Over the past several days, while General Motors (GM) Chairman and Chief Executive G. Richard Wagoner Jr. has repeated his mantra that "bankruptcy is not an option," the specter of a Chapter 11 reorganization is circling GM's downtown Detroit headquarters like vultures.
When it reported its third-quarter earnings on Nov. 7, GM said that it may face cash reserve levels (BusinessWeek.com, 11/7/08) by the New Year that would put it at the threshold needed just to meet payroll and continue some level of normal operations.
It has already suspended most of its future product programs. It has stepped up the pressure on the White House and Congress, especially the Michigan caucus, to find a way to get government help. "The third-quarter results made it clear that, without government intervention, GM is headed for bankruptcy," Gimme Credit auto analyst Shelly Lombard said.
Circuit City Isn't a Model
Bankruptcy lawyers say the automaker could benefit from a prepackaged bankruptcy, which would be a reorganization that is worked out among the automaker's creditors before the case ever gets to a bankruptcy court judge. "It would be messy but ultimately could help the company restructure itself a lot faster," says Mark Bane, a partner at New York law firm Ropes & Gray.
The biggest obstacle to any bankruptcy is the lack of availability of debtor-in-possession (DIP) financing, which is liquidity normally provided by banks and private equity firms that a company in bankruptcy needs to reorganize itself. Indeed, the question of bankruptcy has been on the minds of GM's top executives. On Nov. 6, GM North America President Troy Clarke told a gathering of auto suppliers that obtaining DIP financing would be "practically impossible" given the state of the credit markets and the size of GM's obligations. "But that's where the government could come in," says attorney Bane, "providing the liquidity GM would need to massively reorganize under Chapter 11."
The worst-case scenario for GM, say most experts, is a spontaneous Chapter 11, like the one filed by electronics retailer Circuit City (CCTYQ.PK) on Nov. 10. But a prepackaged filing could be set up to make sure that the vast majority of auto suppliers would continue to get paid on time.
Hoping for Liquidity
Others disagree. Kimberly Rodriguez, a partner at Grant Thornton, an accounting and management consulting firm that works with auto companies and suppliers, says bankruptcy is a "last resort." Rodriguez says that in better times GM and Ford (F) have provided liquidity to its biggest suppliers who would have otherwise been forced into Chapter 11, which is very messy and destructive. "The government could play that same role for GM, and it will be a lot more orderly," says Rodriguez.
Aides to House Speaker Nancy Pelosi (D-Calif.) said on Tuesday, Nov. 11, that the Speaker, whose congressional district is in San Francisco, is working up a bill with House leadership that would help automakers and suppliers with liquidity to avoid bankruptcy. President-elect Barack Obama's transition chief, John Podesta, told reporters Tuesday that he is in favor of helping the auto companies "remain independent."
Robert Reich, former Labor Secretary under President Bill Clinton and a member of Obama's economic transition team, said Tuesday: "The question [about bailing out the U.S. automakers] is what kind of conditions do you put on that bailout?" In an interview on MSNBC, Reich said that those conditions will likely center on job protections and commitments to green technology. A congressional staffer with knowledge of negotiations on Capitol Hill said limits on executive compensation at the automakers is "probably going to be a condition as well."
"Buy" Recommendation on Bonds
After a few days of dire Wall Street warnings about GM and forecasts of possible bankruptcy that drove GM stock down 33% from Friday to Tuesday's close, JPMorgan Chase (JPM) issued a "buy" recommendation on GM's bonds, not its stock, and spotlighted different sources of liquidity it can tap.
"We believe GM has several sources of liquidity it can access to bridge the company to 2010 when it realizes considerable cost cuts," JPMorgan Chase analysts Eric Selle and Atiba Edwards said in a report issued Tuesday. "These include an overfunded pension plan, possible asset sales, capital market transactions, equity injections, cost-cutting, and government loans," they said. Participation by the government could help free up an additional $10 billion, said one source at GM, from banks and equity holders who are sitting on the sidelines waiting for the government to act. GM executives believe they must have $10 billion to $15 billion in government loans to get through 2010 if auto industry sales in 2009 are below the 13 million forecast by some firms.
Certainly, there is a history of companies operating under Chapter 11, and emerging. United Airlines and LTV Steel—now known as Cliffs Erie are examples. But there are several reasons why GM is avoiding the option.
Bankruptcy Would Kill Sales
Chief among them is GM's belief that customers who own GM vehicles, as well as those who might consider them in the near future, would flee the companies' brands if it were in bankruptcy. In the past, when GM has been associated with the specter of a bankruptcy filing, showroom traffic drops off. During an interview with Fox Business News on Nov. 7, Wagoner said that GM's research shows that 80% of those surveyed said they wouldn't buy a car from a bankrupt car company. "If your revenue line falls, you would not be talking about a reorganization, you would be talking about a liquidation."
Some experts agree with Wagoner's assessment. Eric Dezenhall, a crisis management consultant, says the consumer doesn't always act rationally even after he has all the information. "Even though bankruptcy doesn't necessarily mean obliteration, these decisions aren't entirely rational…In the minds of many, bankruptcy equals oblivion," he said.
Still, it's tempting to find out if a coordinated communication effort between GM, Congress, and the White House could persuade consumers that GM would remain in business. Under Chapter 11, the company could renegotiate contracts with the United Auto Workers and more rapidly realign and kill superfluous brands without worry about lawsuits from its dealers. "I can envision a very efficient GM operating Chevrolet, Cadillac, and a third sales channel that sells GMC and Saturn," says independent marketing consultant Dennis Keene. "The aim of GM should be to get to the structure it would choose if it was starting with a clean sheet of paper, and that doesn't, I would think, include Saab, Pontiac, Buick, and Hummer."
Negative Stockholder Equity
GM spokesman Tony Cervone says that kind of speculation is simplistic. He notes that GM has already made huge gains in cost reductions with labor that will start paying off in 2010. "Our cost of sales will be 25%, and that is better than Toyota is today," said Cervone.
GM, in the most recent quarter, has a negative $58 million in stockholder equity on its balance sheet. That's how much the liabilities exceed its assets. That compares with negative $42 billion it reported a year ago.
The aspect of a GM bankruptcy that worries some analysts and legislators is the ripple effect that would impact Ford and Chrysler as well as numerous auto suppliers. Grant Thornton's Rodriguez says that Ford and Chrysler, in the event of a GM bankruptcy, would also be quickly driven to bankruptcy court because their costs would be so much higher than GM's, "they'd quickly find themselves uncompetitive." Too, there could be such a disruption to auto suppliers that the auto companies' production of vehicles would be interrupted as if their workers were on strike. Seventy percent of GM's suppliers also supply critical parts to Ford and Chrysler, and there is no new credit or loans for those companies outside of the government.
A Little Breathing Room
The best-case scenario, says Rodriguez, is for government loans that give GM the time and space it needs to work through the recession, the way a bankruptcy court gives relief from creditors.
"The Detroit automakers have, in essence, been pursuing an out-of-court restructuring over the past three years. These efforts have produced a competitive labor contract with the UAW, a viable solution to reduce retiree health-care expense, and a substantial downsizing of capacity and headcount," analyst Kid Penniman of independent research firm KDP Advisors wrote in a report. "Incremental gains achieved through bankruptcy would be minimal in comparison and would likely result in an even further deterioration of enterprise values as consumers would be far less likely to purchase an expensive vehicle from a bankrupt manufacturer, with or without government guarantees," he added.
6 months ago