Will GM's Tune-Up Work?

By Eric Fox | February 19, 2009 AAA

The financial restructuring plan detailed on February 17, 2009 by General Motors (NYSE:GM) may be the first step in surviving the unprecedented decline in car sales both in the U.S. and internationally, but investors should be wary about buying the stock immediately as the depth of the down turn is still unclear, which means equity holders may get hit with substantial dilution when other stakeholders in the company receive equity in exchange for liabilities.

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When Congress granted General Motors $13.4 billion in loans last December, it required that management submit a detailed plan to restructure the company so it would be a viable long-term business. The plan submitted on Tuesday, by GM comes with a request for another $16.6 billion to survive. If the company does not get this, it will run out of cash by the end of March 2009.

Outline of the Plan
The goal of the plan is to have GM North America breakeven on an earnings before interest and taxes (EBIT) basis with domestic auto sales of 11.5-12.0 million units in 2009.

This will be accomplished by:

- Cutting 47,000 jobs worldwide in 2009. This represents 19% of the company's total work force.
- Closing five more factories in the U.S., bringing the total closed to 14.
- Reducing vehicle models to four major brands; Chevrolet, Cadillac, Buick and GMC. The Saturn brand will be sold or closed.
- Cutting dealerships from 6,246 to 4,100 by 2014.

GM is also keeping on track to produce its Volt car. This long-term thinking will help the company in several years when oil and gas prices move back up in response to increased demand.

Other Stakeholders
Just as important, the company is working toward an agreement with its bondholders to cut its debt by $18 billion, by exchanging part of the debt with equity. Also, the unions at GM have agreed in principal to restructure the Voluntary Employees' Beneficiary Association (VEBA), so that it can be funded 50% with GM stock rather than cash. The VEBA was set up as a trust to contain the company's retiree health costs, the purpose of which was to remove the liabilities off its balance sheet. Both these agreements may result in dilution to shareholders, although this may be discounted already in the stock.

Chrysler Too
Chrysler, which is a private company, also asked for $5 billion in loans. Daimler AG (NYSE:DAI), the company behind the Mercedes brand, sold 80.1% of Chrysler to a private equity firm in 2007. Given the current state of the world economy, this may go down as one of the greatest moves in business history.

Ford Motor (NYSE:F) did not play a part in the moves on the 17th, as the company did not request any government loans. The company lost $14.5 billion in 2008, and has its own plan to restructure the company. Even the strongest automakers are facing problems. Toyota Motor (NYSE:TM) had its bond ratings cut from AAA to AA + and said that it would post its first loss since 1950. (Learn what this could mean for the company in The ABCs Of The Bond Market.)

Will It Work?
The plan does seem viable, but it should be noted that sales of new cars in January 2009, the latest for which we have data, came in at a seasonally adjusted annual selling rate (SAAR) of just 9.57 million units, below the 11.5-12.0 million rate in the GM plan. However, this was probably an artificially low rate due to bad publicity heard by consumers regarding the health of the domestic auto industry. The difficulty in obtaining credit was also a contributing factor to the low number. Since the economy is still contracting, it is not clear what a new sustainable level of demand is for the next few years.

The GM plan is a good start for the company to adapt to the new lower level of consumer demand for automobiles, but its success is dependent on the ultimate depth of the recession, and equity holders may be diluted further in order to implement the restructuring.

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