Driver's Seat Sign of the Times: A Deal for GMAC By Investor Group

Once-Tiny Cerberus Leads Purchase That Brings GM An Eventual $14 Billion Private Equity's Growing Role

By DENNIS K. BERMAN and MONICA LANGLEY

 April 4, 2006; Page A1

Ten years ago, Cerberus Capital Management LP was a tiny "vulture" investment fund, making loans to small or embattled businesses that had few other places to turn. Adult cable channels, a Kansas City mall operator and the publisher of Penthouse magazine came to the secretive New York fund with hands extended.

Last week at the Four Seasons Hotel in New York, the fund's leader, Stephen Feinberg, made his final pitch for a much bigger deal: a controlling stake in one of the crown jewels of General Motors Corp., its giant General Motors Acceptance Corp. lending arm. Advisers from investment bank Goldman Sachs Group had already presented a scenario to the company describing what would happen if it walked away from the deal.

Mr. Feinberg won out, delivering a pitch that, among other arguments, linked GM and its storied past to his own feelings of patriotism. An agreement by Cerberus to buy 51% of GMAC, announced yesterday, will put the investment firm and its enigmatic chief at the helm of what is considered the seventh-largest financial institution in the country. Formed in 1919, GMAC has evolved into a bank, insurance company and lender that finances tens of billions of dollars' worth of cars, homes and college educations.

A group led by Cerberus will pay GM $7.4 billion when the deal closes in six months or so. GMAC then will pay an additional $2.7 billion to its parent, GM said, relating to the conversion of GMAC and its units to limited-liability companies. GM will hold onto $20 billion in automotive leases, which it plans to turn into about $4 billion in cash over three years. In all, the deal -- which includes an option for GM to repurchase GMAC's global auto-finance business in the next 10 years under certain circumstances -- should provide slightly more than $14 billion to GM.

Cerberus, a fast-growing fund that now manages $18 billion of investors' money, is pouring a huge chunk into the GMAC deal. It will spend $6 billion, part from its existing kitty and part new money raised from current investors. While some of this $6 billion is sure to be farmed out to still other investors, it nonetheless represents a mammoth investment at a time when most private-equity firms stretch to commit 10% of their funds in any one deal.

Citigroup Inc. is taking a substantial role, making investments directly from its investment bank as well as its private-equity arm. In addition, Citi is committing $12.5 billion in separate credit facilities for GMAC, while arranging an additional $12.5 billion in credit from other lenders.

The deal won't immediately give GMAC a much-desired investment-grade credit rating. Ratings firms were lukewarm about the pact. GMAC bonds posted modest gains, but GM's shares tumbled 5.3% to $20.14.

The deal carries lots of risks for the buyers, primarily the fate of GM itself. Cerberus could be pushed into a corner should the auto maker enter bankruptcy reorganization or suffer continuing market-share losses. Another risk is the residential-mortgage market, in which GMAC is a big player. It's vulnerable to a possible housing downturn.

Cerberus also could make substantial profit, thanks to the differing values of GMAC's components. The price to be paid is roughly equivalent to GMAC's tangible book value, a finance term meaning the price a thing might fetch if liquidated. But some parts, such as the residential-mortgage division, are worth perhaps 1.5 times tangible book value, according to people briefed on the deal. Should GM recover enough to buy back the auto-finance division, Cerberus would have bought the other GMAC operations for a substantial discount.

Few deals better capture the dramatic changes sweeping through the financial markets than this one, putting a little-known private investment fund in partnership with an auto maker once seen as a bellwether of the entire American economy.

When GM last fall decided to sell a GMAC stake, it expected to be courted by big banks drawn to the size of the unit's portfolio of loans and lease receivables -- $186 billion -- and its $320 billion balance sheet. But the most serious suitors all along were private-equity and hedge funds, lightly regulated private pools of capital catering to the rich and to institutions. The managers of these firms are using their increasing financial heft in a wave of deals reminiscent of the leveraged buyouts of the late 1980s, such as Kohlberg Kravis Roberts & Co.'s $25 billion takeover of RJR Nabisco.

In the past 24 months, such investment firms have snapped up iconic names like Toys 'R' Us, Dunkin' Donuts and Neiman Marcus; placed large bets, such as the $11 billion that fetched SunGard Data Systems; helped purchase supermarket stalwart Albertsons Inc.; and taken stakes in the infrastructure of the financial system. One of main investors in Nasdaq Stock Market Inc. is private-equity fund Silver Lake Partners.

The low interest rates at which the funds can finance such investments are one factor. And their capital from their own investors keeps growing, as so-so stock and bond performances drive more institutions and wealthy people their way. In 2005, private-equity firms and their portfolio companies deployed $353 billion in takeovers world-wide, up 36% from 2004, according to data provided by Dealogic. That represented 12% of the year's total deal volume, up sharply from 4% in 2000.

Broader changes are at play. More than two decades of deregulation has torn down barriers in the world's financial markets. Once the domain of large institutions, they now increasingly are realms open to an individual with more-than-usual smarts, guts or contacts.

Mr. Feinberg is a 46-year-old former Drexel Burnham Lambert employee who formed Cerberus in 1992, naming it after the three-headed dog of Greek mythology who stands guard over the underworld. The market at that time was awash in unloved debt -- junk bonds left over from the 1980s debt boom and lots of assets the U.S. government wanted to unload after bailing out failed savings and loans. Cerberus spent much of the 1990s investing in distressed debt and lending to struggling companies at high rates. When Penthouse publisher Bob Guccione ran into a financial squeeze in 1996, he turned to Cerberus.

The size and ambition of the GMAC deal represent a coming-of-age for the 14-year-old investment firm. "This is their RJR," said one person involved in GMAC skirmishing, referring to the breakthrough 1989 KKR deal.

As Cerberus became a serious bidder for GMAC, some GM executives and directors needed reassurance about the fund and wanted Citigroup to vouch for it, said someone familiar with the situation. Citigroup CEO Charles Prince went to Detroit on March 23 and, in a lunch in GM's private dining room, told GM CEO Richard Wagoner and other GM executives that Citigroup put its credibility and capital behind the venture. Mr. Feinberg paid a separate visit to Mr. Wagoner.

Mr. Feinberg, a onetime Army Reserve paratrooper and Princeton University tennis player, is described by associates as highly competitive and in constant motion. He's also known as an introvert. When he approached former Citigroup executive Robert Willumstad last year about taking a role at GMAC, Mr. Willumstad found him to be cerebral and almost apologetic, said a person familiar with the situation. When it came time to announce the deal yesterday, it was Mr. Feinberg's deputy, Mark Neporent, who stood beside GM's Mr. Wagoner.

Cerberus tangled with famed investor Sam Zell, who fought it for control of Coram Healthcare Corp. in 2003. Mr. Zell, a major Coram stockholder, accused Mr. Feinberg and his fund, a holder of Coram's debt, of failing to disclose certain information related to the takeover. A bankruptcy judge later ruled that no damages could be proved from the failure to disclose a $1 million consulting payment by Cerberus to Coram's chief executive.

To soften a combative image won in the arena of bankruptcy court, Cerberus hired former Vice President Dan Quayle as an ambassador and door-opener in 2000. Cerberus also works with a roster of former chief executives to gain insight about industries and companies, sometimes giving them a role after an acquisition.

The firm at the time was buying interests in Japanese and South Korean banks. It has since moved on to take stakes in such businesses as Mervyn's Department Stores, real-estate portfolios and paper mills from Maine to Kentucky. Its returns, less volatile than those of some other funds, ranged in the past five years from a low of 9% in 2002 (a down year in the stock market) to 22% last year, according to one fund investor.

"They've done a really nice job of morphing from a traditional distressed [asset] hedge fund to becoming a top-tier private-equity player," said Brett Barth, a partner at BBR Partners LLC, which places investment money for wealthy families. But some other investors have complained that Cerberus doesn't provide much information about how its investments are doing or their riskiness.

The GMAC move is part of a push by investment funds to broaden into areas outside traditional stock-and-bond investing. Cerberus has invested in Ohio forest land. Some hedge funds are investing in online universities.

People involved in the GMAC transaction describe it as one of the most complicated and exhausting of their careers. Cerberus and its partner, Citigroup, assembled a team of 200 people to examine GMAC's finances.

GM had approached only big banks to buy the GMAC stake. Citigroup, GM's primary bank, concluded the structure wouldn't work for it. But Citigroup's Mr. Prince told colleagues the bank had to stand up for a customer in a tough spot, says an insider.

Meanwhile, Cerberus was trying to find a way into the process. The late Arthur Zankel, a Citigroup director and friend of former Citigroup CEO Sanford I. Weill, had years earlier suggested that Citi management work with Mr. Feinberg, whom Mr. Zankel viewed as a brilliant investor.

Mr. Feinberg explained the logic behind his interest to Mr. Willumstad, the ex-Citigroup executive, a person familiar with their discussions recalled. The thinking was that despite GM's tarnished fortunes, GMAC was a gem of a financial-service business that could be bought cheaply -- for about the net book value of its assets -- and could be expected to make money from the start. When Mr. Willumstand asked what his strategy was to get a return, Mr. Feinberg said Cerberus would use GMAC to expand and as a platform to get into financial services.

KKR spent months analyzing its own proposal for GMAC. It eventually submitted one but was never too serious about a deal. "For this to work, GM has to turn itself around," said one person familiar with the KKR proposal. "You have to believe in GM."

GM's fate was just what Mr. Feinberg focused on, say people familiar with the matter, as he stood in front of the GM board in a basement meeting room at New York's Four Seasons Hotel on Sunday, March 26. He went through financial details but made a bigger impression by sketching out big themes of history and pedigree, describing the investment as a kind of patriotic act. He invoked his Marine veteran father. The deal would help an American icon restore its greatness, he said. He promised not to "flip" GMAC assets for at least five years without GM's consent.

The presentation wasn't polished, say people familiar with it, and he seemed hesitant and insecure at times. But his message hit home with the 20 or so listeners. Directors also took note of how much of its own money Cerberus would commit.

Mr. Feinberg is challenging another taboo of the private-equity world with the transaction. Private-equity funds usually keep all of their investments separate, to keep their exposure spread around. But one of the companies in which Cerberus is primary owner, Japan's Aozora Bank Ltd., is expected to kick in about $1 billion of its own funding in the deal. A person familiar with the matter said Aozora made its decision independent of Cerberus.

GM's board had long deliberations over the sale, say people familiar with the situation. GMAC, which has 33,000 employees, brought GM $2.5 billion in profit in 2005. Putting GMAC up for sale disheartened several directors, one person said, some of whom described the situation as "sad" and "a shame." The failure of blue-chip banks to line up to buy GMAC was also disappointing.

Some directors asked about selling just mortgage and other lending units, but not auto financing. At the March 26 meeting, Goldman Sachs had outlined such a scenario, saying it was possible. But the strategy depended on stable credit and financing markets for years to come, a factor hardly assured.

As a Cerberus deal looked more likely last week, GM directors, executives and several lawyers had a lengthy call to discuss its complicated mechanics. They agreed to think about it and make a decision on Sunday. As they discussed the pros and cons in a conference call, what finally outweighed the wish to keep the auto-finance arm was GM's desperate need for cash, with its credit ratings now deep in junk territory, making it expensive for GMAC to borrow.

The deal includes the option for GM to repurchase GMAC's global auto-finance business in the next 10 years. The option can be exercised if GM's ratings are investment grade or above GMAC's ratings. Then GM can buy for fair market value or for 9 1/2 times the auto business's net income, whichever is greater.

Cerberus plans to keep GMAC's management team and its diversified portfolio of businesses intact, the investment fund's chief operating officer, Mark Neporent, told analysts.

General Motors was advised by Morgan Stanley in addition to Goldman Sachs, with its board receiving separate advice from Evercore Partners. GMAC was advised by Bear Stearns & Co. GM's attorneys were Kirkland & Ellis and Richards Layton & Finger. The Cerberus consortium was advised by Citigroup and law firm Schulte Roth & Zabel. Cerberus also received separate advice from Lazard.