Today's big news is a new plan unveiled by the White House to pump roughly $17.4 billion into Chrysler and GM in order to save them from slipping into Bankruptcy:
(From WSJ): "The White House announced a $17.4 billion rescue package for the troubled Detroit auto makers that allows them to avoid bankruptcy and leaves many of the big decisions for the incoming Obama administration.
Speaking from the White House, President George W. Bush said the administration decided against forcing a bankruptcy to compel cost-cutting, in order to avoid the risk that consumers would desert one or more of the companies and touch off an industry collapse, deepening the current economic downturn.
"In the midst of a financial crisis...allowing the U.S. auto industry to collapse is not a responsible course of action," Mr. Bush said.
"Under ordinary economic circumstances, I would say 'this is the price that failed companies must pay' and I would not favor intervening to prevent the auto makers from going out of business," the president said. "But these are not ordinary circumstances."
The deal would extend $13.4 billion in loans to General Motors Corp. and Chrysler LLC in December and January, with another $4 billion likely available in February. It also would provide the government with non-voting warrants, although the exact amount was unclear immediately. Ford Motor Co. has said it doesn't need short-term assistance.
The deal is contingent on the companies' showing that they are financially viable by March 31. If they aren't, the loans will be called and all funds must be returned, officials said.
The deal generally tracks key provisions of the bailout legislation that nearly passed Congress earlier this month. But it is relatively lenient in allowing the companies to show their viability. It defines viability as having a positive net present value -- a way of gauging the companies' worth, taking into account all their future obligations.
Notably, it provides significant flexibility to the companies in showing their viability. It sets out targets for the companies to hit in determining their financial health, such as reducing debt and current cash payments for future health care obligations.
But according to a White House fact sheet, the targets "would be non-binding in the sense that negotiations can deviate from the quantitative targets...providing that the [company] reports the reasons for these deviations and makes the business case to achieve long-term viability in spite of the deviations."
One potential move that could help the companies achieve some savings: the companies will be required to reach new agreements with major stakeholders, including dealers and suppliers, by March 31.
Determining viability apparently will be up to the Obama administration. The agreement designates a person to oversee the government's effort, although officials stopped short of referring to that as a "car czar." For the outgoing Bush administration, that person will be Treasury Secretary Henry Paulson. President-elect Barack Obama will choose his own point person later."
I think this whole concept of "viability " is all together spurious since so much leeway is given to how viability can be defined, coupled with the fact that it's arguably mathematically impossible for Detroit to be financially viable by March 31, 2009 when you consider their current burn rates on top of the sheer size of their debt loads and other liabilities. The whole idea that GM (for example) could reduce it's debt by 2/3 via exchanging it for their non-existent equity is all together nonsensical in my view.
After all this is a company that has a market cap of less than $3 billion, total debt of $45.2 billion (as of 9/30/2008), and their total losses over the TTM period are nearly $23 billion, a number that's sure to grow as Q4 '08 and Q1' 09's numbers are added in.
Does this sound like a company that is capable of retiring a significant amount of debt any time soon?
To be blunt I think the provisions around retiring debt, viability, etc (in the White House plan and the rescue package that failed last week), were included to appease angry voters more than they are provisions that anyone (with a clue at least) believes that Detroit will be held to. Of course it goes without saying that if Washington actually believes that this is possible, then we have much bigger problems to worry about.
Anyway let's look at the numbers:
Per the term sheet GM is slated to receive $4.0 billion by 12/29/2008, and another 5.4 billion on 1/16/2009 for a total of $9.4 billion, with another $4 billion available in Feb contingent on Congressional action.
At the end of Q3 GM had $16.2 billion on hand and had burned through $6.9 billion during the quarter, while we won't know Q4's exact burn rate for several weeks it's safe to say that it was significantly higher than Q3's since the company is currently flirting with bankruptcy.
When we consider the amount of time it takes cost cutting measures in the auto industry to take effect, it's pretty obvious that all the money will do is help to finance current and/or future losses and probably delay bankruptcy by a quarter or two (if that). Reducing debt and/or making significant investments in the company's future isn't even on the table right now.
In the end all the White House has done is to not only delay the inevitable with respect to a collapse or bankruptcy, but they've also delayed the real change that's needed in Detroit by helping to perpetuate a broken system.
Looking at the bankruptcy issue for a second: there are many who believe that bankruptcy isn't even an option as it would cause consumers to abandon Detroit en masse. The problem with this line of thinking is that the American Public (in general) already has a rather dim view of Detroit, has been aware of their financial problems going back to '05, knows that they're currently flirting with bankruptcy, and yet still purchases their cars.
If confidence in the financial viability of a car company was a deciding factor in a purchase decision, Detroit's market share erosion should've been markedly more significantly over the past couple of years. Especially when you consider that the prevailing wisdom in the marketplace is that foreign cars are markedly superior.
This is not to say that some customers won't think twice before buying an American car, just that due to a myriad number of reasons (cost, utility, preference for American cars, etc), some consumers will continue to purchase American cars. Especially in many areas of the South and the Midwest where Detroit has the greatest market penetration, and foreign cars (trucks especially) are sneered at by many.
I don't see Texans giving up their American trucks even if the companies are in chapter 11.
The other thing to consider is that customers who are wary of purchasing an American car due to a bankruptcy filing could be plied with government guarantees on warranty repairs, the fact that many repair shops are currently profitable, etc, etc. There are many ways to backstop customer confidence so that people who purchase a Malibu from bankrupt GM, won't have to worry about product support.
However the most important thing to realize here is that Detroit could easily be profitable at current sales levels if it were more efficient, and a properly structured Detroit should be able to turn a profit even if sales dropped by 50% over current levels. Therefore the opportunity offered by bankruptcy to restructure various debts and liabilities, significantly trim down the number of dealers, close plants, get out of old leases, etc, greatly outweighs the risk of declining sales.
If you think about it the real problem here is that the Government is effectively thinking like Detroit, in terms of trying to find a way to prop up sales and/or perpetuate the new model, as opposed to thinking in terms of efficiency and how to be profitable at current and/or lower sales levels.
The rescue package that failed last week and the current one offered by the White House are nothing more than the government's version of Detroit's "generate sales at any cost" strategy, where they'd offer huge incentives, discounts, sell cars at a loss, etc, in an effort to maintain market share and/or because it was cheaper than idling plants/reducing production capacity (i.e. a different version of the same failed thinking).
Instead of thinking of all the ways why a bankruptcy won't work and/or insisting on maintaining a broken system, our Government and Detroit should be working together to come up with solutions that WILL make it work.
In other news: I suspect many people will read the term sheets and think: "wait a minute my mortgage and/or car loan had more paperwork than that" .
WSJ: "Auto Makers to Get $17.4 Billion" -- John D. McKinnon, December 19, 2008.
Financial Data provided by Yahoo Finance & WSJ
Disclosure: at the time of publishing the author didn't own a position in any of the companies mentioned in this article; the ideas expressed are solely the opinions of the author and shouldn't be viewed as financial or investment advice.