What would Blackstone do with Chrysler?

NEW YORK (Fortune) -- Many private equity firms like to brag that the operating expertise they bring to their acquisitions can restore a company's health. But if the expected Blackstone bid for DaimlerChrysler's ailing U.S. auto unit is successful, the company seems likely to make a trip to the chop shop.

No Blackstone bid has been announced, but industry analysts expect the leading private equity firm to make a multibillion play for Chrysler.

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What's the attraction? Yes, car sales are soaring worldwide, but the U.S. auto business is notoriously plagued by high labor costs, hard-to-fund pension promises, sinking customer satisfaction and bad bets on SUVs and gas-guzzling trucks. For that reason, many analysts expect that Blackstone and its partner in the deal, Centerbridge Capital, would break up the business as fast as possible, just as the top buyout firm did after it took Equity Office Partners (EOP) private earlier this year.

"The probability of that is 100%, the question is to what extent," says Matthew Rhodes-Kropf, a professor of finance at Columbia Business School. "Chrysler is not doing well. It has a lot of union and healthcare problems. What happens to companies when they're not doing well? They need discipline and a firm like Blackstone will bring that, but it means that on the other side something must be closed or changed around."

In February, Blackstone paid a premium to beat out rival bidder Vornado (Charts), raising the price more than 14% in the process. In order not get stuck with a money-losing prize, it sold buildings at lightening speed, unloading a clutch of properties to Macklowe the day the EOP deal closed. More than $15 billion in properties were reportedly sold off by the end of the month.

With rival bids for Chrysler on the table, a huge amount of firepower and a will to win, Blackstone might well pay a high amount for an iconic car company, with similar pressure to break it up fast. Representatives at Blackstone and Centerbridge said they had no comment for this story.

"For Blackstone, it's all about the game. You buy an asset, and there's a huge amount of value to be unlocked by repackaging the assets and finding buyers," says Phillip Phan, a professor of management at Rensselaer Polytechnic Institute. "There are really two ways to make money. One is by cutting costs, rewriting pensions contracts, closing capacity and outsourcing to Asia and Eastern Europe, where the auto sales growth is anyway. Or you just sell off the assets and trim product lines."

Yet if the ultimate goal is to break the company up, why doesn't DaimlerChrysler simply do that by itself? Private equity brings in money, banking relationships and a will to make difficult labor choices that the German parent could not make without upsetting operations in Europe. "In the auto industry, Ford (Charts) and GM (Charts) will close down about a third to 40% of capacity over the next two years. The way that union contracts are negotiated in the industry, Chrysler should be able to go to the unions and say, GM is closing down capacity, so that is on the table for us, too," says Phan. "Daimler hasn't made announcements on the same scale because it would have a massive impact on its union contracts in Germany."

Phan estimates that Chrysler has 15% to 20% more product line than they need, including vehicles like big trucks and SUVs. He adds that industry watchers think Chrysler should concentrate on lower margin, but bigger markets, like compact and fuel-efficient cars. The Jeep brand would be the most lucrative part of the business if a private equity firm broke up Chrysler, says Kevin Tynan, an analyst with Argus Research.

Phan adds that in the case of a buyout, debt levels on Chrysler could reach a point that the company would technically be insolvent. This would allow the new owner to go to the government and ask it to take over pension contracts.

Such moves might not go down well with Chrysler's 84,000-strong workforce. Buzz Hargrove, national president of the Canadian Auto Workers, says: "We've had nothing but bad experiences with these leveraged buyout groups, or private equity groups or whatever it is they call themselves these days. It's the same wolf in sheep's clothing. They come in with very little money of their own and a lot of money from someone else, and then cut and slash and throw people out of work in order to make a lot of money for their small group of investors."

If Blackstone pursues a slice-and-dice strategy, labor wouldn't be its only headache. Compared with the other Big Three automakers, Chrysler does not have as much to shed. Its finance unit is primarily for Chrysler auto loans, while GMAC also had robust insurance and mortgage businesses that made it a valuable standalone company. Moreover, GM and Ford have a lot of overlapping product lines. If GM got rid of GMC trucks, it would still have Chevy. When Ford got rid of Aston Martin, it still had Jaguar. "Chrysler works together as a whole because there's not a lot of overlap in the different brands," says Tynan. "This could be a situation where the parts are more valuable as a whole."