Executives at General Motors and Chrysler are speeding to put in place workable plans to restore their faltering businesses. But this may be one race they are unlikely to win.
On Monday, President Obama said the turnaround plans that the two automakers presented to Congress earlier this year hadn’t gone far enough. He gave them one last chance to turn their operations around, raising the threat that he might force GM into a quick, managed bankruptcy if that proves to be the fastest way to restore it to health.
Obama’s measures were drastic. Chrysler received financing for 30 days to complete a partnership with Italian automaker Fiat, after which the government will no longer continue to fund it. GM got 60 days worth of funds to revise its turnaround plan. Despite the tough deadlines, some form of managed bankruptcy now looks like the most probable option for GM, analysts say. And it’s a move that could have a slew of side effects, not least of which would be lower confidence in GM’s products.
“I never thought I’d hear myself say a GM bankruptcy is likely, but I’m saying it now,” said John Wolkonowicz, a senior auto industry analyst with IHS Global Insight. “I think the list of requirements that the government is giving GM means a structured, quickie bankruptcy is almost assured because I don’t think they can accomplish what the government wants them to get done in 60 days.”
With a June 1 deadline to accomplish changes sought by the government, GM’s new CEO Fritz Henderson said Tuesday more of its plants could close and it is likely to offer another buyout program to workers as it looks to cut labor costs. Henderson also said that although GM would prefer not to use bankruptcy protection to save itself, it is “certainly more probable” than in the past.
GM and Chrysler have spent months paring their vehicle production levels, closing plants and shrinking their workforces. But their biggest challenges have been trying to secure ample labor cost concessions from the United Auto Workers union and persuading reluctant bondholders to accept unfavorable terms on the debt GM wants them to swap for equity in the company.
These matters remain unresolved. And although the Obama administration has said bankruptcy is not favored or certain, the feeling among many industry observers is a managed bankruptcy may be the only way to force through these necessary changes. Generally speaking, bankruptcy would break onerous union contracts and force the bondholders to accept less favorable terms.
A bankruptcy for GM won’t be a bankruptcy in the true sense of the word. Under a traditional Chapter 11 bankruptcy filing, GM would gain the “breathing room” to work out its affairs and implement a new business plan. That course of action has been commonly rejected because it could prove lengthy and would likely drive car consumers away from the automakers’ brands.
An alternative course of action suggested by some proponents of letting GM go into receivership is what’s known as a “prepackaged” bankruptcy — one in which a company prepares its reorganization in cooperation with its creditors and implements it as soon as it enters bankruptcy.
But given the automaker’s inability to negotiate concessions from creditors and the union to date, a prepackaged bankruptcy no longer looks like an option, said Douglas Baird, a law professor at the University of Chicago’s Law School.
“A ‘prepackaged’ bankruptcy is one where you line up your agreements with parties ahead of time, but that’s not something you can do in this case because there are too many parties involved,” he said. “So what you’re likely to have is a ‘prearranged’ form of bankruptcy. One in which you go into bankruptcy with a plan and you cram it down on the separate parties.”
GM may be an operationally viable company, but it’s never going to generate enough money to pay off its creditors, Baird said. Indeed according to Deutsche Bank analyst Rod Lache, GM could still be burdened with close to $74 billion in debt after a restructuring, including $18 billion in government loans — that’s close to 50 times GM’s current market capitalization.
“GM has two problems: The first is a capital structure that is hopeless, and the second is it has to come up with a viable business plan, and it’s clear it hasn’t done that yet,” Baird said. “Bankruptcy can’t tell a company how to become a successful company, but it can clean up a company’s balance sheet and that’s what’s going to happen in this case. Solving the capital structure mess has to happen and bankruptcy is the way to fix that.”
Under the sort of major restructuring that a managed bankruptcy would bring, more of GM’s brands are likely to go. The automaker has already said it wants to sell its Saab and Hummer divisions and phase out Saturn. After Obama’s call for GM to implement deeper restricting measures, Buick, Pontiac and GMC are likely to go too, said IHS Global Insight’s Wolkonowicz. That would leave the automaker with just two core U.S. operations: Chevy and Cadillac.
The thinning out of GM’s brands raises the problem of vehicle warranties and resale values. With U.S. auto sales already at their lowest levels in decades, automakers may be pressured further if consumers shy away from buying a car from a bankrupt automaker. The Obama administration has tried to mitigate that issue by offering a temporary guarantee: Even if the carmakers go bankrupt or out of business entirely, car owners will still be able to get their cars serviced under their car-manufacturers’ warranties.
Still, that may not be enough to persuade new car buyers. According to a new survey from the Consumer Reports National Research Center, more than three-quarters (78 percent) of car buyers said they are unlikely to consider buying a new car from an automaker in bankruptcy, while 64 percent said they would be very unlikely to buy one.
Bankruptcy, even in a managed form, has some substantial consequences for GM, according to Jack Nerad, executive market analyst for Kelley Blue Book, which tracks the automotive industry.
“GM has already seen a decline in market share from just the talk of a possible bankruptcy, and so if they were to go into bankruptcy I think there would be an accelerated decline in consumer perception. A car is a visible purchase; it’s not like a washing machine. You talk about it with your neighbors. So even with the government’s guarantee there’s a perception issue, and it’s hard for me to contemplate bankruptcy helping consumer demand for GM products, and I think at least maintaining or growing GM demand for product is essential to future viability and success.”
There’s another unintended consequence of a bankruptcy: If GM succeeds in becoming a leaner, meaner automaker, that could turn rival Ford into a weaker company. Ford is the only U.S. automaker that has not asked for government funding to survive. It is limping along on money made from mortgaging many of its assets. It has also renegotiated its contract with the UAW union and sealed a debt-for-equity deal with bondholders.
“The government really changed the rules here, and it has pulled the rug out from under Ford,” said Wolkonowicz. “The Obama administration has now decided to build this supercompetitive auto company in GM, so if Ford can’t make itself into a mirror image of that they’ll have difficulty competing. The government has to worry about the impact on Ford now.”