Generally Motored! Why GM has the Government by the Gonads

Either the well was very deep, or she fell very slowly, for she had plenty of time as she went down to look about her and to wonder what was going to happen next…” As General Motors representatives prepare for the February 17 discussion with the Treasury Department on viability plans, they shall be under some pressure to illustrate how they plan to pull the company of its $44 billion dollar rabbit-hole of debt and re-emerge into the sunny wonderland where selling cars actually generates profit. The company is expected to show progress on negotiations with its creditors and must have firm commitments by end-March, else it could be forced to pay back the $13.5 billion loaned by the Treasury thus far.  Given GM’s current liquidity crisis, a misstep on February 17 could plunge it into bankruptcy.

Looking back, 2008 appears to be the year of the perfect storm not just for Wall Street, but companies like GM who have long been used to working on sky high operating leverages financed by relatively inexpensive capital.  In 2007, for example, GM had a negative working capital of $ 39 billion – which isn’t always a death sentence, but occasionally proves fatal in times such as these where new vehicle sales drop dramatically.  The company now finds itself crippled by high interest expenses even as its liquidity seemingly evaporates into the ether.
Up to September 2008, GM paid $2.6 billion in interest expense even as its cash and cash equivalents shrunk from a relatively healthy $24.5 billion in December 2007 to a decidedly anaemic $15.8 billion in September 2008.  Despite scaling back production, the company had burnt through almost $ 11 billion in the first 9 months of 2008 – more than a billion dollars a month; and unlike the $39 billion income tax deferments written down in 2007, this was real money.  With the company expected to pay nearly $7.2 billion as the short-term portion of long term debt in 2009, and the company continuing at this Hummer like burn-rate, GM could be out of money by the second quarter of 2009.  The company is also required to pay up an additional $ 0.6 billion of principal in 2009, $0.4 billion in 2010 and another $6.2 billion in 2011.
When faced with a liquidity crisis, a company may exercise a number of options: it could attempt to raise money through either debt in the form of bonds, or equity in the form of stocks. It could approach lenders or syndicates of lenders and set up secured credit revolvers in exchange for collateral, and when all else fails, it could fly its Chief Executive in a private jet to Washington to ask Congress for money.  GM, it appears, has tried all of the above.
Raising money through either bonds or stocks is out of the question, given that the company stock is currently trading at about $3.03 on the NYSE, and that GM’s corporate debt is current rated near about junk.  In fact, liquidity problems are so acute that in September 2008, the company issued 44 million shares of common stock to an institutional holder in exchange for $0.5 billion principal amount of their Series D debentures that were to mature in 2009.
The company has also exhausted a $4.5 billion secured credit revolver and another $0.9 billion revolver that expires in August next year. “Now no one is willing to lend to us,” explained a source at GM speaking on the condition of anonymity, “Everyone is convinced we will default.  This has forced us to come up with more and more collateral to raise capital.” On September 23 2008, Deutsche Bank offered a one year secured revolver worth $0.2 to $ 0.5 billion in exchange for $1 billion in receivables as collateral, i.e. the collateral was double the principal. GM has already borrowed $0.4 billion of that facility.
The company sold off 51% of its share in GMAC in 2006 and Allison Transmission Corporation in 2007 in an attempt to boost liquidity, and is now said to be reviewing its Hummer brand of vehicles. But with customers drifting away from expensive gas guzzling vehicles, it is unlikely to attract much interest from other buyers.
Given that vehicle sales are unlikely to revive in the next two quarters, a bailout by the government appears to be the only possible way to save the company.  Of course, it is an entirely different question if it should. A question that, in many ways, sums a crucial conundrum of our times. If the Government bails GM out, it essentially uses taxpayer – ie public- money to to assist a grossly mis-managed private company that has walked itself down the path to implosion.  However, if it allows GM to go bankrupt, it allows the company to renege on its pension and healthcare contracts with the United Auto Workers union, and essentially passes on a several billion dollar burden onto the Government – i.e. the taxpayer, i.e. the public.

To quote from a Businessweek article,

If GM went belly-up, retirees, workers, and taxpayers could all take a hit. Right now, its $90 billion pension fund is fully funded on an accounting basis. But the government-backed Pension Benefit Guaranty Corp., which acts as a safety net for corporate pension plans, says GM is underfunded by $31 billion.

How that would play out in a GM bankruptcy would be complicated. The PBGC could be on the hook for billions in pensions. The agency also could force the Detroit giant to keep funding its own pension plan even in bankruptcy — though the company could make the case that it should pay less. Still, GM’s 450,000 retirees would get hit: They may end up with smaller pension payouts, and their medical benefits, as well as the health-care plans of existing workers, would most likely be whittled back.

Intriguingly, General Motors’ first ever bailout came when a Bankers trust seized control of the company only two years after it was founded by William Durant in 1908. The reason? Excessive debt and slow car sales.

Aman Sethi

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