Sunday, December 18, 2011

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Case Study: The General Motors Bankruptcy - 2009

Donald DePamphilis
Clinical Professor of Finance
Article available on Google Knol under Creative Commons 3.0 Licence.


Rarely has a firm fallen as far and as fast as General Motors (GM). Founded in 1908, GM dominated the car industry through the early 1950s with its share of the U.S. car market reaching 54 percent in 1954. However, this proved to be the firm’s high water mark. Efforts in the 1980s to cut cost by building brands on common platforms blurred their distinctiveness. Following increasing healthcare and pension benefits paid to employees, concessions made to unions in the early 1990s to pay workers even when their plants were shutdown reduced the ability of the firm to adjust to changes in the cyclical car market. GM was increasingly burdened by so-called legacy costs, i.e., healthcare and pension obligations to increasing large retiree population. Over time, GM’s labor costs soared compared to the firm’s major competitors. To cover these costs, GM continued to make higher margin medium to full size cars and trucks, which in the wake of higher gas prices could only be sold with the help of highly attractive incentive programs. Forced to support an escalating array of brands, the firm was unable to provide sufficient marketing funds for any one of its brands.
With the onset of one of the worst global recessions in the post World War II, auto sales worldwide collapsed by the end of 2008. All auto makers’ sales and cash flows plummeted. Unlike Ford, GM and Chrysler were unable to satisfy their financial obligations. The U.S. government, in an unprecedented move, agreed to lend GM and Chrysler $13 billion and $4 billion, respectively. The intent was to buy time to develop an appropriate restructuring plan. 
Having essentially ruled out liquidation of GM and Chrysler, continued government financing was contingent on gaining major concessions from all major stakeholders such as lenders, suppliers, and labor unions.  With car sales continuing to show harrowing double-digit year over year declines during the first half of 2009, the threat of bankruptcy was used to motivate the disparate parties to come to an agreement. With available cash running perilously low, Chrysler entered bankruptcy in early May and GM on June 1st, with the government providing debtor in possession financing during their time in bankruptcy.  In its bankruptcy filing for its U.S. and Canadian operations only, GM listed $82.3 billion in assets and $172.8 billion in liabilities. In less than 45 days each, both GM and Chrysler emerged from government sponsored sales in bankruptcy court, a feat that many thought impossible.
Judge Robert E. Gerber of the United States Bankruptcy court of New York approved the sale in view of the absence of alternatives considered more favorable to the government’s option.  GM emerged from the protection of the court on July 10, 2009 in an economic environment characterized by escalating unemployment and eroding consumer income and confidence.  Even with less debt and liabilities, fewer employees, the elimination of most “legacy costs,” a reduced number of dealerships and brands, GM found itself operating in an environment in 2009 in which U.S. vehicle sales totaled an anemic 9.2 million units.  This compared to more than 16 million in 2008. GM’s 2009 market share slipped to a post-World War II low of 19 percent. Only the government’s “cash for clunkers” program during the summer months offered some respite from the largely unremitting downturn in U.S. auto sales. However, with the cessation of the program in late August, the boost in sales proved temporary.

Developing a Bankruptcy Strategy

While the bankruptcy option had been under consideration for several months, its attraction grew as it became increasingly apparent that time was running out for the cash strapped firm. Having determined from the outset that liquidation of GM either inside or outside of the protection of bankruptcy would not be considered, the government initially considered a prepackaged bankruptcy in which agreement is obtained among major stakeholders prior to filing for bankruptcy. The presumption is that since agreement with many parties had already been obtained, developing a plan of reorganization to emerge from Chapter 11 would move more quickly. However, this option was not pursued because of the concern that the public would simply view the post-Chapter 11 GM as simply a smaller version of its former self. The government in particular was seeking to position GM as a wholly new firm capable of profitably designing and building cars that the public wanted.
However, time was of the essence. The concern was that consumers would not buy GM vehicles while the firm was in bankruptcy. Consequently, a strategy in which GM would be divided into two firms: “old GM” containing the firm unwanted assets and “new GM” owning the most attractive assets. New GM would then emerge from bankruptcy in a sale to a new company owned by various stakeholder groups including the U.S. and Canadian Governments, a union trust fund, and to bond holders.
Buying distressed assets can be accomplished through a Chapter 11 plan of reorganization or a post-confirmation trustee. Alternatively, a 363 sale transfers the acquired assets free and clear of any liens, claims and encumbrances. The sale was ultimately completed under Section 363 of the U.S. bankruptcy code. Historically, firms used this tactic to sell failing plants and redundant equipment. In recent years, so-called 363 sales have been used to completely restructure businesses, including the 363 sales of entire companies. A 363 sale requires only the approval of the bankruptcy Judge while a plan of reorganization in Ch 11 must be approved by a substantial number of creditors and meet certain other requirements to be “confirmed.” A plan or reorganization is much more comprehensive than a 363 sale in addressing the overall financial situation of the debtor and how its exit strategy from bankruptcy will affect creditors.
Under Section 363, the bankrupt firm must file a motion with the bankruptcy court in which the case is pending seeking the bankruptcy court’s approval of the terms and conditions of the proposed sale. Opponents of the proposed sale will have a designated response period determined by the pertinent bankruptcy court (often 10-20 days) in which to file written objections to the proposed sale. Frequently, this time period will be shortened by the court to as little as a few days. Depending upon the degree of opposition to the sale and how many parties are interested in purchasing the assets being offered, the process could be completed in a matter of weeks. Once a 363 sale has been consummated and the purchase price paid, the bankruptcy court will decide how the proceeds of sale ware allocated among secured creditors with liens on the asses sold.

Terms of the Deal

GM’s U.S. and Canadian assets and liabilities were split between two companies under the protection of the bankruptcy court. GM’s exit from Chapter 11 involved the sale of its most attractive assets to a new company (dubbed the New GM) owned primarily by the American and Canadian governments and a healthcare trust for the UAW union.  The unattractive assets were transferred to the other company referred to as the “Old GM.”  The old GM which will be known as Motors Liquidation Company and includes various properties, including facilities already slated to be closed. Such properties will be sold to the highest bidder under court supervision.  Other assets to be filed under the old GM include the brands Hummer, Saturn, and Saab for which GM already has buyers. 
Total financing provided by the U.S. and Canadian (including the province of Ontario) governments amounted to $69.5 billion. U.S. taxpayer provided financing totaled $60 billion consisting of $10 billion in loans and the remainder in equity. The government decided to contribute $50 billion in the form of equity to reduce the burden on GM of paying interest and principal on its outstanding debt. Nearly $20 billion was provided prior to the bankruptcy, $11 billion to finance the firm during the bankruptcy proceedings, and an additional $19 billion was to be provided before the end of 2009. In exchange for these funds, the U.S. government will own 60.8 percent of the new GM’s common shares, while the Canadian and Ontario governments own 11.7 percent in exchange for their investment of $9.5 billion. The United Auto Workers (UAW) new voluntary employee beneficiary association (VEBA) received a 17.5 percent stake in exchange for assuming responsibility for retiree medical and pension obligations. Finally, bondholders and other unsecured creditors received a 10 percent ownership position. There will be $2.1 billion in preferred shares held by the Treasury and $6.5 billion in preferred shares which will be issued to the new VEBA.

Profiling the New GM

The new firm, which employs 244,000 workers in 34 countries, will further reduce its headcount of salaried employees to 27,200. The firm will also have shed 21,000 union workers from the 54,000 UAW workers it now employs in the U.S. and close 12 to 20 plants. GM did not include its foreign operations in Europe, Latin America, Africa, the Middle East or Asia Pacific in the Chapter 11 filing. Annual vehicle volume for the firm will decline to 10 million vehicles, compared with 15 to 17 million annual vehicle sales from 1995 through 2007. Consolidated debt for the firm will be $17 billion. The firm also will have $9 billion in 9% preferred stock, which is payable on a quarterly basis. GM will have a new board. Canada and UAW health care trust will each get a seat on the board.
GM will focus on its core brands Chevrolet, Cadillac, Buick and GMC through 3600 dealerships from its existing 5969 dealer network. The business plan calls for an IPO as early as the second quarter of 2010 depending upon stock market condition.
By offloading worker health care liabilities to the VEBA trust and seeding it mostly with stock instead of cash, GM has eliminated the need to pay more than $4 billion annually in medical costs. Concessions made by the UAW before GM entered bankruptcy have made GM more competitive in terms of labor costs with Toyota.
GM’s new cars in 2010 include the Chevrolet Volt, a plug-in hybrid electric car.  However, with a price tag of $40,000, the car is likely to be only a niche brand. Other small car models include the Chevrolet Cruz and Spark which may fare well but will face intense competition from models such as Honda’s Insight and the Toyota Prius as well as Ford’s Fiesta.

Future Challenges

New products must be introduced as scheduled and they must meet or exceed the expectations of potential customers. Success in this area would represent a substantial departure from past experience. New more energy efficient models must compete against brands long-established in the marketplace such as Honda’s Insight and Toyota’s Prius.
The need to buyout and workers who will lose their jobs as a result of the eleven pending plant closings will constitute a significant drain on operating cash flow during the next several years.  If the firm’s stock does not do well, the UAW will have to further cut medical benefits for workers covered by the union’s own trust. Bankruptcy allows GM to break dealer franchise contracts. Consequently, GM car owners may have to travel much further to get their cars maintained under warranty as the number of dealerships shrinks.
Finally, GM’s greatest challenge may be in changing the firm’s corporate culture which some have accused of being slow to innovate, risk adverse, and bureaucratic. The firm intends to eliminate as many as one-third of their current managers. While this may go a long way in changing the firm’s culture, it also will represent a loss of substantial expertise and experience.

Source article in Knol