Bailout or Bankruptcy?

With the economy in the doldrums, Barack Obama in the White House, and Elton John releasing a line of crystal encrusted Ipods for charity, it’s suddenly fashionable to talk about “Sacrifice” once more; a trend that senior management at General Motors seems to have picked up on.  Their December 2, 2008 proposal to the Senate Banking Committee calls for sacrifices no less than nine times in twenty four pages from everyone including stake holders, share holders, bond holders, management, senior executives and in one instance, even the GM balance sheet (it has been asked to sacrifice leverage).   That the Company wrangled out $13.4 billion from the TARP suggests an era in which nothing succeeds like sacrifice, but the accompanying term sheet suggests that the time for martyrdom has just begun.

While the Company has already received $ 9 billion to tide it over its liquidity crunch, by February 17th it is required to show concrete progress in stripping itself of its $30 billion debt, and fundamentally transforming its relationship with its workforce. Else, it could find itself forced to return the money by the end of the month with drastic consequences for the company’s cash levels.

While GM is likely to pursue several simultaneous negotiations, one of primary importance shall be the bondholders who currently hold the company’s $30 billion dollars of debt. For continued access to bailout money, the Treasury’s term sheet requires that GM restructure at least two thirds, or twenty billion dollars worth of debt through either debt for equity swaps or bond exchanges. While it may appear that the Company is in no position to negotiate, the very real possibility of bankruptcy might serve as a useful bargaining tool.  Once GM enters bankruptcy, bond holders might never see their money again, or at the very least would have to take a severe haircut.  As of December 31 2008, GM debt was already trading at a severe discount of between 19 and 13 cents on the dollar (depending on maturity), hence bond holders may be amenable to a bond exchange wherein they GM offers them 50 cents on the dollar and a higher tranche of debt in return for effectively halving their current holdings.  The other option is a debt for equity swap, but with GM stock trading at $2.5, few would be willing to accept it.

Bond holders willing to negotiate would also be conscious of the “holdout problem” wherein the higher price of GM debt that shall accompany a successful debt exchange shall end up enriching those who did not participate in the negotiations but profit anyway from the deal. This would incentivise bond holders to hold out for longer and longer periods, hoping that other debt holders would buckle under the pressure instead.  Evidence of this is already underway with PIMCO, one of GM’s larger debt holders, resigning from an investor committee set up to negotiate an exchange of debt for shares.
Bondholders would also be aware that while a bankruptcy could force them to take severe write downs, they shall still be better off than shareholder who shall be obliterated in the event of a bankruptcy. This very real possibility makes a debt for equity swap even more unattractive.

GM would also have few kind things to say about Rod Lache, a Deutsche Bank analyst, who set a strike price of $0 for GM shares.  Such pessimism is unlikely to help motivate the second big group in line for sacrifice – the United Auto Workers Union. According to the terms and conditions of GM’s federal assistance, GM is required to reduce the “total amount of compensation, including wages and benefits, paid to their U.S. employees so that, by no later than December 31, 2009, the average of such total amount, per hour and per person,” is “competitive” with that paid to non-union employees at Nissan, Toyota and Honda’s U.S. factories.  The term sheet also calls what it calls “severance rationalisation”, “labour modification” and the provision that “not less than one half of the value of each future payment” of GM to the union run beneficiary association be make in the form of the stock of the company.
GM’s legacy costs concerning its payments for employee healthcare and pensions have long been in the centre of a heated debate on the nature of employment in the auto-industry, with critics of the UAW blaming high union wages for GM’s profitability problems, and union supporters pointing to the job security and healthcare support offered by the union to its members.

While the exact rate per hourly wage paid to UAW members is a matter of some debate –with figures ranging from $30 an hour to $75 an hour – depending on how the rate is measured, a person involved in the restructuring process claimed that the wage difference between GM workers and their non-unionized counterparts is close to $14/hr broken into a $2 difference on cash wages, a $3 difference on total wages and a significantly larger $9 dollar difference in pension and healthcare.  Under the new two-tier agreement with UAW, the hourly wages shall actually be lower than Toyota’s wages.

However, the current battle shall be around a $20 billion payment that GM is required to make as part of a new deal that involves spinning off a union controlled Voluntary Employee Beneficiary Association that shall free the company from its pension liabilities.  As the term sheet indicates, half of every future payment into the VEBA, or approximately $10 billion shall have to be in stock – a demand that shall be extremely hard for the Union to accept – especially since GM stock is practically worthless. Thus, union members would be understandably unhappy with such a deal.  Essentially, the term sheet offers GM a chance to do what it would always liked to without shouldering the blame. The conditions laid by the treasury appear to be a direct response to GM’s  proposal before the Banking Committee where they note that “GM will engage relevant stakeholders in the capital structure to complete a conversion and rescheduling of its indebtedness as contemplated in the Plan, including the VEBA obligations.  These negotiations will be completed no later than March 31, 2009, and may require Oversight Board support to be successful.”(emphasis added).

Interestingly, it isn’t as if a majority of Toyota’s global work force operates with healthcare or retirement benefits. However, as GM itself points out, it just so happens, that in most other countries, the state provides citizens with a degree of healthcare that saves companies the costs of doing so.

In a scenario where the US government itself takes on the role of the union buster, it is possible that the UAW might see no point in averting a GM bankruptcy. One of the union’s biggest incentives for averting the company’s collapse is that bankruptcy shall allow the company of re-structure on its pension obligations.  As it appears, even a bailout might be of little use.

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