Sunday, May 31, 2009

Thoughts on the GM Bankruptcy

The time has finally come for GM shareholders to meet their maker. They will be wiped out along with most of the creditor claims. Of course this makes sense since GM had a negative net worth at this time last year. $40/per share of losses later and we have a 10% payout on secured claims.

So what happens next? GM will receive many billions of Debtor-in-Possession funding by the Federal Government so GM can continue building cars that no one wants or not building and paying union members their full salaries anyways on the taxpayer dime (who will now own over 70% of GM). Now that we have 2 of the Big 3 automakers cleared out, what happens to the last one, Ford, who happened to have a little bit of foresight and got enough funding to last through a downturn?

Clearly, Ford has a significant competitive disadvantage to companies that have gone through bankruptcy to clear out the overhang of debt. GM and Chrysler, thanks to the generosity of the American taxpayer, will have a lower cost, and more importantly, a lower cost of financing because the Federal Government does not have a clear financial investment policy. Typically, a private equity company would come to the table with a required internal rate of return of maybe 40% to take the risk of getting GM back running. The government has no required internal rate of return and extremely deep pockets, thanks to the tax paying slaves like you and me. How does Ford fight this? It will be nearly impossible. Ford had over $154 billion in debt on Dec 31, 2008. GM and Chrysler will have basically no debt. The interest payment last year was $9.7 billion which represented about half of their Gross Profit (before operating expenses).

Now, think about what the Government will do to try to make themselves look good. They will likely:

1. Subsidize any GM or Chrysler built car through tax credits
2. Subsidize any research going towards making green cars
3. Subsidize any GM or Chrysler green car through further tax credits
4. Penalize people for not buying a GM or Chrysler, by raising or not lowering tariffs on imports

So now Ford has to build green cars, do green research, carry a higher interest burden, and still compete against foreign automakers? Unless Ford's CEO, Alan Mullaly, is a miracle worker, I would say Ford is going to go into bankruptcy as well, just because of its interest burden. Unfortunately, they are being punished for making a smart decision by obtaining financing for a coming downturn (whether or not they predicted it would be this bad is up for debate). Ford's shareholders should be pissed as their company will not be able to compete very well against subsidized automakers.

I expect that GM and Chrysler will not be able to compete without heavy subsidization through tax credits and research grants. Their products will be politically driven instead of market driven, too costly without heavy subsidies, and of generally lesser quality than other non-subsidized companies. These are bloated companies that survived on 0% financing offers for the last few years. GM and Chrysler should have never been bailed out in the first place (Thanks Bush!). They would have gone down, Chrysler would have been liquidated, and GM would have been restructured over several years in bankruptcy court, and Ford would have survived this ugly mess as the top American auto manufacturer. Instead, Ford is in a bit of a quandry on how they are going to overcome the mountain of BS the government has dumped in front of their ability to compete in the government owned auto market.

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