End of an Era for U.S. as GM Files for Bankruptcy, Chrysler Sale Approved

GM Goes for Chapter 11

General Motors (GM) will file for Chapter 11 bankruptcy this morning in New York City. President Barack Obama will then spell out the government's actions at 11:30 am Eastern Standard Time, before CEO Fritz Henderson gives a press conference to detail the specifics. Some details were provided by the presidential administration through a White House briefing last night, however, so no major surprises are expected. A key question is how the government will behave as a majority stakeholder in the new GM. According to senior administration officials, the situation will play out as follows:

• GM enters Chapter 11, using Section 363 to sell its "good" assets. A new company will be formed, to which GM will try and sell its assets through the use of a bankruptcy court. The U.S. government will provide an additional US$30.1 billion in debtor-in-possession financing—this will be the end of the government's financial involvement in GM, according to the officials, who said that this final amount will put the company on the path to profitability.
• The UAW gets a new VEBA. The United Auto Workers (UAW) have accepted a new contract that will see a significant portion of the US$20 billion that is owed to them by GM for the Voluntary Employee Beneficiary Association (VEBA) retiree healthcare trust fund converted into equity. A new VEBA has been created, and will be funded by a US$2.5-billion note payable in three instalments through 2017, US$6.5 billion in preferred stock, and 17.5% equity in the New GM with warrants to purchase an additional 2.5%. In return, the UAW will have one non-voting seat on the New GM board of directors.
• The governments of the United States and Canada take a stake. The U.S. government has already pumped US$19.4 billion into GM, and will put another US$30.1 billion into the company; the majority of that stake will be converted to equity, leaving the government with a 60% equity stake and US$8.8 billion owed to it in cash. Yet the Canadian and Ontario provincial governments are also slated to provide US$9.5 billion to GM, in exchange for US$1.7 billion in debt and preferred stock, and 12% equity in the new company. The Canadian government will also select one member of the board of directors; the remaining directors will be selected by the government, but they will not be government employees.
• The bondholders have largely capitulated. Approximately 54% of the bondholders have agreed to convert their debt to equity as set out in the government's newly sweetened deal. The government and GM had tried to coerce the holders of US$27.4 billion in GM debt to turn it in in exchange for a 10% stake in the company, with warrants to eventually purchase an additional 15%. Those who have accepted the deal will receive a pro-rated equity holding based on that deal, the government has stated.
• Business as usual for most employees, suppliers, and dealers. GM will pay its employees as usual, and all pension and benefit plans for both hourly and salaried employees will be transferred to the New GM. The company will seek to continue payments to suppliers as part of its "first day" bankruptcy activities, as well as honour warranties for customers. Major additional dealer closings are already expected as part of a second wave of notifications, but the government says that they will be given an 18-month window to wind down operations, as opposed to the rapid closures that were seen at Chrysler.

Government's Role Under Scrutiny

Much concern has been voiced over what the government's role will be as a majority owner of GM; in yesterday's briefing, it went to great pains to outline its involvement in not only GM, but any company in which it is taking an ownership stake in these troubled economic times. To that end, it published its "Principles for Managing Ownership Stakes", a set of rules that it says it will follow in any company in which it takes a stake. The principles include items such as the idea of not keeping holdings in any company any longer than absolutely necessary, setting upfront conditions in exchange for providing capital to struggling companies, and managing companies in a hands-off way, in the manner of a silent equity partner. The government has said that it will only vote on core governance issues, and not day-to-day operations. In layman's terms, this means that if a company wants government money, it must accept the changes that the government mandates in the interests of the American taxpayer. After the company does what the government wants, then the government will sit back and let the directors and management run the show.

Deal for GM's European Arm

The whirlwind of announcements over recent days has also seen the future of GM's Opel and Vauxhall European operations decided. The victor is Canadian components manufacturer Magna, left as the only bidder after Fiat effectively withdrew. The assets and shares of General Motors Europe (GME) will be placed in trust to ring-fence the company's assets from the U.S. Chapter 11 process. The company will also immediately receive the 1.5 billion euro (US$2.1 billion) of credit guarantees that were being offered by the German government. The original terms of Magna's deal saw 700 million euro offered for a 55% stake in Opel/Vauxhall, a portion of which was due to be guaranteed by the German government. This would have seen the new shareholding structure in Opel/Vauxhall as follows: 35% owned by GM; 35% owned by Russian state bank Sberbank (who are Magna's investment partners in the bid); 20% taken by Magna; and the remaining 10% allocated to Opel's partners. It has yet to be confirmed, however, whether this proposed structure is the one that will be adopted by the company. Magna has also said it will provide Opel/Vauxhall with an immediate cash facility of 300 million euro to ensure the company's operations in the short term.

While the deal comes as some relief, several influential players in the saga have not given it a ringing endorsement. Germany's Economic Minister Karl-Theodor zu Guttenberg is quoted as saying "The balance of risk was such that I would have come to a different conclusion. But looking at the big picture, it is a decision we can all endorse.” It appears that the schism between the political parties that make up the German government—the Christian Democratic Union (CDU)/Social Democratic Union (SDU) and the Social Democratic Party (SPD)—brought their own pressures. The CDU, of which zu Guttenberg and Chancellor Angela Merkel are members, was reportedly willing to give the rival Fiat bid consideration, but Merkel's deputy and leader of the SPD Frank-Walter Steinmeier preferred the Magna bid from the beginning as the company was less aggressive in its cost- and job-cutting plans for German plants. The co-chief executive of Magna, Sigfried Wolff has said that all the company's German plants would be maintained, although Magna had already stated it planned to shed 2,500 jobs in Germany as part of its bid. Magna will now complete its due diligence on Opel/Vauxhall and will now be tasked with finalising a contract with GM.

Magna's victory in the bidding contest means that Fiat, which at one stage was favourite to secure a deal, will have to reconsider its global strategy. As described in the next section, it is still on course to finalise a production and vehicle technology alliance with Chrysler. This will give Fiat a significant presence in the United States, but will still leave it some way short of previously stated ambitions. It is meanwhile an impressive coup for Magna, which is well run and robust. Factors in its favour include its status as the world's most diversified major automotive components supplier, that it is has an extensive history as a successful contract vehicle manufacturer, and that it has significant vehicle research and development (R&D) capability of its own. Nonetheless, there is also no doubt that the deal is very risky for the firm. Meanwhile, the workers' union leaders and governments involved in the other facilities in GM Europe's portfolio that dealt with Opel/Vauxhall production will be nervously awaiting Magna's examination of the company's books. The company has already stated that it will look to cut around 20% of GM's European headcount of 55,000, and this is likely to affect the company's plants in the United Kingdom, Belgium, Poland, and Spain. Magna has indicated that it will do everything it can to retain staff headcount and plants, within reason. However, it is illogical to take over the company and not tackle its cost base and excess capacity—particularly if Magna is effectively adding capacity to Opel through GAZ's new plant in the Nizhny Novgorod region of Russia.

Chrysler Sale Cleared

The situation at Chrysler, another fallen U.S. automotive icon, is being closely watched for pointers as to how the GM story will play out. Last night a federal judge cleared the path for the firm to exit its bankruptcy. Most of the firm's assets will be sold to a new entity that will be run by Italy's Fiat. As in GM's case, the government is closely involved and has given the arrangement its backing. It is hoped that the court ruling will allow the newly reorganised Chrysler to exit bankruptcy as early as this week. This is a month after it sought protection, a remarkable achievement given the scale and complexity of the reorganisation. The new entity will be 55% owned by a union retiree trust, while Fiat will hold 20% and further minority shares will be held by the U.S. and Canadian governments. The Fiat stake could eventually rise to 35%. Chrysler's new chairman is to be C. Robert Kidder, who formerly headed up Borden Chemical and Duracell. There are still some potential hurdles to the deal. Three Indiana state funds are expected to appeal, arguing that they deserve better repayment terms. A number of Chrysler dealers are also objecting.

Outlook and Implications

GM's bankruptcy declaration comes during its 100th year of operation and caps an unprecedented corporate collapse that has been a long time in coming. Thankfully, the implications look much less severe than they would have been had it filed for protection just six months ago. Towards the end of 2008, GM would not even discuss bankruptcy, and the prospect fuelled talk of an economic, employment, and financial disaster with wide-ranging implications for all industries and all areas of the country. That situation has been largely avoided due to one key difference between the environment now and the environment then: the full financial support and assistance of the U.S. government. Six months ago, the George W. Bush administration was winding down, and the government had no significant support for the automotive industry. Most politicians were advocating no assistance at all for GM and Chrysler, preferring to let the bankruptcy process play out. An uncontrolled bankruptcy at GM would have cost over US$100 billion, pensions would have been transferred to the government's Pension Benefit Guaranty Corp., and the likelihood of a reorganisation without any financial support from the still-frozen financial markets would have quickly been replaced with talk of liquidation. Now, however, there is a task force specifically created by the new American president whose sole purpose is to assure the survival of the American auto industry, and which has worked extremely closely with the automakers to provide the kind of financial support that the market itself balked at providing. There has never been this level of interaction and co-operation between the government and the auto industry in the United States, despite the familiarity of such arrangements in countries such as China or Japan. It can be said that the formation of the task force and its subsequent actions has probably saved both Chrysler and GM from a far more uncertain fate, and while GM's smooth exit from bankruptcy is far from guaranteed, it would seem that a sufficient number of stakeholders have already committed to co-operation such that a reasonable hope of success can be posited.