GM: The Vultures Circle

General Motors (GM) is moving faster to remake itself with decisions to ax Pontiac, thin its huge herd of car dealers, and cut more plants and workers. But the company still needs its bondholders to cash in $27 billion in debt for stock to avoid bankruptcy.

That won't be easy. GM wants its bondholders to take 225 new shares of the company for every $1,000 in bond value. GM will also pay the interest. That adds up to at most 5¢ on the dollar for the debt, says Barclays (BCS) analyst Brian Johnson.

That's what could make it a tough sell. The Treasury Dept. will also be offered 50% of GM's stock in exchange for erasing half of the $20 billion in government debt GM will have accrued as of June 1. The government will also get stock. GM also plans to give the United Auto Workers 50% of the value of $20 billion owed to the union's retiree health-care trust in cash and the rest in stock. So the bondholders are being offered a lot less.

GM hopes that at least 90% of the bondholders will accept the deal so the company can reduce its total debt down to $48 billion. But the company will have to convince bondholders that the deal is better than fighting for more in bankruptcy court. "This is not something the bondholders will be inclined to accept," says Johnson. "If you don't take their offer, you may be able to do better."

Bankruptcy Judge May Give Bondholders More

If bondholders refuse the offer, they will be betting that they can get more than 5¢ on the dollar in cash from a bankruptcy judge. Since bondholders stand on equal footing in bankruptcy court as unsecured creditors along with the United Auto Workers, they may figure that the judge will give them some of the stock or cash that GM plans to give the UAW.

There is one other catch. Some bondholders own credit default swaps, which amount to an insurance policy on GM bonds that pay in full if the company goes bankrupt. Tim Backshall of Credit Derivatives Research says that there are contracts backing an estimated $2.7 billion in bonds on the market. If those contract holders all hold bonds, it won't take too many more bondholders to refuse the deal and send GM to bankruptcy.

Treasury wants GM to get enough buy-in to wipe away $24 billion of the $27 billion in debt, said GM CEO Frederick A. "Fritz" Henderson. "If we fall short, we will fall into a bankruptcy process," Henderson said.

If the bond exchange goes through and the UAW and Treasury agree to the deal, the government and union will collectively own 89% of GM. The government would own about half of the company. The current stockholders will be diluted down to 1% of the company.

Already the offer is getting pushback. An ad hoc committee representing owners of about $6 billion in bonds—and which has dialog with owners of another $6 billion—issued a statement saying that its members are, "deeply concerned with today's decision by GM and the auto task force to offer only a small, inequitable percentage of stock to its bondholders." The committee griped that the union's healthcare trust is getting 50% of its $20 billion GM debt in cash and 39% of GM's stock while the bondholders, who have the same legal standing as the union, are being offered a 10% stake in GM and almost no cash. GM does have some limited options to change the debt-for-equity offer. But under the terms disclosed so far, the company is offering so much equity to the government and the union's healthcare trust that it would be tough to make the offer substantially sweeter than it is.

The good news is that if GM avoids bankruptcy or makes it out of court, the company will be seriously restructured. Henderson said GM will be sized to break even in a market selling 10 million cars, but at current market share levels of around 19%.

Back on Track in 2014?

That means GM needs to hold market share or see sales rebound, but it stands a much better chance of making money than it has since the company needed a U.S. market selling at least 16 million vehicles a year. "When the market improves—and it will improve—we can be very successful," Henderson said.

Last year, the company lost $31 billion when sales fell to 13.2 million vehicles. So far this year, American consumers are on pace to buy less than 10 million.

But for the government to get paid back, GM would need to post earnings before interest and taxes of about $16 billion, says Johnson. That's more than any of the projections from GM's recovery plan. Plus, GM will still have a lot of debt. Henderson said in an interview that with the restructuring and a rebound in the car market, GM can start paying down its debt and get its borrowing more in line with other successful industrial companies. But it may take through 2014 to get there.

With the closure or sale of other brands including Saturn, Hummer, and Saab, GM will go forward with four brands, Chevrolet, Cadillac, Buick, and GMC, Henderson said.

By closing Pontiac and ditching Saab, Hummer, and Saturn, GM will have 34 cars, 13 fewer than its February plan included.

Cutting Dealers and Workers

Next up, GM has to get a lot of dealers to go away. Henderson said he will slash GM's dealership count by 42% from 2008 to 2010, from 6,246 to 3,605. The company will offer those dealers some kind of compensation, but hasn't determined how much, says Mark LaNeve, GM's vice-president for North American sales and marketing. "We have been overdealered for years," LaNeve said.

Cutting dealers could be costly, but GM might be able to negotiate cheaper buyouts than it did with Oldsmobile in 2000. Faced with bankruptcy, which would make it tough for dealers to get anything, they may take lower payouts. Henderson said GM will still have to pay to buy back parts and help exiting dealers sell off inventory.

Henderson is also cutting more workers. GM said it would cut 21,000 U.S. factory jobs by next year, dropping its blue-collar workforce to 40,000 employees. Its total number of factories will shrink from 47 to 34, which is three fewer than GM planned to close in February.

Buyouts for workers still have to be negotiated with the UAW, Henderson said. But he added that the union has been cooperative.

Will the cuts be enough? Henderson did say that GM needs to hold market share and vehicle pricing for it all to work in a poor market. That won't be easy. LaNeve said GM's retail market share has been stable, so GM may have bottomed out. But the company still needs a market rebound. And even more important, LaNeve says, GM will have to burnish its image: "Eventually, we'll get a strong message out there that we really have reinvented GM."

Click here to read BusinessWeek's complete coverage of the U.S. auto industry in our Special Report: Detroit in Crisis.

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