Chrysler: Reshuffle the Corporate Capital Structure?

I just caught up with the Chrysler story today. What I found out shocked me, for the implications could be mind boggling.

Here are some key facts I've gathered that are relevant to what I'm about to say. If you think I got any of them wrong, correction is appreciated.

Fiat will pay $2B for 20% of Chrysler, with options to go up to 35% but it's not yet clear what Fiat would pay to exercise them. UAW's retiree health trust, VEBA, will effectively exchange the $10B cash owed by Chrysler into a 55% equity ownership. 70% of senior debtholders (about $4.8B of $6.9B total) have agreed to a 32% recovery cash offer. The remaining senior debtholders have announced they will fight the sale to Fiat in court, hoping to get better recovery at the end of Chapter 11.

If they fail to stop the sale, they'd get 29% recovery. The US and Canadian government will provide another $8B financing on top of $4B earlier, get 10% equity, and offer subsidy to Chrysler in the form of honoring warranties as well as help to UAW in the form of guaranteeing part of their pension and health benefits, valued at least billions (Pension Benefit Guarantee Corp alone is worth $2B). The existing majority equity owner, Cerberus, gets nothing for their 80.1% stake.

The mind-boggling part comes from the discrepancy in how various priorities in the capital structure get screwed up and treated inconsistently.

1. Fiat's offer is the basis for valuation. It values the company at about $10B total -- in terms of technology transfer and market/network sharing, it's mutual so let's call it net 0 for simplicity.
2. Ceberus has already benefited hugely from various government help to GMCC and Chrysler Financial. At least they're better off than Daimler (DAI), which wrote down their 19.9% ownership of Chrysler down to 0 late last year. And there's a chance they may get a better deal with GM, or at least through GMCC and Chrysler Financial on continuing basis. And, of course, they were the management directly responsible for Chrysler's troubles in recent years. No tears there.
3. Assuming tax-payers get 30% recovery on present-value basis, consistent with the offer to senior debtholders, for their loan, they get 9% recovery of all of their investments (10% equity is $1B, for about $11B give or take). Tax-payers hold the bag. No surprise there.
4. Senior debtholders get about 30% recovery.
5. UAW gets 55% for $10B, which translates to 55% recovery. That's worth a Borat "NIIIIICE", no? Especially considering pension/benefit creditors are supposed to be junior to secured debtholders in the capital structure. It's widely opined that UAW got an unprecedentedly good deal out of this one.

There you have it. Senior debtholder is the new junior.

What does this tell future potential senior debt investors in US corporations? Lehman's case taught them that the bankruptcy reform of 2005 pushed them behind derivatives counterparties.

As a result, bonds of all US companies with substantial financial derivatives activity have all had their valuation cut down by 10~50%, arguably even more depending on the extend of derivatives exposure. Without explicit government backing, even Madoff wouldn't touch it.

Now the Chrylser case has taught them that they're further pushed behind junior creditors, or at least junior creditors in the form of strong labor unions. One can only assume bonds of US companies with a strong labor union presence will take a big beating. This is hardly labor friendly in the long run.

The government has already effectively underwritten consumer mortgages, insurance, derivatives, and bank debt. Are we now going to underwrite all labor union contracts? Then let's be honest and call ourselves commies.

It's even more perverse than this. Why would senior debtholders agree to such an arrangement? Are they stupid?

Of course not. The 70% senior debtholders, being JPMorgan (JPM), Citi (C), Morgan Stanley (MS), and Goldman Sachs (GS), surely have most of their bonds covered by CDS. If you're 100% hedged with CDS, you care little whether your debtor goes bankrupt or not, or how much the recovery is. In fact, if your debtor is already in trouble, you'd rather have the debt default soon so that you can collect 100% at CDS settlement and move on.

This is in stark contrast to the Old World of creditors being stuck throughout Chapter 11, thus incentivized to help the company recover. The beauty of the New World is that you get the say without putting your skin in the game.

Chapter 11 can hardly be called "protection" any more.

So who are the losers besides tax-payers and the hold-out senior debtholders who aren't hedged? CDS sellers who sold protection on Chrysler loans. But chances are that they're the big banks who're underwritten by tax-payers.

After the reshuffle of corporate capital structure, we can expect the cost of financing and credit protection for corporate America, especially those with strong labor unions, to surge. This will only deepen and prolong the credit crisis.

Comments

[anjali pai:]

Blasphemy on part of this administration!!!!!
Systematically Obama's so-called team members are trying their best to bring down many major companies by confusing general public to comprehend the reality on many issues. It is no secret anymore that Obama is breeding such terrorists within US to bolster his popularity.
Many who understand the purport of his drastic actions realize at this stage that our own selected leader has decided to take the treacherous path in leading our country.

May 03 10:09 AM

[DaveBlz:]

Bo:
Nice overview. The WSJ first dissected this right after the announcement. And even though I have no objections to unions - I was a member of one before I retired - this pandering to a group that primarily supports democrats means investors must now alter their issue analysis. We have entered an era when conventional stock analysis is not enough. We must now consider the ramifications of political favoritism in future price estimates, and avoid the uncertainty of issues that could be used to further entrench the leftists/socialists. It is difficult enough to determine which company is undervalued when it is on a somewhat level playing field with its competitors. Now, the future of a particular company which can "aid" the administration in some way is virtually impossible to predict.
For example, what is going to happen to medical insurance and drug stocks during the drive to truly "socialize" medicine? I am not prepared to place bets on the long side.
Since about 12 days after the inauguration I have been looking for "non-political" areas that are undervalued, such as food producers and oilfield services, that can be accumulated cheaply, and may not yet be on the government's hit list. And there are volatile areas that can be exploited, such as gambling stocks.
It is unfortunate that our workload is increased in this manner by having to figure in what the economy will look like if Lenin were running it. But our job has always been to identify long-term trends quickly. Thank you for your article.

May 03 10:26 AM

[Tori:]

This is exactly what Obama wanted, to turn these companies over to the unions. Next comes card check, which is crazy considering there isn't a single successful unionized company in this country. But hey..the democrats need this voting block, so they'll give them whatever they want.

May 03 11:45 AM

[PastTense:]

I don't agree.

32% debt recovery in cash is better than 100% of nothing. Lots of us think that Chrysler is going to fail shortly and I see it as having negligible liquidation value: What would auto companies buy? The distribution network and brands are probably salable (I think the Chinese might be interested). But who would want the factories? Any auto company would prefer to build a high-tech automated factory in a non-union state. And since manufacturing is moving overseas anyway I don't see much demand from other industries who would have to spend a fortune to refurbish the sites. I suppose Chrysler has some general real estate which is salable. But the manufacturing equipment is so specialized it probably has little more than scrap value.

And the whole bankruptcy process bleeds value--so much of the money goes to lawyers...

As far as the federal government note the government is paid not only returns from the company (which as stated are very poor)--but also the government collects taxes and avoids paying benefits to laid-off workers and retirees (underfunded pension plans). So I think the risk is worth taking for the government.

As to the UAW, I think it will decide to kill the goose who lays the golden egg (via greedy collective bargaining demands)--so will end up with nothing.

May 03 12:22 PM

[Bill Couture:]

The point is the main value in Chrysler is the brand names. It would be against the national interest to allow these to be sold outside the US. It is a mater of national defense that the ability to manufacture cars and trucks stay in the US, because that is the ability to manufacture tanks and other heavy weaponry. So what are we doing? We're allowing a company from an allied country to buy a minority interest. We keep jobs and profits in the US. Who in the US, besides the UAW would bid on Chrysler or GM? Hopefully, this cram down will result in a profitable US auto industry in which case all parties will do a lot better then the pessimists currently expect.

Bill Couture

May 03 02:04 PM

[car_guy:]

You have a number of items incorrect, but you do make some interesting points.

First, Fiat is not "paying" $2B for 20% of Chrysler. Fiat is receiving their equity stake for specific commitments to share technology, distribution network, and to make specific investments to build product in the US. Fiat estimates it will spend $2-3B, however, Chrysler estimates that it will save $8-10B it would have to spend to develop the same technology. This is one of the many things the Cerberus bankers learned about the Auto industry AFTER they bought the company from Daimler. Chrysler will replace all of their mid-size & small cars & trucks (B, C, D platforms) with models based on Fiat designs and produce new very small cars (A platform) from Fiat designs & engines. Chrysler must have these platforms & engines to meet new US CAFE standards, even if gas stays cheap for the long term. Daimler would have provided this technology with the DCX model. With Cerberus Chrysler tried to farm it out to partners (Chery, Nissan, etc) and was unsuccessful (only Nissan came to fruition and the strong Yen broke that model). Chrysler's only options were outright aquisition, which the credit crisis made impossible, or a Renault/Nissan style alliance which is what they accomplish w/Fiat.
The terms for Fiat earning the additional 15% are defined in the press release and are the result of specific milestone achievement (build 40mpg car in US, build new small engine for Chrysler in US, sell Chrysler vehicles w/global network). Tooling plants to produce the car & engine will require cash from Fiat, at least $1-2B. What Fiat gets from Chrysler is hardly mutual. Aside from the US sales distribution network, which is really cost avoidance on their part, they get access to Chrysler's new V6 engine and SUV platforms which are helpful, but not mission critical. Chrysler can't survive w/o Fiat because they can't meet the 2020 CAFE standards without the $8-10B investment even if gas stays cheap in the long run. Fiat wants the Chrysler alliance because Marchione believes that a global Auto OEM will need to produce over 5 million vehicles/year to survive in the future. While this is logical, only Toyota, GM, VW, Ford, and Renault/Nissan achieved this goal in 2007 which would provide Fiat with plenty of partners if this theory becomes more real.
Cerberus gets to keep Chrysler Financial (which they admit they ran into the ground in WSJ) and Chrysler Real Estate which has value, but how much is not clear. Cerberus is also using Chrysler to be GMAC's (not GMCC) captive Auto OEM since, due to more brilliance on their part, GMAC is no longer tied to GM and suddenly needs to compete for business. They don't walk away empty handed, but this obviously was not the ending they intended. I agree, no tears for them.
The US taxpayer gets 8% (Canadian get 2%) for their initial $4.5B loan ($1B from Canada). The return is more like 20%. The DIP funding and approx $11B to get out of C11 will be loans that will have to be repaid.
The UAW is not really getting 55%. Classifying them as an unsecured debtor may be legally accurate, but is not an accurate description of the liability they hold for Chrysler. When Cerberus bought their 80.1% of Chrysler from Daimler, they took on $18B of health care liability. The UAW took over this liability for approx 0.70/$1 when the VEBA was created in 2007. The $10B was the remaining cash owed to the VEBA to fund the $18B liability. Counting the approx $2.5B in cash already deposited into the VEBA, the UAW's liability is around $15.5B so using your numbers they recover approx 30%. Same as the bond holders, but they can't simply write off their losses. The UAW is still on the hook for the health care costs and is going to be struggling with this for years to come.
You are right on the money with your assessment of how this situation was impacted by CDS. Based on their actions, it is reasonable to assume the hold outs were fully hedged and drove the C11 to cash out their positions. This is no different than buying a building and burning it down for the insurance money. You would think that the companies issuing the CDS would be smart enough to protect against this behavior or at least void the claim. You propose that the hedged owner transfers their voting rights to the insurer, which makes sense. I propose that a simpler solution is to simply call this what it is, insurance fraud, and prosecute accordingly.

May 03 02:07 PM

[car_guy:]

Many of Chrysler's plants are brand new and loaded with advanced automation technology. GM/Ford/Chrysler plants tend to have higher levels of advanced automation because they are compensating for much higher labor rates. In the '80s and '90s the US 3 were closing very old outdated plants that nobody wanted. The remaining plants have modern layouts and it would be much cheaper to buy one of these than to spend $1-2B building a new one. Also, Honda has multiple plants in heavily union Ohio and has had them there for over 30 years.

That said, these plants still have very little value because of the overcapacity that exists, especially in a 10-13M vehicle market (down from 16 in 2007). Also, the only plants built by the import OEMs in the last 10-15 years have been truck plants to support that uniquely US vehicle the SUV. With the SUV dying or dead, the existing plants will likely be converted to build other vehicles, but there is no reason to build a new plant. I doubt there will be a new auto assembly plant built in the US for next 10-20 years if not longer. Remember, Toyota has a brand new plant sitting empty with no plans to fill it.


On May 03 12:22 PM PastTense wrote:

> I don't agree.
>
> 32% debt recovery in cash is better than 100% of nothing. Lots of
> us think that Chrysler is going to fail shortly and I see it as having
> negligible liquidation value: What would auto companies buy? The
> distribution network and brands are probably salable (I think the
> Chinese might be interested). But who would want the factories? Any
> auto company would prefer to build a high-tech automated factory
> in a non-union state. And since manufacturing is moving overseas
> anyway I don't see much demand from other industries who would have
> to spend a fortune to refurbish the sites. I suppose Chrysler has
> some general real estate which is salable. But the manufacturing
> equipment is so specialized it probably has little more than scrap
> value.
>
> And the whole bankruptcy process bleeds value--so much of the money
> goes to lawyers...
>
> As far as the federal government note the government is paid not
> only returns from the company (which as stated are very poor)--but
> also the government collects taxes and avoids paying benefits to
> laid-off workers and retirees (underfunded pension plans). So I think
> the risk is worth taking for the government.
>
> As to the UAW, I think it will decide to kill the goose who lays
> the golden egg (via greedy collective bargaining demands)--so will
> end up with nothing.

May 03 02:41 PM

[niteshift:]

tori your blaming the worker? the problems seem to be mang. didn't pay there bills and did not put together products that people want to buy. when the ceo's of these company's make millions of dollar to do these thing for the company's to be successful. when they make money hail to the ceo! so know now is it pointed at the worker.


On May 03 11:45 AM Tori wrote:

> This is exactly what Obama wanted, to turn these companies over to
> the unions. Next comes card check, which is crazy considering there
> isn't a single successful unionized company in this country. But
> hey..the democrats need this voting block, so they'll give them whatever
> they want.

May 03 06:23 PM

[Bo Peng:]

Thanks for the info, car_guy.

When you invest in a company, your valuation is based on all-in cost. So whether Fiat put the $2B cash upfront or later doesn't change the valuation. I think the $10B ballpark valuation for Chrysler still stands.

As to UAW's recovery, it's recovery for its "investment" in this deal, not its overall VEBA liability. So I think 55% recovery is correct. I'm not sure it was smart for UAW to accept the conversion of their junior debt into equity, though. It does carry a lot of risk. And now they're on the hook to lower their demand in contract negotiations. It's a no win situation for them.

May 03 06:33 PM

[henarl:]

Now that this is in bankruptcy court, there will be a blizzard of legal pleadings for the court to wade thru and rule on and then another blizzard of pleadings with regard to those rulings and then a blizzard of appeals to a higher court and finally more appeals to the highest court. After years of this, the various attorney firms will have billed out far more than the total worth of Chrysler and, since attorney bills always have priority in any division of assets, there will be less than nothing for any of the other principals. These big attorney firms are already rubbing their hands in glee over this bankruptcy. And so goes the American lawyer dominated legal system.

May 04 01:59 PM

[billddrummer:]

What amazes me about this deal is that Fiat gets its 20% stake with NO MONEY IN!!

So the 'promise' of small vehicle technology is the currency they used to sit at the table in the first place.

Let's not discuss how these companies used to use their own money for R & D, and developed some good, popular vehicles as a result.

Nowadays, it seems like no one wants to use their own money for anything.

May 04 05:24 PM

[The Betsy:]

"Correction is appreciated."???? You just did the blogger/reporter's homework for him. Did he bait you?


On May 03 02:07 PM car_guy wrote:

> You have a number of items incorrect, but you do make some interesting
> points.
>
> First, Fiat is not "paying" $2B for 20% of Chrysler. Fiat is receiving
> their equity stake for specific commitments to share technology,
> distribution network, and to make specific investments to build product
> in the US. Fiat estimates it will spend $2-3B, however, Chrysler
> estimates that it will save $8-10B it would have to spend to develop
> the same technology. This is one of the many things the Cerberus
> bankers learned about the Auto industry AFTER they bought the company
> from Daimler. Chrysler will replace all of their mid-size & small
> cars & trucks (B, C, D platforms) with models based on Fiat designs
> and produce new very small cars (A platform) from Fiat designs &
> engines. Chrysler must have these platforms & engines to meet
> new US CAFE standards, even if gas stays cheap for the long term.
> Daimler would have provided this technology with the DCX model. With
> Cerberus Chrysler tried to farm it out to partners (Chery, Nissan,
> etc) and was unsuccessful (only Nissan came to fruition and the strong
> Yen broke that model). Chrysler's only options were outright aquisition,
> which the credit crisis made impossible, or a Renault/Nissan style
> alliance which is what they accomplish w/Fiat.
> The terms for Fiat earning the additional 15% are defined in the
> press release and are the result of specific milestone achievement
> (build 40mpg car in US, build new small engine for Chrysler in US,
> sell Chrysler vehicles w/global network). Tooling plants to produce
> the car & engine will require cash from Fiat, at least $1-2B.
> What Fiat gets from Chrysler is hardly mutual. Aside from the US
> sales distribution network, which is really cost avoidance on their
> part, they get access to Chrysler's new V6 engine and SUV platforms
> which are helpful, but not mission critical. Chrysler can't survive
> w/o Fiat because they can't meet the 2020 CAFE standards without
> the $8-10B investment even if gas stays cheap in the long run. Fiat
> wants the Chrysler alliance because Marchione believes that a global
> Auto OEM will need to produce over 5 million vehicles/year to survive
> in the future. While this is logical, only Toyota, GM, VW, Ford,
> and Renault/Nissan achieved this goal in 2007 which would provide
> Fiat with plenty of partners if this theory becomes more real.<br/>Cerberus
> gets to keep Chrysler Financial (which they admit they ran into the
> ground in WSJ) and Chrysler Real Estate which has value, but how
> much is not clear. Cerberus is also using Chrysler to be GMAC's (not
> GMCC) captive Auto OEM since, due to more brilliance on their part,
> GMAC is no longer tied to GM and suddenly needs to compete for business.
> They don't walk away empty handed, but this obviously was not the
> ending they intended. I agree, no tears for them.
> The US taxpayer gets 8% (Canadian get 2%) for their initial $4.5B
> loan ($1B from Canada). The return is more like 20%. The DIP funding
> and approx $11B to get out of C11 will be loans that will have to
> be repaid.
> The UAW is not really getting 55%. Classifying them as an unsecured
> debtor may be legally accurate, but is not an accurate description
> of the liability they hold for Chrysler. When Cerberus bought their
> 80.1% of Chrysler from Daimler, they took on $18B of health care
> liability. The UAW took over this liability for approx 0.70/$1 when
> the VEBA was created in 2007. The $10B was the remaining cash owed
> to the VEBA to fund the $18B liability. Counting the approx $2.5B
> in cash already deposited into the VEBA, the UAW's liability is around
> $15.5B so using your numbers they recover approx 30%. Same as the
> bond holders, but they can't simply write off their losses. The UAW
> is still on the hook for the health care costs and is going to be
> struggling with this for years to come.
> You are right on the money with your assessment of how this situation
> was impacted by CDS. Based on their actions, it is reasonable to
> assume the hold outs were fully hedged and drove the C11 to cash
> out their positions. This is no different than buying a building
> and burning it down for the insurance money. You would think that
> the companies issuing the CDS would be smart enough to protect against
> this behavior or at least void the claim. You propose that the hedged
> owner transfers their voting rights to the insurer, which makes sense.
> I propose that a simpler solution is to simply call this what it
> is, insurance fraud, and prosecute accordingly.

May 04 07:29 PM

[niteshift:]

Tori: this had happen before President Ronald Reagan(I THINK HE WAS REPUBLICAN) did a bail out for Chrysler in the Late 70's and early 80's.So I guess to the Republicans wanted the Union to run the company first? Not only did they pay it back they paid it off 5yrs early. With all the interest including the 5yrs they didn't have to pay. So lets hope they do it again!! And lets hope Management wakes up this time, and puts out some cars and trucks made with quality and not push them out just cause of the numbers. Hopefully they control the waist, the bonus's to all. Upper Management should listen to there Foreman's on the floor. Cause they are there eyes and ears, since upper Management (plant Manager ) is never there. And the workers should not be worried if they or going to get fired if they bring up a problem to there Forman and his boss finds out. Such a power struggle between the different groups!! Why cause One wears a tie and the other wears coveralls. Oh you need to check the lie you put down about no Union Company has every lasted. Fru & co 2nd biggest Construction company in the world~Union. Monsanto ~Union. Budweiser~Union . Union Pacific~Union... Want more Do your research


On May 03 11:45 AM Tori wrote:

> This is exactly what Obama wanted, to turn these companies over to
> the unions. Next comes card check, which is crazy considering there
> isn't a single successful unionized company in this country. But
> hey..the democrats need this voting block, so they'll give them whatever
> they want.

Oct 23 03:12 AM