Why General Motors Should Enter Bankruptcy

(Scene: At Play Now – in the bosses office)

Thomassoulo: George, I’ve realized we’ve signed a one-year contract with you, but at this point I think it’s best that we both go our separate ways.
George: I don’t understand.
Thomassoulo: We don’t like you. We want you to leave.
George: Clearer

(Scene: At Monks Café)
Jerry: So you’re staying at Play Now?
George: Why not? Pay is good. I got dental, private access to one of the great handicapped toilets in the city.
Jerry: But they not you aren’t handicapped, aren’t you ashamed?
George: They’re the ones who should be ashamed. They signed me to a one-year contract. As long as I show up for work every day, they have to pay me.

(Scene: At Play Now – in the bosses office)
Thomassoulo: You win George. We’ve had it. If you leave right now, Play Now will give you six months pay. That’s half of your entire contract. Please…just go.
George: You see if I stay the whole year, I get it all.
Thomassoulo: Want to play hand ball huh? Fine. (calls on intercom) Attention Play Now employees, George Costanza’s handicapped bathroom is now open on the sixteenth floor to all employees and their families.
George: Well played.
Thomassoulo: I’ll see you in hell Costanza.

— Seinfeld Episode 158 "The Voice"

General Motors CEO, Richard Wagoner, probably never watched Seinfeld regularly but if he had, he might have been able to save his company.  His strategy of appeasing the union and waiting for employee attrition to reduce the company’s payroll has backfired.  As it stands, I believe that employees will be able to outlast GM’s precarious liquidity position.   The company is currently being run to fund current and former employee benefits, not for shareholders or creditors.  Therefore, I believe GM will have to file for bankruptcy to restructure the company’s crushing pension and healthcare obligations. 

With the GM fiasco on the front pages, it’s an opportune time to look at how I analyzed this situation.   At first glance, GM might seem to be a reasonable speculative bet.  The stock is trading at about 1x trailing EBITDA, 2x trailing cash flow, .09x sales, 4.5x trailing earnings and has a 7% yield.   

In other words, the company’s horrible fundamentals are probably priced into the stock at these levels. Among the well know problems are the company’s short-sighted strategy of providing 0% financing and additional incentives for new car buyers.  This pulled demand for the company’s cars into the present, leaving future demand very low.  The company’s line up of brands and cars also gives you an insight into the company’s problems.  Aside from Cadillac and Hummer, none of the company’s cars offer a distinctive marketing angle or economic benefit.  If you want reliability you buy Japanese, and if you to show off, you buy German, if you want cool, you certainly don’t buy a Pontiac.  In fact, 4 of the company’s 10 brands should probably be killed – Pontiac, Oldsmobile, Buick and Opel – because they are so tired and have no cache left.   

These problems could be resolved by aggressively managing the company’s operations.  If the operational issues were all that plagued GM, I would probably be tempted to buy the stock rather than run for the hills. 

The real problem is the company’s onerous expense and liquidity position which is the result of the financial obligations owed to current and former employees.  There are several aspects to this problem. 

First, the company is not capable of cutting expenses aggressively because of its union contract.  According to the Detroit Free Press, the big three U.S. auto makers and the largest auto-parts supplier are paying about 10,000 hourly workers in the U.S. and Canada full wages and benefits not to work, despite falling U.S. market shares, shuttered plants and production cutbacks.   These workers are essentially in a holding tank for hourly employees who are off work a long time, a system devised by the auto makers and the United Auto Workers union.

While most of the companies refused to say how much they are spending to pay these workers, a Free Press survey suggests it is likely well over $1 billion this year, given the number of workers and typical union wage-and-benefit packages. Auto supplier Delphi has told Wall Street that it will spend $300 million in 2005 to pay the salaries and benefits for about 2,300 union workers who currently don’t have jobs, and it says that cost is "as high as it has ever been for us."  GM’s 2004 10-K states that the average hourly wage for its employees is about $74/hour.  I’m guessing few employees are actually getting paid that but once you add in the healthcare expense and "excess" workers, it’s probably close.

Second, closer examination of the footnotes to the company’s pension and other obligations, reveals that the company cannot survive with its current expense structure.   The obligations due to current and former employees are a drain on the company’s resources. 

This table from the company’s 2004 10-K from Footnote 16 reveals many of the issues.  The colored items represent areas of interest: