GM & Cerberus End Game: The Bailout

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October 29, 2008


For over a year now I have been documenting the systemic troubles with the US domestic automotive manufacturers. In that time, there has been little doubt that Chrysler and it majority owner Cerberus Capital Management were in for trouble. I have also documented many grave concerns with General Motors’ automotive operations as well as the problems shared at its lending unit GMAC with co-owner Cerberus. Chrysler and GM have appeared to have been in the worst shape as both are stretched by supporting multiple brands in the worst market in decades where credit has dried up and they are in need of capital. Through most of this, Ford has been given a pass not because it is in that much better shape, but because the company “got lucky” and mortgaged much of the company when credit was easy, to raise $20+ billion dollars for its restructuring.

The past couple weeks have been interesting since it was first reported that Cerberus and GM had initiated talks about a possible GM merger with Chrysler. At the time there was speculation that Cerberus wanted in exchange for Chrysler, increased control over GMAC. According to reports, the companies’ intent was to finalize a merger agreement between GM and Chrysler before the presidential election and are lobbying for government financial assistance to help fund the deal. Early on, as the news was unfolding, I was convinced any deal was about GM and Cerberus angling to prevent a bankruptcy at GM, GMAC and Chrysler. One thing that I did not discuss beyond a high level overview was how Cerberus would prevent a collapse at GMAC if they were able to get control.

Since I last wrote on this subject, GM and Chrysler continue to take steps to conserve cash. Chrysler announced last Friday it would trim its white-collar and contract staff by 25 percent with voluntary layoffs beginning in November. The staff reductions include about 5,000 workers is in addition to 29,000 job cuts Chrysler has enacted in the past two years. Furthermore Chrysler plans include more production cuts, plant closings and product cancellations.

Automotive News just reported GM is postponing nearly all of its spending on product development in 2009 and 2010 as a cost-cutting move to save $1.5 billion. This move could delay the introduction of important vehicles that were intended to help restore profitability to the company. GM also announced the temporary closing of two plants. An Automotive New source stated:

"It's not just capital budget; it's also engineering, design ... everything that would cause money to flow out in 2009."

I have personally been told by a source within GM:

“Take all the bad news being reported in the press about GM’s financial state and multiply that by a factor of 10.”

I do believe the situation for both companies is grave, however, as of today GM has not scheduled a date to report its 3rd Quarter financial results and Chrysler as a private company does not report earnings and the true picture is uncertain. Given the market collapse and ongoing global liquidity freeze with the banks, I am expecting GM’s cash burn rate could be well over the one billion per month they have been averaging the first six months of the year. Late September GM did access the remaining $3.5 billion in a $4.5 billion line of credit which will give them a small cash buffer. GM also raised $322 million in a debt to equity exchange. Chrysler is reported to have about $10 billion in reserves available.

It has been my position that the only way GM can survive in this tight credit market is for a US government bailout and that may come through a merger with Chrysler. Automotive News reported GM and Cerberus have asked the US government for roughly $10 billion to support a merger between GM and Chrysler. The government funding would include roughly $3 billion in exchange for preferred stock in the merged automaker. The U.S. Treasury Department is considering the request and a decision could come this week. Three billion dollars in equity to support a GM acquisition of Chrysler would be roughly equivalent to the current value of the largest US automaker.  Furthermore, Chrysler owes JP Morgan, Morgan Stanley, Goldman Sachs, Bear Stearns (now part of JP Morgan), and Citigroup $10 billion.  Much of that debt is still sitting with the banks and on their books.  I believe this is also important to consider when rationalizing the motives. (See:Chrysler Debt Sells for Junk) 

According to the Detroit News, the US Department of Energy is expediting its rulemaking effort to begin lending money through a $25 billion auto loan program that was authorized last month by congress to support fuel efficient vehicles and could be a critical source of funding for GM. The DOE is circulating draft regulations for the loan program with final rules as early as next week. Personally I am suspect of the timing as being unrealistic and I suspect it will be months before the rules are issued. However, it a now appears to me that GM and Cerberus will make a strategic deal very shortly once the government funds are secured.

It also appears, Cerberus is also angling for the government to bailout GMAC as a way to salvage its $14 billion investment in the company. GMAC has stated it wants to be part of the federal government's $700 billion rescue of the nation's financial system and as part of the bailout structured automotive loans are eligible to be purchased by the treasury. GMAC spokeswoman Toni Simonetti has said:

"GMAC has been in discussions with the government on a multidimensional level."

"We are interested in exploring options that are available to us through the federal government's tool kit that was implemented under the new legislation."

The situation at GMAC must be deteriorating fast given its source of cash as dried up as the commercial paper markets have frozen. Earlier this month, GMAC took action to restrict lending to only those with good credit and reduced longer-term auto lending in the US due to its limited access to funds. GMAC has also reduced its exposure to vehicle leases in the US because of declining residual values of off-lease vehicles. GMAC is futher restricting lending as the company just said on Tuesday it would stop making new consumer car loans in seven European countries starting November 1.

Today it all came together as the Wall Street Journal reported, GM and Cerberus are seeking to have GMAC LLC become a bank holding company just as the investment banks Goldman Sachs Group and Morgan Stanley recently took similar action to avoid insolvency. Such a move would allow GMAC to gain access to the US government's $700 billion financial rescue plan. GMAC could also receive equity injections from the Treasury Department's capital purchase program and have its debt temporarily guaranteed by the Federal Deposit Insurance Corporation. Also as a federally chartered bank, it could access the Federal Reserve’s discount window for inexpensive, short-term emergency loans.

If a deal were to arise GM may need to transfer at least half of its ownership in GMAC to Cerberus so that the automaker no longer owned more than 24.9% of the voting shares. That way GM will not have a controlling interest in the firm under federal law. Cerberus could then merge GMAC and Chrysler Financial, Chrysler's lending arm, into an entity controlled by the bank holding company. However, GMAC's pursuit of a bank holding company designation would require approval from multiple government agencies and according to the WSJ it is unclear at this point whether it could win approval.

So the end game appears to be a US government cash infusion for both GM and Cerberus.

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