The Case for Chapter 11
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These are desperate times in Detroit. General Motors attempted to merge with Ford Motor, only to be rebuffed. As of this writing, it was exploring a buyout of Chrysler, which is an intriguing possibility but faces very long odds. (Who would lend G.M. money for that deal right now? In fact, who would lend G.M. money for anything right now?) In the meantime, all three carmakers are burning through cash as if they were internet companies circa 1999. Ford and G.M. have explicitly stated they aren't considering filing for bankruptcy, further fueling rumors that they will. But maybe they should, especially G.M., which is currently in the most dire situation of the Big Three and has perhaps the most to gain from a Chapter 11 reorganization.
To be sure, Ford isn't exactly comfortable, but it has more cash than G.M.-about $27 billion as of the most recent quarter-and is consuming it less rapidly. Ford also has some attractive assets that could find buyers, like its Volvo division and its 33 percent stake in Mazda, whose profits remain healthy. As for Chrysler, the company's best hope isn't a U.S. government bailout but Cerberus bailing out. The private equity firm bought an 80 percent stake in Chrysler last year for just $7.4 billion-less than a quarter of what Germany's Daimler had paid a decade earlier. Yet in hindsight, Daimler probably got the better deal. Chrysler's sales have plunged 25 percent this year, far more than any other major car company's. Still, like Ford, Chrysler has some assets-specifically its Jeep brand, its minivans, and its Dodge pickup-truck division-that could attract a healthy foreign automaker looking to expand in the U.S.
The most sensible buyers would be Japan's Nissan or India's Tata Motors.
Which brings us back to G.M. and the case for Chapter 11. A bankruptcy filing, if managed properly, might not be a death sentence for G.M. but instead a chance for it to streamline its operations. A desperate move? Sure, but less so than acquiring Chrysler, which is akin to tying two stones together to see if they'll float. A G.M.-Chrysler merger, should it happen, would produce lots of fancy PowerPoint slides about synergies and savings. But it would also be an enormous distraction for a company that has dithered too long without addressing its urgent need to restructure and downsize.
Numbers tell the story: G.M. reported $21 billion in cash at the end of the second quarter and then added $4.5 billion by tapping existing credit lines. During the third quarter, the company's cash probably dropped back to $21 billion or so. Even before the global financial crisis, G.M. was tearing through about $1 billion a month, and with vehicle sales now slowing not just in the U.S. but also overseas (formerly a growth area for G.M.), the burn rate is only increasing. Management can't drain the cash hoard all the way to zero-the company says it needs $11 billion to $14 billion at any given time just to meet payroll, buy parts, and keep the lights turned on. If you do the math, General Motors will likely run out of cash next summer.
The company could raise money by unloading assets, but which ones? In October, it tried to refinance its headquarters, downtown Detroit's Renaissance Center, with the city's public-employees pension fund. G.M. was flexible; it was willing to sell the building and lease it back, or even put it up as collateral for a loan. But the fund declined, which is a little like, say, the City of Chicago rebuffing the Cubs. G.M. has also put Hummer on the block, but who wants a maker of gas-swilling S.U.V.'s? A federal bailout might happen, but the U.S. government just gave Detroit $25 billion to develop fuel-efficient cars, so additional funds might be tough to come by. Besides, betting on a bailout is no way to run a company.
That leaves bankruptcy. The main advantage of Chapter 11 is that it would give G.M. a chance to wipe the slate clean and do what pretty much everyone agrees it needs to-reduce its number of brands and cut costs. Right now, it can't take those steps because the opposing parties (car dealers, labor unions, and suppliers) are strong enough to push back. When G.M. killed Oldsmobile, in 2004, it was forced to spend more than $1 billion to buy out all the disgruntled Olds dealers. The company still has eight domestic brands but probably needs only two or three-Cadillac, Chevrolet, and perhaps GMC. The others (Buick, Hummer, Pontiac, Saab, and Saturn) need to be sold or folded. That means about 60 percent of G.M.'s more than 6,000 dealers have to go, says automotive guru Steve Girsky of Centerbridge Partners, a private equity firm. A ballpark estimate for shutting down those dealerships is about $4 billion. G.M. can't spend that kind of money at the moment, but in a bankruptcy filing, it would essentially be taking itself hostage to force dealers into accepting less favorable terms.
The process would also help the company secure better deals with suppliers and the United Auto Workers union. G.M. is on the hook for about $11 billion to settle claims with its biggest parts supplier, Delphi (formerly part of G.M., and currently mired in its own Chapter 11 proceedings). The U.A.W. has already agreed to let G.M. restructure its pension and health-care obligations for retirees, but those savings won't show up until 2010. Bankruptcy proceedings would give G.M. a better chance to accelerate the timing.
Of course, there are downsides. Shareholders would be wiped out, but the stock is down 74 percent this year alone, so they've been pretty much obliterated anyway. The more serious objection is that it would be a catastrophe for vehicle sales. No one, the theory goes, will buy a car from a bankrupt company out of fear that the warranties would be worthless and parts wouldn't be available. But G.M. has access to plenty of $1,000-an-hour lawyers, and one of them should be able to find a way to guarantee warranty protection to G.M. vehicle owners. Get a court guarantee; buy coverage from Midas or Hertz or whomever.
The bottom line: General Motors can no longer be Generous Motors, as the automaker was long called in Detroit. A successful bankruptcy would require warranty guarantees, a public-relations blitz to reassure consumers, and a solid plan to inject capital into a revamped and rejuvenated company. "There's a reason the corporate bankruptcy law exists," says Daniel Montgomery, of Montgomery Advisors, a restructuring firm. "If it's used effectively, it's better than letting a franchise melt down."VisitÂ Portfolio.comÂ for the latest business news and opinion, executive profiles and careers.Â Portfolio.com© 2007 Condé Nast Inc. All rights reserved.