FRANKFURT -- DaimlerChrysler will spend up to 1.2 billion euros ($1.56 billion) in 2005 to revamp its ailing Smart brand, adding to its woes just a day after announcing its biggest-ever recall for its Mercedes brand.

"The substantial expenses in connection with the new Smart business model will impact DaimlerChrysler's earnings forecast for 2005," the company said in a statement on Friday.

Daimler reiterated it expects a slightly higher operating profit this year compared to the last, but only when excluding the one-off restructuring charge for the loss-making marque, and said it was targeting break-even for Smart in 2007.

The announcement comes on the heels of Thursday's recall of 1.3 million Mercedes-Benz vehicles worldwide, including its E-class sedan and brand new CLS four-door coupe, signaling just how dire the situation is at Daimler's flagship division.

In the fourth quarter of last year, operating profit at the Mercedes Car Group, Daimler's former jewel, comprising the Mercedes, Smart and Maybach brands, plunged 97 percent to just 20 million euros.

"Key component of the new (Smart) business model is a restructuring program with which earnings are to be increased by some 600 million euros in the year 2007," the carmaker continued, saying it aimed to lower fixed costs at Smart by around 30 percent within the next two years -- in part through "significant" reductions in the workforce.

Robert Heberger of Munich-based bank Merck Finck downgraded shares in Daimler to "sell" from "hold" on Friday on account of the higher-than-expected restructuring charges and the recall.

Citigroup, meanwhile, said the plan fell short of hopes for a more radical approach.

"Investors hoping for some new thinking will be disappointed that the company appears determined to 'grow its way' out of trouble at the Smart unit."

ONLY TWO MODELS LEFT

As part of the rescue plan, Smart will discontinue production of its roadster model at the end of 2005 and will discontinue plans to build the Smart ForMore compact off-roader.

This leaves just the original microcar ForTwo and its new ForFour subcompact in the brand's model range.

"The new product concept calls for the intensified development of the successor to the Smart ForTwo, including fulfilling the requirements for the U.S. market," it said, adding that the next generation three-cylinder petrol engine would also be available for other carmakers to use.

The cooperation with Mitsubishi Motors on the production of its Smart ForFour at the Japanese carmaker's plant in the Netherlands would continue, but measures would be taken to ensure the model will break even in the future, it said.

The brand will lose more independence as key areas of development, sales, purchasing, after-sales and service would be integrated into Mercedes-Benz to generate greater cost savings. A quarter more Smart outlets will also be opened within the showrooms of existing Mercedes-Benz dealerships.

Daimler has limped from one bailout plan to the next in recent years, first trying to restructure U.S.-arm Chrysler, then fix alliance partner Mitsubishi, only to find that its steady workhorse Mercedes finally began to crumble from neglect.

CSFB's Harald Hendrikse said the massive recall of Mercedes-Benz cars ran counter to the brand's claims that new vehicles leaving the factories enjoyed the highest quality in its history.

"It is surprising that the product launch of the CLS went ahead in (late) 2004 when it was being manufactured using components that had already been failing on the E class," he told clients in a note on Friday.