Fiat's Deal With Chrysler Puts Its Credit Under the Microscope

Fiat's Deal With Chrysler Puts Its Credit Under the Microscope

It's a done deal - Fiat and Chrysler rang in the new year by joining forces as Fiat bought out the 41.5% interest in the American automaker owned by the United Auto Workers' union health care trust. Shares of Fiat rose 16% as the market approved of the purchase price of $4.35 billion, which met market expectations of a price under $5 billion.

The combined automaker is expected to bring numerous benefits and provide competitive advantages to both companies. Sergio Marchionne, CEO of Fiat, will be integrating several of Fiat and Chrysler's operating areas including production, sales, and engineering. While these changes will take time to be put in place, it will position Fiat-Chrysler into a global player that will be better able to compete with the likes of Volkswagen and General Motors.

Meanwhile, others in the market are concerned about the impact that the deal will have on the company's liquidity. As a result, Moody's Investor Services announced that it would review Fiat's credit for a possible downgrade.

Merger can help Chrysler deliver more fuel-efficient cars
The combined company is expected to gain from its dual presence in the U.S. and Italy. Fiat has struggled to sell its models in the U.S., while Chrysler has had similar problems in Europe. Since its bankruptcy, Chrysler's profits have come mostly from its line of Jeep SUVs and Ram pickup trucks. Fiat has yet to deliver on its promise to help the American automaker build more fuel-efficient cars.

According to The Wall Street Journal, the government recently ranked the average fuel efficiency of 11 car companies, and Fiat-Chrysler came in last place. Chrysler could face challenges in meeting federal fuel efficiency mandates and needs additional R&D investments in this area.

Fiat has fallen on hard times since its heyday in the 1990s when it was Europe's second-largest car brand. The company is currently in seventh place with a 6.2% share of the European car market, well behind front-runner Volkswagen.

Volkswagen has about a 25% share of the European car market. The company's latest 2013 results showed a delivery of over 400,000 models for the second consecutive year. However, year-to-date total units sold dropped 6.9%. For 2014, the company will be introducing new vehicles in the Golf family and expects consumer interest to continue in its other core models. The company's luxury lines - Audi, Porsche, and Bentley - posted record unit sales for 2013.

Debt refinancing may be necessary to pool cash resources
Fiat's plans to lift the company out of its funk include expanding its profitable luxury brand, Maserati, with a goal to increase sales to 50,000 models from the 6,000 cars sold in 2012. Fiat also has plans to relaunch its Alfa Romeo brand in the U.S., where it sees potential for greater sales volume.

Both companies are looking to streamline the number of platforms its car models are based on. A key aspect for the company will be to build models that don't require major revisions to sell well in different markets.

The Journal reports that sources close to the matter believe that Chrysler may need to refinance about $6.1 billion in debt to eliminate restrictions that prevent the two companies from combining their cash accounts. A credit downgrade for Fiat by Moody's Investor Services could adversely affect Chrysler's efforts to obtain financing.

Credit rating pending review
Moody's announcement places Fiat's corporate family rating and probability of default rating under review for possible downgrade. Three of Fiat's subsidiaries have also been placed on review for downgrade of their issued debt. Currently the debt items under review carry a "speculative grade" rating and are considered high risk.

Moody's decision to review Fiat's credit is a result of the $1.73 billion (1.27 billion euros) cash payout the company will issue when the transaction closes on Jan. 20. After the payment, Fiat's cash balance is expected to approximate $9.65 billion (7.1 billion euros), an amount Moody's believes will materially affect the company's liquidity. Despite the impact of the cash transaction, Moody's expects Fiat to have sufficient cash to meet its obligations for 2014.

My Foolish conclusion
If Fiat's future liquidity is questionable, Chrysler-Fiat's plans to combine both businesses and implement new growth strategies may stall. A credit downgrade could also lead to a drop in the price of Fiat's shares. It will be interesting to see how the company jumps through this new hurdle and moves forward.

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Eileen Rojas has no position in any stocks mentioned. The Motley Fool recommends Moody's. 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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Originally published