It May Be the Right Time for GM to File for Chapter 11 Bankruptcy

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February 15, 2009

This Tuesday General Motors and Chrysler will be submitting viability plans to the US Treasury Department as part of the $17.4 billion bailout agreement reached late last year.  The two companies have until February 17th, to present initial plans outlining a restructuring of their labor agreements and debt or risk having the federal government call in the loans.  Reuters has reported that GM specifically is considering a Chapter 11 bankruptcy reorganization.  See The GM and Chrysler Bailout: Approved for specifics on the bailout agreement.

The Reuters article stated:

One plan includes a Chapter 11 filing that would assemble all of GM's viable assets, including some U.S. brands and international operations, into a new company," the newspaper said. "The undesirable assets would be liquidated or sold under protection of a bankruptcy court. Contracts with bondholders, unions, dealers and suppliers would also be reworked.

Citing "people familiar with the matter," the story said that GM could also ask for additional government funds to stave off a bankruptcy filing.

The terms and conditions set forth by the US Treasury, established targets such as the companies had to reduce debts by 2/3 via a debt for equity exchange, make one-half of healthcare VEBA payments in the form of stock, eliminate the union jobs bank along with the labor union agreeing to more flexible work rules.

GM has also been in negotiations with the UAW over restructuring the requirement of the healthcare VEBA for retirees.  GM is required to convert half of its $20 billion healthcare VEBA liability negotiated with the union in 2007 to equity.  According to the latest news report the UAW walked away from the talks.

The report stated:

At GM, UAW negotiators walked away because the company made demands that were "detrimental to retirees and the ability to provide health care," according to the person, who asked not to be identified because the talks are private.

The UAW labor union has already agreed to eliminate the jobs bank, however, this was a concession agreed in principle by the union prior to the auto companies receiving federal assistance.  Chrysler and even Ford who did not receive aid from the government also will be permitted to eliminate the jobs bank.  The jobs bank program pays nearly 100 percent of wages and benefits to workers who have exhausted their unemployment. Unemployment and supplemental benefits represent about 72 percent of gross pay.

GM has also been in negotiations with bondholder to slash its $27.5 billion in unsecured debt by two-thirds to $9.2 billion as required by the Federal loan agreement.  However, the bondholders want parity with the UAW, and only convert 50% to equity.  This demand is inline with half of the healthcare obligations being converted into equity.  To put this into perspective, GM’s long-term debt is currently trading at 15 cents on the dollar and bondholders want 50 cents on the dollar while the company needs 30 cents on the dollar to satify the Treasury.

According to a Detroit Free Press article:

A report by Dow Jones said Thursday that bondholders want to recoup at least half the debt owed to them by GM. Some analysts say they don't think GM's bondholders should have to give up as much as other stakeholders, since they don't view all the stakeholders as contributing equally to GM's problems.

Analysis

I was not a proponent of GM filing for a Chapter 11 bankruptcy early into the financial crisis.  For starters my biggest concern was establishing the financing to restructure was not going to be possible and to a degree consumers would shy away from a “Bankrupt” auto company because of the uncertainty related to long-term service and support for the vehicle.

A few months later and the collapse in the US market has spread to the rest of the world.  GM specifically cannot afford the burden of the UAW healthcare VEBA negotiated in 2007 or the interest on its debt at current market levels.  

At this point in time, a Chapter 11 restructuring may be in the best interest of the company.  Current shareholders are already wiped out and the UAW remains a hangman’s noose around the neck of the company.  It is in the UAW's best interest to meet the demands of the government because at this point in time, the healthcare VEBA has a chance of being funded if the economy gains some traction and GM can show profits improving the value of the stock. However it would appear the UAW still believes this is 1970 and GM is the world's largest and most profitable company controlling 50% of the US market. 

If the company decides to go into a Chapter 11 bankruptcy, more likely than not, the healthcare VEBA will be a liability the court voids.  For starters, with Medicare, the UAW retirees have an option.  Also, the GM retiree pension plan is well funded.  It is doubtful the court will be sympathetic since the retirees will continue to get their pension checks and a GM bankruptcy would not put a burden on the Pension Benefit Guaranty Corporation (PBGC).  The PBGC is the US government sponsored entity that protects defined benefit plans, investment income, and assets from pension plans.  Furthermore the entity does not guarantee health and welfare benefits.

The UAW agreed to establish with the Detroit 3, a more competitive pay scale for new employees but that does not correct the pay imbalance with more senior workers and the transplant manufacturers that now represent about 50% of US production.  My biggest concern that should be addressed in a Chapter 11 bankruptcy will be more flexible work rules that currently restrict the US companies from being more efficient.  There has been significant progress made over the years but again there is an imbalance that is absent at the transplant operations. In my opinion this is not a point of negotiations for the UAW but a fact that must be eliminated.

My biggest assumption is the US government will provide the Debtor In Possession (DIP) financing GM needs to conduct the restructuring.  With the current economic climate what it is, the impact on sales from consumers shying away from the company because of the uncertainty associated with a bankrupt GM may have a negligible impact on sales.  The needed reduction in GM’s dealer base will be helped by poor state of the economy and a Chapter 11 bankruptcy will allow the company to shed brands such as Saturn, Pontiac, Hummer and Saab quicker.

The bondholders appear to be resisting the debt-to-equity swap because they want parity with the UAW.  A portion of GMs unsecured debt is already convertible and currently worthless.  Furthermore, this debt went to pay for GM’s unfounded pension liabilities earlier in this decade, which was still fully funded as of the end of the 3rd Quarter. Maybe bondholders have a point in this discussion and the pain should be shared more equally for that reason.  For example, should the healthcare VEBA be funded at all given the status of the pension fund?

For the above reasons in may be the right time for GM to push "ctrl-alt-delete" and reboot the company under a Chapter 11 bankruptcy if the reports are correct and the bondholders and particularly the UAW are not cooperating.

On a side note, the Financial Times reported Cerberus, the majority owner of Chrysler could loose most of its equity in the company.  As Chrysler has to comply with the same terms as GM with respect to debt and the healthcare VEBA in addition to the proposed tie-up with Fiat diluting its 80% stake in the company that is expected.

We will find out more on Tuesday when both companies’ viability plans are released. 

 

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