GM: Unrealistic Expectationsby
Editor's Note: This version clarifies that legal and financial advisors to GM's bondholders have endorsed the company's offer as long as GM agrees to some changes.
As promised, General Motors (GM) and Chrysler delivered their turnaround plans to the Treasury Dept. on Tuesday, Feb. 17. While both companies have slashed costs, both say they need more government cash and concessions from the union or their creditors to survive the downturn.
GM got another $4 billion from Treasury on Tuesday, completing a government commitment made in December to give the automaker $13.4 billion. But GM says that given the weaker economy and declining auto market, the company still could need as much as $30 billion in total. Chrysler has asked for $5 billion on top of the $4 billion it has borrowed from the government.
Bondholder and UAW Debt Burdens
It will be up to Treasury to decide if the two companies' plans go far enough to prove that they are viable and will be able to pay the money back. There is risk that GM can't get all of the concessions it needs and that sales won't rebound fast enough to build revenue. In GM's case, the company still has to convince its bondholders and the United Auto Workers to reduce future debts. The car market will also need to revive in the next couple of years to the levels that both automakers have forecast.
And there's still a lot of work to be done. GM has two major issues that need to be resolved. First, the company has to negotiate with its bondholders to drop its unsecured debt burden from $27 billion to about $9 billion. Second, GM owes the UAW $20 billion to start a union-led trust fund to manage retiree health care.
GM wants to give the UAW half in cash and half in stock. But like bondholders, the UAW has balked. GM Chairman and Chief Executive Officer G. Richard Wagoner Jr., said the company is making good progress on both fronts. But GM could not strike a deal before the proposal to Treasury was due.
Getting both parties to reduce GM's long-term debts will be vital to ensuring the company's viability. The automaker has more than $60 billion in debt between its creditors and the union. "What has weighed on us more than anything," Wagoner said, "is that we have a huge debt burden. We had to raise money to pay $103 billion in post-retirement benefits over the last 15 years."
Wagoner said GM's cost cuts will make it profitable in a car market of 11.5 million to 12 million cars, about 1 million fewer vehicles than the company said it needed in December before it cut more jobs. If all goes according to plan, GM could return to profitability within 24 months, Wagoner said. "Supporting GM's viability is a sound investment for U.S. taxpayers and one that will be paid back," Wagoner said.
GM has an offer on the table to a committee representing its bondholders, which the legal and financial advisors have endorsed if GM makes a few changes that they want. GM and the bondholders representatives will kick their proposals back and forth, but they are getting closer. It will be up to the bondholders to examine GM's turnaround plan and agree to the terms of the offer to get a deal done.
GM said it also has a deal to reduce its labor costs with the UAW, but the company wouldn't give details until UAW President Ron Gettelfinger took it to his members for a ratification vote.
But if Chrysler's deal with the UAW is an indicator—and the union usually treats all three automakers somewhat equally—GM should be able to cut its remaining $20 billion in cash obligation to the union's health-care trust by 50% and give the rest in stock. Chrysler said that the UAW agreed tentatively to swap half of its $10 billion in health-care funding obligations for equity if Chrysler can successfully get banks and other debtholders holding $6.9 billion in debt to take two-thirds of that in equity such as preferred stock.
GM is in a similar pickle. The bondholders will want to see that GM's deal with the UAW goes far enough. And the UAW wants to make sure that their concessions are going to make Wall Street investors whole. So both companies will have a job of shuttle diplomacy to get both deals done.
Cutting Labor Costs
GM needs to make further cuts to its labor costs to satisfy the original qualifications set in place by the Bush Administration. Right now, GM's costs are $77 an hour versus $48 an hour including benefits at foreign-owned plants in the U.S. But about $18 an hour goes to retirees.
A source close to GM's planning says the company wanted wage and benefits concessions from the union. The UAW already agreed that new hires will make $14 an hour in wages compared with $28 for veteran workers. The source said that GM was also trying to cut wages and health-care benefits for veteran workers. That complicated talks. GM also wants to get more flexible work rules in the plants and to cut the number of skilled tradesmen, like electricians and plumbers, who make more than $30 an hour. GM's Wagoner wouldn't give details, except to say that "We came into this with very ambitious targets. This will take a big bite out of our labor costs."
GM did say it will close five more factories globally on top of the nine that the company has already announced. A total of 47,000 jobs have been eliminated worldwide this year.
There's another possible pitfall for GM. The company said its pension plan was significantly underfunded at the end of 2008. The company could have to plow more cash into the pension plan in 2012 or 2013 if the stock market doesn't rebound. That could further hit GM's balance sheet.
Chrysler said it reached agreement with the United Auto Workers on work rules and wage concessions that meet the criteria of Treasury, putting its employees at parity with U.S. workers assembling vehicles for foreign automakers like Toyota (TM) and Honda (HMC).
Perhaps the biggest wild card for GM, Chrysler, and Ford (F), which has not asked for government assistance, is how low auto sales will remain and for how long. Chrysler, perhaps to shock legislators and Treasury into funding the restructuring plan, projects sales this year of 10.1 million units, and a moribund average selling rate for the industry of 10.8 million units between 2010 and 2012. GM thinks it will be much higher, ranging between 11.5 million vehicles and 14.3 million vehicles in 2010 and from 14.5 million to 17.5 million in 2012.
If sales are on the high end of GM's plan, the company would pay back its government debt by 2014. If sales stay on the low side of GM's projections, the company would still owe Uncle Sam $30 billion in 2014.
GM's plan has a rosier sales outlook that Chrysler's. Jeremy Anwyl, CEO of Edmunds.com, a Web site tracking auto sales pricing and data, says it's safer to use GM's lower sales estimates. He thinks sales will be in the range of 12 million to 13 million vehicles in the U.S. over the next couple of years. But in a few more years, 16 million cars and trucks isn't a crazy idea, he says. "Everyone wants to know if they will be back for more, and that depends on auto sales," Anwyl says. "I have to believe that 15 million or more is the industry's average."
The High Cost of Bankruptcy
If the government doesn't support the two companies they both could end up in bankruptcy. GM executives maintain that bankruptcy is their last option and could result in liquidation. In its report to Treasury, the company says that bankruptcy would cost the government more in loan support since banks are doing very little debtor-in-possession financing for bankrupt companies.
GM says a quick bankruptcy, or a prepackaged bankruptcy in which terms are agreed with the union and creditors before filing with the court, would require $36 billion in government funding. On the long end, a traditional Chapter 11 bankruptcy would require between $71 billion and $86 billion in government loans.
Chrysler's bankruptcy plan says it would need $24 billion in debtor-in-possession financing from the government. Without it, the company would face a 24-month-long liquidation. Chrysler estimates the cost of the loan program to be $65 per tax filer, with the expectation that the loans can be repaid. Liquidation, with the resulting unemployment, lost tax revenues, and the government assuming pension liabilities would be $1,200 per tax filer, the automaker estimates.
Chrysler's plan calls for the company to stay independent but in an alliance with Italian automaker Fiat (FIA.MI), which would share vehicle platforms, engines, and technology with Chrysler in exchange for 35% of the company and the possibility that it could acquire an additional 20% at a later date.
But Chrysler also outlined enormous savings that could be gained from a consolidation of Chrysler with another automaker. It does not name General Motors as the other company, but the two companies talked at length last year about merging. One source at GM said the company does not have much interest in merging with Chrysler and that talks didn't get very far last year before GM realized that the costs outweighed the benefits.
GM Winnows Brands
Chrysler has too many problems, and GM has a lot of work to do. One of its big issues is winding down four of its eight brands. GM will spin Saab into a separate independent company. Saturn will effectively be closed after 2011, and Hummer will be shuttered if a buyer isn't found soon. GM has set aside money to pay dealers for their investment in the euthanized brands. Pontiac will just be a niche player selling a couple of sports cars in Buick-GMC showrooms.
That will allow GM to drop down to 36 nameplates from 48. With fewer mouths to feed, GM says it could be competitive spending just $6.5 billion a year on new vehicles. The company spent as much as $8 billion in recent years.
But going forward, Chevrolet, Cadillac, Buick, and GMC will get all of the funding. "GM has to continue on its very recent path of building cars people like," says Roger Martin, dean of the University of Toronto's Rotman School of Management. "The entire product portfolio has to look that way."