Daimler-Benz AG followed in the disastrous footsteps of two other German carmakers when it failed to perform 'due diligence' research before buying Chrysler Corp. in 1998.
BMW and Volkswagen did not properly examine Rover and Seat before taking them over and it cost both companies billions of marks. The acquisition of Seat almost put VW out of business.
Daimler-Benz might have saved itself some headaches, too, if it had delved more deeply into Chrysler. Daimler executives have said they were prevented from conducting due diligence at Chrysler because they were merging with the American company, not buying it.
But US legal experts say there were no rules to keep Daimler from doing the kind of research that would have foretold the severe problems that emerged at Chrysler in 2001.
Daimler-Benz sought advice from investment bank Goldman Sachs before the merger, but only to make the deal happen - not to formally research its implications.
Earlier this year, DaimlerChrysler board member Jurgen Hubbert acknowledged that Daimler-Benz management was blinded by Chrysler's profits.
'There was no due diligence,' he said in an interview with Automotive News Europe in January, shortly after the scale of Chrysler's financial crisis became known.
Chrysler lost $1.8 billion (E2 billion) in the last half of 2000 and burned through $5 billion from its cash reserves. And last month it announced it had lost another $1.2 billion in the first quarter of this year, with overall losses for 2001 estimated as high as $2.5 billion.
Daimler-Benz and Chrysler had a combined market capitalization of $76.8 billion the day before the merger took effect in November 1998. The combined company's figure is now about $50 billion.
Purchase offers are usually made dependent on due diligence, a detailed analysis of the financial, business and legal prospects of a company being considered for acquisition.
Without due diligence research, Daimler-Benz management overlooked the poor timing of model changes, excessive inventories, steadily rising incentives and the declining attractiveness of the Chrysler brand in an increasingly competitive American market.
'We didn't see these signs because of the big numbers,' Hubbert said. 'It is so easy to have a $5.1 billion operating profit when you sell 3.2 million cars with a unit margin of $1,600. But this might not be enough if you come into critical times. We didn't see that, we just said, 1/8Wonderful, $5.1 billion, fantastic.''
In the same January interview, Chrysler President Dieter Zetsche insisted that the deal was technically a merger, and added: 'There is no merger that includes due diligence.'
Christoph Walther, Daimler-Chrysler senior vice president for communications, said in March that due diligence was prevented by the US Securities and Exchange Commission's (SEC) strict insider trading rules.
'If one intends to merge with another publicly traded company, SEC insider rules do not allow due diligence,' said Walther. 'If we would have carried out a due diligence and for some reason the merger wouldn't have happened, Daimler-Benz and Chrysler could have faced lawsuits from their respective shareholders for allowing a competitor access to confidential information.'
By merging with Chrysler, rather than buying it, Walther said Daimler-Benz sought to avoid the so-called 'goodwill write-off' that generally accepted accounting principles require in the case of a takeover.
A goodwill write-off is a charge against earnings, usually taken incrementally over years. The write-off reflects the difference between the purchase price of a company and its tangible assets. Daimler-Benz avoided the charges and thus lower reported earnings in future years.
But neither DaimlerChrysler nor the SEC could point to any specific rules that disallowed due diligence in the Chrysler deal.
'None of our experts knows about a rule that would prevent due diligence in the case of a proposed merger,' said SEC spokesman John Heine. 'Our experts couldn't find anything that would rule out a formal and full due diligence process.'
Meanwhile, corporate and securities law specialist Lawrence A. Hamermesh, professor at the Widener University School of Law in Wilmington, Delaware, USA, said he was 'underwhelmed by this 1/8legal' explanation for a failure to do due diligence in connection with the proposed merger.'
In a written statement following an Automotive News Europe inquiry, Hamermesh said: 'I have no insight into why a need for pooling accounting treatment [avoidance of goodwill writeoff] would prevent a company from examining the information about the merger partner's financial condition and prospects.
'It is true that potential merger partners who are competitors need to be quite careful about sharing proprietary information in the course of due diligence,' he wrote. 'However, that concern is usually addressed through confidentiality agreements that allow access to internal information while prohibiting competitive use of the information in the event the merger is not consummated. The agreements also usually preclude hostile takeover efforts for some period, say five years, after the agreement is signed.'
Hamermesh said that 'stockholders would be far more likely to challenge a deliberate failure to investigate and assess the prospects of a potential merger partner than to sue over loss resulting from misuse of confidential information shared pursuant to a negotiated confidentiality/standstill agreement.'
He added: 'As to whether either Chrysler or Daimler failed to do due diligence in a meaningful way, I simply don't see ... a convincing set of legal reasons that would have precluded such investigation.'
Recently, DaimlerChrysler changed its story on whether due diligence was carried out. 'Of course, there was a due diligence before the merger between Daimler-Benz and Chrysler,' said Michael Pfister, DaimlerChrysler vice president of corporate communications, in a written statement to Automotive News Europe. 'Both sides had been - as is common in these sort of transactions - exchanging data and figures, and had been assessing those in necessary depth. The results of this process went into the valuation. Also, Daimler-Benz assessed Chrysler in 1995 ... when analyzing a close cooperation at that time.'
Two other German carmakers made acquisitions without carrying out due diligence research. When BMW took over Rover Group in 1994, its management boasted of having handled the deal without the support of an investment bank. Today, BMW executives say those statements by former and current management board members 'were possibly playing down the importance of a due diligence process.'
'Of course [due diligence] was conducted in necessary depth,' said a company spokesman.
In fact, the entire evaluation of Rover's finances, as well as the negotiations, were done by the so-called 'A-team,' a small group of strategists led by Hagen Luderitz, the company's top lawyer. Luderitz reported directly to then-Rover CEO Bernd Pischetsrieder.
Sources at BMW said the company did not conduct formal due diligence when taking over Rover. Instead, they say BMW used a proposed diesel engine deal 'to gain a deep insight into Land Rover and Rover in 1992 and 1993.'
The consulting and accounting group KPMG assisted in the evaluation.
'It wasn't the usual procedure one would normally carry out and expect before an acquisition,' BMW executives now admit. But they insist that the disguised assessment's content was comparable to a full due diligence investigation.
'Maybe 1/8de jure' this was not a due diligence, but 1/8de facto' it was,' one executive said.
When the new owner carried out an in-depth evaluation after the 1994 acquisition it concluded that the price of E2 billion represented only 20 percent of Rover's value, a BMW manager said.
'But the cheap price couldn't offset the company's fundamental problems,' he said, including Rover's weak brand image; the low quality of its products; a poor model line-up, out-of-date plants; lack of research and development and engineering competence; overdependence on local suppliers; and the disadvantage of an increasingly strong currency.
The disastrous six-year ownership of Rover cost BMW E4.3 billion. In March 2000, BMW sold Rover to British investment group Phoenix, and Land Rover to Ford. Both Phoenix and Ford carried out formal due diligence procedures. As a result, Ford renegotiated payment terms for Land Rover included in the original letter of intent as well as the price for Land Rover.
Meanwhile, Phoenix and BMW have still not settled their dispute over the valuation of remaining Rover Group assets.
The other example of a failure to do due diligence dates back more than a decade. In June 1986, Volkswagen CEO Carl Hahn bought 51 percent of Seat and six months later acquired another 24 percent of the Spanish carmaker.
The acquisition of a 75 percent majority occurred without due diligence research, a veteran VW executive says. A company spokesman declined to comment.
Before the Spanish government holding INI sold its remaining 25 percent stake in Seat to Volkswagen in 1990, VW's finance department finally analyzed the company. The assessment was based solely on balance sheets and financial forecasts, and was without the support of an investment bank or consultancy firm, according to the VW manager.
'The worst-case scenario which the controllers could foresee for Seat was a loss of DM1.4 billion (E709 million),' the VW executive said. 'But nobody assessed, for example, the market risks. So the incredible weaknesses on the sales and distribution side of the business, including the dealer network, and in the brand image, were not detected.'
The loss in the three years that followed the acquisition of the final 25 percent exceeded DM2.2 billion.
But the financial strain on Volkswagen was much bigger - so big even, that CEO Ferdinand Pi'ch recently said that the Seat adventure almost put VW out of business.
By 1993, Seat losses had dragged VW deep into red ink and forced the parent company to pump billions of marks into restructuring the Spanish carmaker.
