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  When Giants Stumble: General Motors to File for Bankruptcy

When Giants Stumble General Motors to File for Bankruptcy

By David Welch

GM's June 1 Chapter 11 filing will cap a decades-long slide, but GM should emerge relatively quickly from court with lower labor and debt costs.

Decades of decline and seven months of negotiations with its union, creditors and the US Treasury Department will culminate in an historic bankruptcy for General Motors in New York on Monday morning, June 1, senior Obama administration officials and company sources said Sunday night.

The once proud and dominant company, which owned half of the American car market at its peak, was finally brought to its knees by the recession and frozen credit markets, forcing GM into the arms of the federal government. But the money the government gave to keep GM upright -- $19.4 billion (€13.7 billion) to date and as much as $30.1 billion (€21.3 billion) more down the line -- came with big strings. President Barack Obama wanted GM to completely restructure so it could become competitive again. The only way to get the savings the carmaker needed from bondholders and its sprawling dealer network was under the umbrella of court supervision.

Starting Monday, GM will get a chance at a new start. Management and its government overseers hope GM can wipe away decades of outsized retiree and labor costs and its brand-and-marketing strategy, both of which were designed for an era that had long passed. The result will be a much smaller GM, one that won't even challenge Toyota for the crown of world's biggest car company. But with far less debt and a reworked labor contract that will get costs closer to foreign-owned auto plants in the US, the new GM has a shot at regaining profitability and becoming competitive again. Legendary GM Chairman Alfred Sloan's strategy of selling a "car for every purse and purpose" will still be in place, but the models will be sold through four focused brands -- Chevrolet, GMC, Buick and Cadillac -- instead of eight.

The plan is to have the new GM emerge from court protection relatively quickly, perhaps within 60 to 90 days. Meanwhile, some of the weak brands -- Hummer, Saab, Saturn and Pontiac -- plus any unwanted assets, such as factories, would stay with the old company, which would be liquidated. All of those brands are already for sale, except for Pontiac, which will be shut down. Treasury officials declined to say Sunday night which brands or factories will go into the old company.

Everyone's Banking on a Turnaround

The federal government will hold 60 percent of the new company's stock in exchange for forgiving all but $9 billion of the loans it extended. Similarly, the governments of Ontario and Canada will loan GM $9.5 billion and will forgive all but $1.7 billion and keep 12 percent of the stock in the new company. By the time GM is on its feet, the US government will have loaned it about $50 billion. For the government to recoup its investment, GM's stock value -- all but vanished today, to below $1 billion -- would need to eventually be worth about $58 billion. Says the administration official: "I don't know how much we're going to recover. We hope to recover as much as we can."

Bondholders and the United Auto Workers (UAW) union are also relying on GM to come roaring back. The union agreed to take 17.5 percent equity in the new GM, stock warrants for an additional 2.5 percent of the company, plus $2.5 billion in cash and $6.5 billion in preferred stock that pays a $585 million annual dividend -- all in place of the $20 billion GM had pledged to the UAW to start a Voluntary Employee Benefits Association, or VEBA. That entity, which GM set up in an earlier attempt to offload its massive health-care plan for workers and retirees, will pay medical benefits the way a pension fund pays retiree checks. Bondholders, meanwhile, would take 10 percent of GM's stock and warrants that could eventually give them an additional 15 percent of the company in exchange for the $27.2 billion of GM debt they hold.

In another twist, GM will be a private company for 6 to 18 months while it reorganizes, a Treasury official said. Its publicly traded stock has been a component of the Dow Jones industrial index for many years.

GM is also getting a new board. Some current members will stay, but a new majority will be put in place. The government will have input as a major shareholder in the new GM. Canada and the UAW's health-care trust will each get a seat on the board. A senior administration official said board members will be picked based on their business background regardless of political affiliation. The administration and the company are "seeking business leaders and former CEOs," the official said.

For the government, union or bondholders to get their cash back, GM will have to be successful. Management and Treasury think they have the right plan in place to do that. GM's debt will shrink from well in excess of $60 billion to about $17 billion. Even better, by offloading worker health-care costs to the VEBA trust and seeding it mostly with stock instead of cash, GM has been relieved of paying more than $4 billion a year in medical costs. "Our balance sheet was our greatest weakness," CEO Frederick A. "Fritz" Henderson said in an interview. "We will fix that."

There will be pain for many workers, dealers and creditors, though. If the bankruptcy court agrees with management's plan, GM's bondholders would take a big haircut even if the company's stock has some value; the steep discount on their holdings remains the biggest hurdle to a fast reorganization. While GM has greatly reduced its workforce, about one-third of GM's remaining 54,000 factory workers could still lose their jobs since the company plans to close 11 more plants, though the workers will likely be bought out and sent into retirement. And if GM's stock doesn't do well, the UAW will have to further cut medical benefits for workers covered by the union's own trust. On the retail front, GM also plans to get rid of 1,600 of its 4,800 dealers by the end of 2010.

A 50-Pecent-Plus Share at Its Peak

The reason all those moves are necessary is because GM's business model was broken for years. Agreements at the bargaining table to pay generous health-care and retirement benefits cost the company billions of dollars that could have gone into new models, investments in new technology, and marketing. And the need to fund those big workforce obligations -- along with restrictions on the company's ability to cut workers or make its factories more flexible -- required management to fight for every bit of market share. If sales dropped too far -- regardless of whether they were producing a profit -- the company feared it wouldn't be able to generate the cash to cover its huge fixed costs.

The "zero percent" showroom wars GM waged in recent years drove auto sales to historic highs but, in fact, reflected the sickness of GM's structure. The company had too many plants because union contracts all but forbade layoffs. Even if workers had no work, they made 95 percent of their pay while idled. So GM was loath to close plants. Management figured that if it was going to pay money for rebates to keep sales up or for furlough pay, it may as well keep sales going.

GM's market share losses have been an ongoing problem since its share of the US market peaked at more than 50 percent in 1962. Since then, numerous GM CEOs and marketing executives have sworn they would stop the slide, but there were only a few periods when the company held ground. GM had close to a 30 percent share at the start of the decade but just 19.1 percent so far this year. GM says it can hold 18.5 percent in the next few years, but analysts expect it to be more like 14 percent to 17 percent. Wherever it is, GM will have to be sized to meet that share profitably. Says Henderson: "We'll have capacity at the right levels."

GM's dealer network was equally problematic. Dealer franchise laws in nearly every state make it easy for dealers to sue if GM gets rid of a brand. The company's decision in 2000 to close Oldsmobile cost it some $2 billion. So GM wound up spreading its resources thin, often designing models as Saturns or Pontiacs when they would have been better suited to a stronger brand like Chevrolet. The weakling brands also siphoned marketing cash. Plus, GM's dealers average 400 to 500 sales a year in a decent car market, while a good Toyota or Honda dealer could triple that level. That gave competitors higher profits to upgrade showrooms, retain better staff and take better care of customers. GM's bloated dealer force was losing the battle on the showroom floor.