Automakers Bailout: Good or Bad for the Industry?

The first official step was taken on December 10 to help stave off a bankruptcy by the struggling U.S. automakers. The bill passed through the House of Representatives and was approved by a vote of 237 to 170. Thirty-two GOP representatives voted with 205 Democrats in support of the bill and 20 Democrats and 150 Republicans opposing the bill. The bill, which allocates only $14 billion (of the original $34 billion that was asked for), now moves onto the Senate where it will face much more scrutiny. If Congress thinks that the $14 billion will be enough, I think they have another thing coming. This cautious initial action could end up costing the taxpayers more money in the end.

There is a plethora of dubious language in the current version of the bill that will go to the Senate for a vote. We feel it will fail on the first vote through the Senate as there are still many points of contention. The bill is said to include caps on executive pay (expected), no golden parachutes (expected), no more dividends while the loans are outstanding (expected), and the companies have to get rid of the corporate jets. Personally, I don't understand the uproar surrounding the jets, but it looks like just another example of wealth redistribution. In our opinion, the worst inclusion is the use of equity warrants. We expected the government to take an equity stake in the Company, but the current bill reads that it will receive warrants for up to 20% of the loan value of the companies.

In the case of General Motors (GM), it has taken $10 billion worth of loans so a 20% stake would be $2 billion, or approximately 77% of the current market value. Convincing bond and other stakeholders (as well as the union) to take an equity stake as a term of the negotiations would further make the stock worthless. Additionally, come March 31, is the government going to take a larger stake in the Company if they require more funds?

General Motors and Chrysler are expected to agree to the bailout while Ford (F) will remain on the sidelines with access to a credit line. General Motors is expected to tap $10 billion ($4 billion by the end of the month to continue operations, and management believes it'll need an additional $6 billion in the first three months of 2009) and Chrysler estimates it will need $4 billion by the end of the first quarter. Ford has more liquidity now than its closest rivals as a result of it selling Jaguar and Land Rover earlier this year and mortgaging most of its assets during 2006. This is a risky gambit for Ford; if the economy doesn't begin to show material improvements, all of the automakers will be in trouble.

Let's step back for a moment. There have been many articles about the failures of Detroit's "Big Three" automakers, ranging from decades of mismanagement, to the UAW's high pay and uncompromising position, to making vehicles that no one wants to buy. The first argument I can't really argue as the problems didn't develop overnight, but rather has been festering for decades dating all the way back to when Roger Smith was the CEO of General Motors (from 1981 to 1990). Ford has been in a similar situation before, with various family members acting as Chairman and CEO to no avail. Lee Iacocca revived Chrysler in the early 1980s (with help from the government), but since then it has been all downhill. Even the purchase of Chrysler by the efficient Daimler AG (DAI) couldn't save the Company.

Including healthcare costs and benefits, legacy costs, and actual hourly pay, an average UAW worker earns between $65 and $70 per hour. Ford outlined that its cost per employee is approximately $71 per hour. The following chart outlines the hourly cost per worker for Ford ($71) and Toyota ($49).

The UAW has made considerable concessions over the past two years, but there is still so much that the union needs to do. During the 2007 labor contract negotiations, the union agreed to take the pension and benefits costs off the books of automakers and put them into a Voluntary Employee Benefit Association (VEBA account). This move will take most of the $16 off the top layer of Ford's wage scale column above. Hopefully, the union will take a long term approach and see that the benefits now will help the companies stay afloat, where as if the Big Three is forced into bankruptcy, the union will probably get much less. UAW President Ron Gettlefinger has indicated that without the bailout, General Motors could fail by the end of the year. We are confident that in addition to the bailout money, Mr. Gettlefinger will realize that it is best to receive less now and save jobs than it would be if no additional concessions were made, which would cost many more people their jobs.

With respect to the third argument that the companies were producing vehicles that the American people didn't want to buy, well, it's just plain untrue. Americans left and right were still buying SUVs and light trucks, exactly what the Big Three were producing. It took gasoline prices spiking to over $4.00 per gallon for Ford's F-150 to lose its title as the best selling vehicle in America, a spot it had held for more than 25 years. When fuel prices were so high and the economy began to falter, auto sales began to come crashing down hard, and even the once impervious Japanese (and to a lesser extent European) automakers couldn't avoid the downturn. Toyota (TM) and Honda (HMC) announced production cuts earlier this year, and have since slashed global production and sales estimates. So, apparently the argument that the auto industry is making cars that no one wants to buy cannot be confined to just the Big Three any longer.

European automakers have already received a type of bailout from the European Union and a few outside countries. However, it is interesting to note how silent the management at the foreign automakers have been throughout this entire saga.

To recap, I think the bailout will be successful, but how successful it ultimately is depends on the government's and the public's time horizons on tangible results. Three months down the road, maybe even three years down the road, I do not think the industry will be able to sufficiently restructure itself and may forced into bankruptcy, but give the industry say five years and we should see the resurgence of ingenuity in Detroit with the Detroit "Big Two" rivaling Toyota, Honda, and Volkswagen. Chrysler will likely not make it out of this mess, but instead will be forced into a shotgun marriage or be sold off in parts. If the current version of the bailout bill goes through, the biggest winner could be Ford, as its equity won't be diluted; however, come March, we believe that Ford will succumb to the inevitable and tap the credit line. Shares of General Motors should decline modestly as a result of the dilution, but we believe that it will reemerge as a strong member of the industry. Toyota and Honda should see continued auto sales declines well into 2009, which will pressure earnings and revenues, but will realize only few benefits or detriments from the auto bailout.

In summary, in my view, the current version will only cause more problems and not issues enough solutions; while I am in favor of a bailout for the industry as noted above, the structure as it's presented right now needs to be greatly reworked. Fuel efficiency standards need to be put on the backburner to current financial demands, not come as a prerequisite for the aid. However, I think that the companies will be forced to meet unattainable standards and restrictions that will eventually force one or more of the automakers into bankruptcy. The "car czar", the person supposed to oversee the industry restructuring, would need to take a big picture approach to the industry. If I knew exactly what that entailed, I would throw my name into the hat for the job.

An organized bankruptcy filing doesn't seem like such a bad idea as there are plenty of potential positives, including the riddance of the lucrative UAW contract, renegotiation of supplier contracts, and the lessening of high debt loads. However, such a filing would run the risk of entering bankruptcy and never emerging. Additionally, if Mr. Wagoner is to be believed, auto sales could be hit even harder if consumers won't buy a car from a bankrupt automaker.