Chartered Financial Analyst, August 2009

Chartered Financial Analyst

August 2009

A New Lease on Life

-by Art Wheaton
Industry Education Specialist, Cornell University ILR School

General Motors’ 100th anniversary could see either the rebirth or death of the automaker.
It is not clear whether GM will be able to survive, but bankruptcy could give it a new lease on life. For now, GM is going through a very painful and public transformation. GM and Chrysler have repeatedly faced difficult times over the last 30 years. The pain and suffering have resulted in layoffs, plant closings, restructuring, spin-offs, mergers and acquisitions. Automotive industry restructuring has been a recurring problem for GM and all of Detroit. What makes this
restructuring different from the others is the necessity to file for bankruptcy. Chrysler was forced into bankruptcy and a partnership with Fiat one month prior to GM. It is believed that Chrysler was forced into bankruptcy first to allow GM to learn from their experience.

The fall of GM has been a long, slow, and painful decline in market share. Bankruptcy was something former GM CEO Rick Wagoner never wanted to consider. Wagoner believed that consumers would not purchase vehicles from a bankrupt automaker. The global recession
has caused turmoil in the financial, banking, manufacturing and housing sectors. The US government has taken a very active role in forcing GM to restructure. The government appointed automotive panel forced the resignation of Rick Wagoner and promoted Fritz
Henderson so that bankruptcy would be considered. The decision to force GM into bankruptcy was not taken lightly.

Addressing threats

In normal times, customers and consumers tend to view bankruptcy as a failure. These are not normal times. President Obama has made some unusual and potentially life changing guarantees to help support GM and Chrysler. Three key items that make bankruptcy dangerous
and scary for a unionized auto company are: fear of auto warranties, financing to get out of bankruptcy, and union contractual benefits/collective bargaining agreements being thrown out.

The threat of not being able to honor warranties from GM was alleviated by President Obama in the early press conferences. President Obama has pledged that the US government will honor all new car warranties for GM and Chrysler. President Obama went as far as to say that the warranties under the government protection are stronger than GM’s current warranty programs. This guarantee takes away one of Rick Wagoner’s often repeated threats of a GM bankruptcy.

The second threat of debtor-in-possession financing to get out of bankruptcy is also being addressed by the Federal government. By pledging up to $30 bn additional funds to finance GM
through the bankruptcy process, President Obama has cleared a major obstacle that has prevented Delphi (formerly part of GM) from emerging from bankruptcy for almost four years. By giving GM adequate financing to make major and difficult restructuring changes, they have gone a long way in providing stability.

The third threat of eliminating employee/ union benefits is a frequently and hotly debated subject. The legacy costs and burden of GM’s retiree obligations are massive. President Obama clearly supports the employees and retirees. Throwing out the collective bargaining agreement, dropping pensions and eliminating healthcare were not part of the President’s plan. Finding a creative way to avoid throwing out the contract and benefits during bankruptcy proceedings was critical to getting labor support and could have political implications in future elections. President Obama and his auto panel recognized that eliminating the pensions and retiree healthcare could threaten the solvency of the Federal Pension Benefit Guarantee Board. Negotiating a provision to give the Voluntary Employee Benefit Associations a stake in
the new GM in exchange for retiree obligations was not warmly received by bondholders.
By allowing a soft landing for employees and retirees, President Obama managed to keep the unions engaged and deeply involved in rebuilding the shareholder value of the new GM.

In a few short months of negotiations, the US government had taken control of two automotive companies and set the stage for either a great comeback story or a political catastrophe. The history of GM has been filled with management mistakes and unmitigated ego. The upper
levels of management at GM have consistently overestimated their ability to manage the breadth and depth of the largest auto company in the world (GM lost that title to Toyota in 2008). GM now has the opportunity to remake itself as a stronger smaller company.

The long list of brands or nameplates GM managed or had a financial stake in is truly taggering. The likelihood of any company managing that many different car companies and brands is very low. During the past 10 years, GM has had some vested interest in the following companies/brands: Chevrolet, Cadillac, Oldsmobile, Pontiac, Saturn, Hummer, Saab, GMC in the US market with 100% ownership. The list of partial ownership and foreign nameplates gets even longer: Holden, Vauxhall, Opel, Daewoo, SAIC, Wuling, Suzuki, Isuzu, Fuji Heavy Industries and Fiat. There are also joint venture projects with Toyota and others. There is no question that the management had more than enough projects to work on. There was never a strong chance that GM could manage all of these projects and companies with ever declining resources.

Blessing in disguise

The bankruptcy process being imposed on GM may end up as a true blessing and ensure the rebirth of a historic company. The Obama auto task force has forced GM to cut its losses in the number of brands, dealerships, suppliers, and other entities dragging down their management time and financial resources. GM did not have a great deal of success in reducing its brands on its own. The winding down of its oldest brand, Oldsmobile, caused serious headaches for its image and cost over $1 bn. Severing ties after a failed Fiat marriage resulted in over $2 bn in divorce agreement, often referred to as the ‘Fiatsco’.

GM is not alone in having difficulties with mergers, acquisitions, parts supplier spin-offs and joint ventures. Chrysler had poor experiences with Mitsubishi and Daimler. Ford faced similar problems with Jaguar, Aston Martin, Volvo, Think, Land Rover and Visteon. The bankruptcy process and, more importantly, the think tank and political access involved with the automotive
task force, have forced GM to think more strategically. The tough decisions that were avoided by Rick Wagoner are now being made by the task force with the blessings of Fritz Henderson. The cost of failure is too great a risk for such a young Presidential administration.

What the task force contributes is not automotive expertise, but management and restructuring experience and political clout. The close ties to the treasury and the government make financing the reconstruction of GM in the national interest. Forcing GM to make the tough
decisions and aligning the strategic goals with government policies should go a long way towards making GM a sustainable entity. If GM can maintain its focus with its new Chairman and as a well financed company with fewer brands, it could be a successful company for the
next century. I am cautiously optimistic that the automotive panel and new board of directors will bring the much needed reality and ego check for the GM corporate culture.

The bankruptcy process allowed GM to eliminate $172 bn in debt, shut thousands of redundant dealerships, reduce labor costs, and get off the Delphi anchor that has been weighing it down for years.

It also gets GM to a more manageable and sustainable size with less complexity and more flexibility. The infusion of $50 bn in taxpayer funds will help GM build its new company on a strong foundation. The automotive task force will make sure that GM will reduce its footprint
in the world and try to keep their ego in check. Humility and focus will help GM regain its customer and consumer image. This new GM has the opportunity to wipe clean the poor public image and the past mistakes in quality and design in the 1970s and the 1980s.

It will not be an easy journey for GM to restructure. It took them decades of decline to get into bankruptcy. It will take years for them to rebuild the bridges burned with consumers and steer the new GM on the road to success. The poor quality and lackluster designs in the 1970s and the early 1980s caused serious damage to GM in public relations. The union contracts with cost of living adjustments and the annual improvement factor negotiated in 1950 left labor costs
out of line with other manufacturing jobs in the US. Now, bankruptcy and the automotive
task force could ironically help GM put all those things behind.

Road to recovery

Edward Whitacre Jr., the new Chairman of the board, will have his hands full reviving GM public image and managing its new corporate culture. The pace of change in the next three months will be faster than ever. GM will probably emerge from bankruptcy by October. The process with Chrysler and Fiat has allowed GM to learn and benefit from the bankruptcy
process that has survived its first Supreme Court challenge. The Chrysler bankruptcy and takeover by Fiat took less than two months.

The complexity of GM will extend the process, but the political resolve and the economy will provide GM opportunities to emerge in months instead of years. With the added political, financial, and business acumen that the task force has brought to the table, GM has a brighter future than thought possible only a year ago.
Reference # 01M-2009-07-08-01