This is an alternative plan for the restructuring of the US automobile industry and also a solvency analysis of General Motors. I was one of the first analysts to advocate that GM should file for bankruptcy protection under Chapter 11 of the US Bankruptcy Code, although I also believe that the government should not turn its back on this important firm, but provide a massive debtor-in-possession (DIP) loan to sustain it during what is likely to be a long restructuring period.
After failing to get congressional bailout packages, GM and Chrysler received in December 2008 a $13.4 billion loan and a likely additional $5 billion for interim financing they say is necessary to restructure these companies. Unfortunately, this loan is destined to fail in the current environment and will be followed by additional requests for more rescue funds and/or a bankruptcy.
Both GM and Chrysler should file for protection -- yes protection -- under the US Bankruptcy Code, as soon as feasible (even with Chrysler's joint venture with Fiat). The benefits afforded to firms whose assets are protected and whose fixed payments on most liabilities are suspended are clear. Another enormous benefit is their ability to borrow substantial amounts of funds under a DIP financing. This unique aspect of our bankruptcy code gives the lender a super-priority status over all existing claims and is almost always accompanied by specific collateral, such that the chance of the lender losing any of its investment is remote. Indeed, the number of DIP losses to lenders can be counted on one hand from the thousands of such financings in the past.
Because the current DIP market is extremely tight, and the enormous amount involved (we advocate $50 billion), the DIP lender-of-last-resort must be the US government. I advocate that the government work with one or more conduit organisations who are experienced in structuring and monitoring DIP loans. Bankruptcy status also enhances the ability for management (likely to be new management) to renegotiate existing and legacy pension and healthcare claims, which is much more difficult outside the protective confines of the court system.
Some fear that a GM bankruptcy announcement will cause immeasurable harm to the economy. But, a clearly articulated communication of guaranteed government support via the post-bankruptcy DIP financing route and warranty guarantees -- should the firm eventually have to liquidate -- will help blunt consumer fears of lost warranties and spare parts availability.
The viability of GM with a government bailout
I assessed the financial viability of GM (including its 49% interest in financial services firm GMAC) by utilising the Altman Z-Score model and by taking the financial results at the end of the third quarter of 2008 as well as an estimate of the fourth quarter operating performance. I also assumed a $2 billion per month "cash-burn" in the fourth quarter and adjusted the capital structure for a $30 billion reduction in debt and addition to equity.
The Z-Scores, as of the end of the third quarter of 2008, places GM clearly in the "D" (default) bond-rating equivalent category. Indeed, GM's Z-Score became negative for the first time in June 2008. When I estimate the pro-forma financial profile as of December 31, GM's Z-Score improves slightly but still remains much closer to a "D" rating equivalent than to a "CCC" rating. Even with generous assumptions as to the fourth quarter operating results and careful adherence to its own proposed restructuring, GM is still a highly distressed company and likely to go bankrupt, probably within one year.
This editorial is based on Professor Altman's testimony before the US House of Representatives' Committee on Financial Services, which was part of a hearing on the plans to stabilise the American automobile industry on December 5, 2008.
