Automaker Bailout Is Just Buying Time

Just as I have been predicting since the Senate voted not to give the automakers a $15.0 billion loan, President Bush and Treasury Secretary Henry Paulson offered a lifeline to the struggling industry totaling $17.4 billion ($13.4 billion now and $4.0 billion come February). This is very different from the original auto bailout proposed in that this is not the final solution. The money today only prevents bankruptcy for hopefully three more months.

I want to make this clear, I am in favor of the bailout, but the fact remains that the government could throw an unlimited amount of money at the automakers and it still won't be the panacea that some are expecting. It seems that some pundits feel that this and TARP have similar objectives. Both are meant to stave off disaster, however TARP is seen as the solution, whereas the move Friday is merely an instrument to buy time. If the government feels that the bill for this industry will only be $17.4 billion, it has another thing coming to it.

The real solution will come when the economy improves and auto sales begin to grow once again. Regardless of how "financially viable" these restructuring plans will be, the industry is at the whims of the American public and how many cars they decide to buy. This money should help begin to lay the groundwork for the restructuring plans. If the government wants to keep pumping money into the industry, eventually Chrysler and General Motors (GM) will become viable, but that process will take longer than the three months the industry has. The bondholders and UAW now have to really step up to the plate and do their part. Approximately 20 minutes after President Bush announced his plans, the UAW's President Ron Gettlefinger requested a meeting with President-elect Obama saying that the required concessions are too much.

Yes, the UAW has given up a lot to get us to this point (without those concessions, all three automakers would already be out of business), but there is still much work that needs to be done. It is unfair to put the blame entirely on the shoulders of the UAW, but statements such as the one on December 19 following the bailout announcement does not help its case at all with the American people. If any portion of this plan is successful, equity holders of General Motors are going to be crushed, but hopefully the industry will still be functioning six-months from now.

Under the term sheet, General Motors will receive $4.0 billion on December 29, 2008, and another $5.4 billion on January 16, 2009. An additional $4.0 billion is scheduled to be released on February 17, 2009, but it is contingent upon Congressional action. Chrysler said it would receive $4.0 billion from the TARP program on December 29. The Treasury said that General Motors and Chrysler will pay a minimum of 5% interest on government loans and must repay them by December 29, 2011. The interest rate will be 300 basis points over the London Interbank Offered Rate, with a LIBOR floor of 2.0%, making the effective minimum rate 5.0%. In the event they default, the rate spread increases to 800 basis points over LIBOR.

Binding Terms and Conditions: The binding terms and conditions established by the Treasury will mirror those that were voted favorably by a majority of both Houses of Congress, including:

• Firms must provide warrants for non-voting stock.
• Firms must accept limits on executive compensation and eliminate perks such as corporate jets.
• Debt owed to the government would be senior to other debts, to the extent permitted by law.
• Firms must allow the government to examine their books and records.
• Firms must report, and the government has the power, to block any large transactions (> $100 M).
• Firms must comply with applicable Federal fuel efficiency and emissions requirements.
• Firms must not issue new dividends while they owe government debt.

Targets: The terms and conditions established by Treasury will include additional targets that were the subject of Congressional negotiations but did not come to a vote, including:

• Reduce debts by 2/3 via a debt for equity exchange.
• Make one-half of VEBA payments in the form of stock.
• Eliminate the jobs bank.
• Work rules that are competitive with transplant auto manufacturers (foreign manufacturers such as Toyota (TM) or Honda (HMC) by 12/31/09.
• Wages that are competitive with those of transplant auto manufacturers by 12/31/09.

These terms and conditions would be non-binding in that negotiations can deviate from the above targets, given that the companies report the reason for the changes and still makes the case to achieve long-term viability despite the changes. In addition, the firms will be required to conclude new agreements with its other major stakeholders, including dealers and suppliers, by March 31, 2009. Ford wanted no part of the bailout as it says is has ample liquidity for all of 2009. This is a good start to help the industry, but some of these terms seem rather onerous and could cause more harm than good. Mr. Paulson said that an organized bankruptcy could be a viable option; however, we feel that the effects on the financial markets will be worse than when Lehman Brothers was allowed to fail.

I think this is a step in the right direction, but still will not fix the problem. There are going to be many difficult choices to make, and to be successful these problems need to be solved sooner rather than later. If I had all the answers, I would be standing in front of some microphone in Washington, D.C. or Detroit, but I do not. There are pros and cons to every plan that has been released, but none of them forces all parties to the table. Debt holders seem to be the hardest to get to the negotiating table and yet they are probably the most important aspect. Few people realize that the companies have been reducing their liabilities over the past year. This is a stop gap measure, giving General Motors and Chrysler time to get their ducks in a row, but is not the answer. The actual answer is going to cost the taxpayer much more money.

Additionally, I think the industry is on the cusp of a major consolidation wave, and at this time next year, many of the unprofitable brands will cease to exist, and if these plans aren't progressing fast enough for the government's liking I think Detroit's Big Three could end up Detroit's Big One and a Half, with General Motors and Ford collaborating much more. No more Mercury, Pontiac, Buick or Saturn, just Chevrolet, Cadillac, Ford, and Lincoln. If the combination could make vehicles profitably that would be a force to be reckoned with, but honestly given the current marketplace, the timeline to make cars profitably in the United States is at least three years away. We are not going to be able to save every job; many factories are going to be closed, but if the industry can emerge more nimble and more financially stable, it will be able to commence its growth stage again, instead of always contracting.

Written by David Silver, a Research Analyst for Wall Street Strategies (www.wstreet.com) covering companies in the Transports, Autos, and Beverage sectors.

Comments

[Tesa:]

Yes they are buying time and time for marginal recovery is what is needed now. The market needs time to sort out a reality that is sustainable but that reality should not be related to credit market crash.

2008 Dec 21 01:13 PM

[Fastlane12:]

Finally, a comment on SeekingAlpha that has been researched and offers a balanced view of this disaster. The road to recovery for American industry - automotive or otherwise - comes only when consumer confidence returns and the credit markets stabilize. The American auto industry is part of the GLOBAL economy and manufactures products all over the world that are fully competitive in the markets they serve. The current overhaul will bring down the volume required to break even and in the long term, is the path to profits and strength. One factor not mentioned is the essential contribution these companies (mostly GM) is making to developing the next generation of transportation. Without American participation in bringing these technologies to the showrooms, we face even further weakening in our capabilities as a county...

2008 Dec 21 01:29 PM

[John D:]

I'm quite sure that the UAW & CAW must both realize now that they are no longer barganing with the companies but with the government and that they will have to reconsider some of the points of the contracts that were hard fought for. The only way you can look at it right now is that it would be better to give up on certain items such as wage reductions, some benefits in order to keep a job rather than fight the government and not have a job. Perhaps now would be a good time to negotiate with the government to take another look at FREE trade and push for EQUAL trade so that the Asian car companies can't keep DUMPING cars here unless we are allowed the same numbers in those countries, one for one or invoke a tarriff on all those over the limit (2007 the Koreans shipped 750,000 vehicles in North America - we shipped 5000 to them in return) - this would put things on a level playing field and also contribute to turn the North American auto sector to a profitable, viable business once again.These are most definately trying times and cooler heads will hopefully prevail.

2008 Dec 21 02:34 PM

[Gumby:]

Shareholders lost money on GM Ford stock, UAW gave up wages and benefits. Managements stop flying in corporate jets. President Bush finally gave in with $17 billion for GM and Chrysler. Did I miss anything else? Aha! Yes,.... the carbuyers has not come back yet... This is the last item we forgot... Right? duh?

2008 Dec 21 09:20 PM