have been positive, too. Chrysler's retail sales -- in contrast to the lower-margin fleet sales that long sustained Detroit -- increased 40% year over year. That shows that Chrysler's competitive standing is improving in the eyes of consumers -- quite a feat in an era where the competitive bar has been raised out of reach even for some longtime stalwarts.

Looking ahead: A real merger of equals?
Chrysler's profit and sales growth doesn't mean that the automaker -- either automaker -- is completely out of danger. To really make this thing work, Marchionne and his team need to complete the job of mashing these two regional automakers into one streamlined global contender. A "corporate convergence," as Marchionne calls it, would allow Fiat to maximize profits and best rationalize its product line. And it's the only route to the global economies of scale and distribution reach Fiat will need to compete with the likes of Toyota, GM, Volkswagen (OTC: VLKAY.PK), and Ford around the world.

But making a full-blown merger happen won't be simple. Fiat has its own issues, starting with an aging product line that has been neglected as the company focused resources on Chrysler's revamp. Fiat currently owns 53.5% of Chrysler, a number that will rise to 58.5% by the end of the year if Fiat meets performance targets set as part of the 2009 bailout deal. Marchionne would like to see the two companies merge within the next three years, but obstacles remain, not least the fact that 41.5% of Chrysler is owned by a UAW health-care trust.

But Fiat noted in its own earnings report that Chrysler's results -- consolidated into its parent's for the first time -- contributed 65% of the overall firm's "trading profit," Fiat's term for earnings before interest, taxes, and special items. Put another way, having been saved by Fiat, Chrysler may now be effectively returning the favor.

Marchionne has worked impressive magic on Chrysler, and the Detroit cast-off's profits may be able to carry Fiat for a while. But whether the two automakers will really be able to become one -- and whether they'll be able to compete with the global giants once they do -- remains an open question.

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At the time this article was published Fool contributor John Rosevear owns shares of Ford and General Motors. You can follow his auto-related musings on Twitter, where he goes by @jrosevear. The Motley Fool owns shares of Ford. Motley Fool newsletter services have recommended buying shares of Ford and General Motors. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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