A Deal That Could Save Detroit
Just a few weeks ago, United Auto Workers President Ron Gettelfinger had nothing but contempt for the "strip-and-flip" private equity investors bidding for Chrysler Group (DCX ). So most people expected him to come out slugging when Cerberus Capital Management agreed to buy the struggling automaker on May 14. Instead Gettelfinger embraced Chrysler's new owner. "The status quo is off the table," he declared.
Attitudes are evolving rapidly in Detroit these days, and it is clear that the arrival of the bare-knuckle financial wizards from Cerberus is only going to hasten the pace of change in town. Managers and UAW leaders alike appear to accept that a time of reckoning is at hand. As they look ahead to landmark labor talks this summer, both sides finally appear set to face up to the most vexing problem of all: unsustainably high health-care costs. Thanks to luxe benefits handed over during the golden age of corporate largesse in the 1950s, the Big Three will have an estimated $120 billion in long-term medical liabilities, a crippling burden that puts them at a nearly insurmountable disadvantage to global rivals.
But General Motors (GM ), Ford Motor (F ), and Chrysler's new owners at Cerberus believe they may have a cure for Detroit's epic health-care woes. Their idea: to propose handing over the companies' long-term liability to an independent fund managed by the UAW, which would be financed by a huge one-time injection of cash and stock. Union workers would probably contribute more toward their own coverage costs but would gain protection from the devastating prospect of bankruptcy. The automakers, meanwhile, would wall off a risk that terrifies investors--and earn perhaps their final shot at becoming competitive again. "I think an independent health-care fund has to happen," says Sean McAlinden, chief economist at the Center for Automotive Research in Ann Arbor, Mich. "Ron Gettelfinger may even be resigned to doing it."
This radical idea already has some precedent in Detroit. In 2005 GM and the UAW created a so-called voluntary employee benefits association (VEBA) trust, for a small portion of the company's retiree health-care expenses. The union has also consented to VEBA funds for individual plants belonging to a few parts suppliers. Over the past few months, managers at all three car manufacturers have been closely studying a similar deal struck between the United Steelworkers and Goodyear Tire & Rubber Co. (GT ) in December that relieved the tiremaker from most of its medical obligations without stiffing union workers.
While the Big Three have not been trumpeting the VEBA trust plan, expect to hear more about it as this summer's labor talks approach. Creating such a trust "for the whole industry [is the] primary objective of this year's round of bargaining," says one investment banker well- connected in Detroit. "That's clearly what the Big Three want."
To see why Motown executives are so excited, take a look at how GM would benefit from such a trust. The company has UAW health-care liabilities of $52 billion, not including $18 billion for white-collar workers, according to JPMorgan Chase & Co. (JPM ) analyst Himanshu Patel. The company's first step would be to reduce its liability by asking current and former workers to fork over more for their own health coverage. Then GM would set up a trust fund. Because it would be invested to grow over time, the fund could be valued at, say, 60% of the liabilities, around $31 billion. That may sound risky for the union, but there are risks on both sides of the equation. Unlike pensions, retiree medical benefits are not guaranteed by law and would not be protected in a bankruptcy, a big worry with the U.S. car companies floundering.
How in the world would GM come up with so much money? The company could start with the $15 billion in VEBA money already set aside in some existing trusts. Patel thinks GM could then afford to take a further $8.2 billion in cash from its coffers and sales of some assets, plug in some equity, and borrow about $5 billion. Add it up, Patel contends, and GM could fund all of its union health-care obligations.
Setting up the fund would add debt and drain cash, but it would yield big benefits immediately. Patel estimates that such a deal would boost pretax profits by $900 million in the first year and save GM about $700 million in cash. Accounting for inflation, GM's health-care expenses would drop by about $200 million a year and cash flow would improve by $400 million a year. Ford's health-care expense would drop by $800 million the first year and cash flow would improve by $200 million. Patel thinks the growing improvement to cash flow would help the Big Three narrow the gap with Toyota (TM ) on product and research and development spending. Right now Toyota dedicates almost 12% of its revenue to capital expenditures and R&D. GM spends just 8.4% of its revenue.
If it all sounds too good to be true, it may very well be. The devil will be in the plan's infinite details. The companies' ability to fund a big trust, first of all, depends upon how much money the UAW requests. If the union seeks assets totaling 80% of liabilities, then GM and Ford may not be able to afford it. Since GM already borrowed $18 billion in 2003 to shore up its pension fund and Ford borrowed $23.5 billion this year for restructuring, neither wants to shoulder much more long-term debt. Both have junk debt ratings, so the money would be quite expensive.
At some point, a judge would also have to sign off on a global Big Three trust, because Ford and GM face a legal impediment. When the union gave them concessions on health care last year, a lawsuit was filed to freeze retiree benefits. The courts upheld the deal, but froze the new benefits package until 2011. GM Chairman and CEO G. Richard Wagoner Jr. said in a December interview that further concessions made on behalf of those retirees would need court approval. The same goes for Ford--but not Chrysler, which never won the same health-care concessions as its rivals.
NEW BALL GAME
Nothing in the court order prevents the two companies from setting up a fund to cover new retirees, of course. McAlinden says that the 34,000 GM workers who took retirement as part of the company's recent restructuring could be covered by a new independent VEBA if UAW leaders consented to such a deal. Then, GM and Ford could set up a fund to cover the rest of their retirees beginning after 2011. McAlinden estimates that 80% of the long-term liabilities will be incurred after that date.
The diverging legal and business dynamics at the three companies make a big trust covering benefits at each one difficult to establish. But it is unlikely the UAW would allow one or two of the companies to establish a separate trust to wall off health-care liabilities, even though such a scenario is theoretically possible. That would violate a longstanding union policy against giving any particular member of the Big Three a substantial cost advantage over the other two.
If giant independent trusts get established for all of the auto companies, one far-reaching implication of the move is that the UAW would become an enormous health-care provider. Another is that the union would be forced to manage benefits. That means if costs rise faster than investment returns, the union might have to offer weaker medical benefits to its own members. Right now, if health care gets more expensive, GM, Ford, and Chrysler just cut bigger checks. But it's possible the UAW may do just as well at managing the money as the companies do. Major union-run pension plans nationwide made nearly 14.6% returns last year, about half a point better than large corporate-run funds did, according to Wilshire Associates.
So there's reason to believe that the UAW, even though it will certainly negotiate aggressively, may be willing to go for the idea of a VEBA trust. Although the idea would have been a nonstarter in 2003, the last time the union contract was renegotiated, things have taken a powerful turn for the worse in the past few years. And the arrival of Cerberus may well increase Detroit's willingness to engage in complex financial engineering. "You bring in private equity, and the game changes," says Center for Automotive Research Chairman David E. Cole.
By David Welch and Nanette Byrnes, with Anthony Bianco in New York