Dec. 19 (Bloomberg) -- Students of distressed companies wondering about the prognosis for ailing General Motors Corp. might do well to drop by the office of Professor Edward Altman after his finance class.

Altman, a teacher at New York University's Stern School of Business, may be willing to give a quick tutorial on a formula he has spent almost 40 years refining. It uses elements of a financial statement to predict the likelihood that a manufacturer will collapse. His formula currently assigns GM a very bad score, one that ought to unnerve any GM investor.

More precisely, GM rates an Altman Z score of 0.84, based on its third-quarter financial report. That number implies, along with some additional figuring, that GM has a 15 percent chance of filing for Chapter 11 within the next year, and a 47 percent probability within five years.

``Under present management it could be a longer time-frame for GM to file,'' Altman says. ``If the board brings in new management, then some type of radical restructuring or bankruptcy is likely sooner.''

Various Outcomes

Opinions about GM's prospects and whether it will fail run the gamut. The automaker says that it has more than $19 billion in cash, plenty to carry it through its current rough patch of multibillion-dollar net losses and U.S. market-share erosion. The price of GM bonds and associated hedging instruments, on the other hand, show that investors believe the worst is coming.

And there are still those who appear miraculously unaware of GM's travails. GM is ``in very good shape,'' United Auto Workers President Ron Gettelfinger declared this week as the union prepares to resist cuts in workers' pay and benefits.

Altman's formula is no crystal ball. Yet he does inject some hard numbers and facts from history into an inherently subjective call -- whether GM's current management will be able to pull the company out of its tailspin before a crash.

Much of the evidence suggests the world's biggest automaker remains pointed in the wrong direction.

Standard & Poor's lowered its credit rating on $102.9 billion of GM bonds to B (``speculative'') from BB- on Dec. 13. S&P first lowered GM to junk territory on May 5 -- months after Altman predicted that event based on GM's financial performance.

GMAC, GM's financial subsidiary, which is forecast to earn $2.5 billion this year, isn't included in the Z score. The formula wasn't created to account for the peculiarities of banks, insurers and other financial companies. GM is in the process of trying to sell a majority stake in GMAC to raise cash and to improve the BB credit ratings on $141 billion of GMAC debt.

Passing Grade?

Based on GM's financials, Altman thinks the company's bonds warrant a CCC+ (``currently vulnerable to nonpayment'') rating from S&P. The 64-year-old professor says ratings firms tend to change grades more slowly than would be merited by financial reports alone. Companies being rated, especially those in trouble, often argue with the ratings firms for ``stability'' of ratings, he said.

The Z score -- the Z having no meaning except as a letter favored by statisticians -- is derived from calculations performed on a company's most recent numbers for working capital, assets, retained earnings, earnings before interest and taxes, market value of equity, sales and debt.

Good, Bad and Neutral

A Z score above 3 indicates bankruptcy is unlikely. Exxon Mobil Corp. for example, rates a score of 5.36. Below 1.8, bankruptcy is possible. Xerox Corp., the world's biggest copier maker, rates a 1.79, after returning to profitability following net losses in 2000 and 2001. Numbers between 1.8 and 3 are inconclusive.

Altman says 80 percent to 90 percent of the public companies that went bankrupt over the past 35 years had scores of less than 1.8.

To determine the probability of bankruptcy, he correlates Z scores with credit ratings on respective debt securities. Then he calculates, retrospectively, the fates of other distressed companies in similar circumstances.

Altman, in effect, does actuarial studies of companies with similar ratings and performance, much like those done by life insurance specialists to figure out how long people will live, given their age and health.

The original Z score, with additional versions since modified so they apply to more than just manufacturing companies, is an outgrowth of his doctoral thesis at the University of California at Los Angeles. He has taught at NYU for almost 40 years; many of his students work nearby on Wall Street.

Chapters on Chapter 11

Two months ago, Altman published the third edition of ``Corporate Financial Distress and Bankruptcy,'' (John Wiley & Sons Inc.). The book's subtitle, ``Predict and Avoid Bankruptcy, Analyze and Invest in Distressed Debt'' is revealing, because it points out that catastrophes often present investment opportunities.

Though prices on GM bonds have fallen on bankruptcy concerns, the doubts also have boosted the prices of GM credit default swaps -- a sort of insurance policy against a bond going into default -- to more than $1.2 million. That's the amount that it costs now annually to protect $10 million of GM bonds maturing in five years, up from about $325,000 at the start of 2005.

The good news for GM is that a bad Z score doesn't preclude the possibility of recovery. If new GM vehicle models are hits and if costs are brought under control -- big ifs, for sure -- GM's numbers are bound to improve.

A few strong quarters could prompt S&P and others to raise credit ratings. And Altman's Z score would rise, signaling the reduced the probability of default.

Even an F student sometimes turns it around.

To contact the writer of this column: Doron Levin in Southfield, Michigan at dlevin5@bloomberg.net

Last Updated: December 19, 2005 00:02 EST