Assessing the Auto Industry Wreck

Barring divine intervention come Monday, GM will be in bankruptcy and probably around the end of the summer will emerge as a new company owned for all intents and purposes by the U.S. government. Chrysler probably comes out of bankruptcy next week, also under government control. Given all of that, I thought it a good time to offer a few personal thoughts on the saga.

First, let’s review what the new GM is going to look like. The government will own 72.5% of the company, existing bondholders get 10% and the UAW and its health insurance fund end up with 17.5%. All of these entities have some warrants to buy more stock in the future as well as a few other incidentals that were thrown in for who knows why. GM emerges from bankruptcy with a modest amount of debt — $8 billion — advanced from the government. The taxpayer is putting up about $50 billion give or take a billion here and there in exchange for its equity interest and the $8 billion loan.

Winners

There’s one clear winner here and that’s the UAW. In both Chrysler and GM the union’s sacrifices have resulted in proportionately larger shares of the companies than were garnered by the other stakeholders. This is somewhat surprising due to the fact that the UAW stood to lose the most in the event either one had been liquidated.

Yes, the union did lose some jobs and future jobs will not be of the gold plated variety but little was truly sacrificed from the standpoint of wages or benefits. The contract still provides salaries and benefits that far exceed what’s available to most workers in the private sector and the union has a big say, some would aver a virtual veto, over future actions that may affect its well being.

Losers

Where to start. Certainly creditors. In the case of Chrysler they were smashed, while in the GM bankruptcy they’re fairing somewhat better. In neither case have they been allowed to play their usual role in the proceedings — we’ll get to that in a second.

Shareholders are wiped out. There was never any alternative for this one. Either liquidation or reorganization spelled the end for them.

You and I as taxpayers are out $50 billion. Whether we get any of it back is an open question. For the time being count it as a loss.

The rule of law took a big hit. In the Chrysler case, the government ran roughshod over normal bankruptcy procedures and used its not insignificant leverage to split apart the creditor group and impose a reorganization plan. The bankruptcy court likewise appeared to fold. In the case of GM, well you can just say that most of the parties looked at Chrysler and got religion.

Our economic system. The entire turn of events will no doubt be one more thing that any investor or lender to large American business is going to consider when making an investment decision. Now that it’s evident that the government will resort to extra-legal solutions to protect industries and/or constituencies a new dynamic has been introduced.

Ford and other competitors are no doubt holding their breath. Having the U.S. government as a competitor tends to put one at somewhat of a disadvantage. It remaing to be seen how agressive a competitor the newly socialized companies will be but don’t bet on shrinking violets.

Will It Work

I mean this in the sense not of will these companies hang around for a long time but will they truly prosper and pay back everyone. We know they’re not going out of business no matter how badly they do. Their backed by the full faith and credit of the government now.

True profitability is another issue entirely. The government estimates, perhaps rosily. that in five years that GM will be worth $75 billion. That assumes annual industry sales of 16 million units and only a modest reduction in market share from 19.5% to 18.4%. If that turns out to be fact then the implied value of the government’s investment would be $46 billion (there would be some dilution in the governments ownership in five years). You would have to count that as a success.

Those are pretty aggressive projections and there is some reason to doubt it is going to work out quite that well. One indication that not all the players see it turning out so well was the opinion that Ron Gettelfinger, the head of the UAW, offered with respect to the warrants that his union is receiving as part of its package.

The one element of the VEBA that is still up in the air is a warrant for an additional 2.5% in GM stock. In order to attain this stake, GM’s stock needs to hit a market value of $75 billion, a mark it has never reached in decades of being a publicly traded company.

During a press conference, when asked when the 2.5% stake would be available, Mr. Gettelfinger moved close to the microphone attached to his podium, raised his eyebrows and slowly said “$75 billion in equity for the company…we didn’t put a whole lot of emphasis on the 2.5% warrants, let me put it that way.”

Mr. Gettelfinger later said “on the equity warrants, with the company’s equity value being at $75 billion, we sort of (said) that’s over there in the corner somewhere.’ We’re basing everything else on reality.”

For the record the highest market capitalization GM ever achieved was $60 billion about 10 years ago.

Aside from the health of the domestic car market, the cost of complying with new efficiency and carbon mandates from Washington and the overall economy, the approach that the union takes to the companies will ultimately determine their success. If they opt for a business approach that puts profitability ahead of short-term job considerations there is a chance. If their focused on union self-interest the venture is doomed.

Already the signs are not good. Mr. Gettelfinger has gone out of his way to point out that the union does not own the stock of the companies rather the retirement trust fund does. The implication being that they were not going to be constrained by ownership concerns. The union also managed to get GM to drop its plans to manufacture small cars in China and import them for sale in the U.S. and negotiated the retooling of a shuttered factory to do the manufacturing. I haven’t seen the numbers justifying that one!

Bottom line, it may work but the sun, moon and stars are going to have to be in perfect alignment for a long time for that to occur.

Whatever else, the bankruptcies of GM and Chrysler represent a watershed event in the history of American politics and business. Had there been a better economy when the two went bust things might have worked out differently but that wasn’t the case. Where it takes us is any one’s guess. Many would say no place good.

more: here, here and here

• Become A Funded Futures Trader