Lets first analyze the pension plan, which is actually in reasonable shape. GM has historically had an underfunded pension plan but it is currently overfunded by $1.9 billion in the US. The plan is in good shape because the company funded it with a $10 billion contribution from the largest corporate debt offering ever in 2003. This essentially shifted the risk from employees (who might not get their pension), to creditors (who might not get full value of the bonds if GM goes into bankruptcy).
The foreign pension plan, which the company inherited when GM bought Saab, is in worse shape as it is underfunded by about $9 billion. This could cause a problem since GM will have to fund it from ongoing operations or existing cash on the balance sheet. And the company will probably be unable to raise capital at a reasonable price unless investors become more comfortable with the operations.
A minor side note is the company’s assumption on the discount rate used to calculate its pension plan obligations. The company looks like it makes a slightly aggressive but still reasonable assumption that the pension plan will return 9% over the foreseeable future. That’s down from 10% in the past year – which was clearly too aggressive. I think a more reasonable assumption would be 8%, and which would make the plan look underfunded again, but I can live with 9%.
The real problem for General Motors comes in the form of the Other Post Retirement Employee Benefits lines. These amounts refer to the retirement benefits provided by a company to its employees other than those from its pension plan – for the most part "healthcare expense". A look at the Other Post Retirement Employee Benefits from the table shows why this is the key issue for GM – the company’s future obligations in this segment amount to $77 billion, while the company’s plan to fund those obligations only contains $16 billion – leaving the company on the hook for about $61 billion in future healthcare expenses.
CSFB analyst David Zion, who has done an outstanding job analyzing retirement obligations, succinctly explains the problem with the Other Post Retirement Employee Benefits for existing and potential shareholders – "In many cases, in particular among large companies, the risk of rising benefit costs is absorbed directly by the company if the OPEB plan is self-insured. Investors need to take this risk into account when valuing a company with an OPEB plan, as they are not only investing in an operating company, but they may also be purchasing a healthcare insurance company, and, for those with pension plans, an asset manager, all rolled into one."
The Company paid out $3.8 billion in 2004 for expenses related to retiree healthcare. In addition, GM used $5 billion to fund the OPEB plan in the hopes that one day the plan will be fully funded and the company will no longer have to use cash from operations to pay for retiree expenses. I believe the $3.8 billion expense will probably rise at a faster rate as employees continue to retire and grow older. It seems unlikely that GM will be able to get the OPEB plan fully funded at any time in the near future.
The under-funded OPEB plan is essentially a cash flow problem. The $3.8 billion in expense and $5 billion in plan contribution is a high price to pay for a company that will only be breakeven on a "cash from operations" basis according to its own forecast. This is cash flow that could be used to pay down debt or pay a dividend is essentially diverted to paying for retiree healthcare.
There are two ways out of this predicament for GM – 1) fund the obligations with outside capital, as it did in 2003 when it issued $10 billion in debt or 2) renegotiate the extent of its obligations.
Given the state of GM’s balance sheet, I don’t believe the company will be able to float additional debt at reasonable rates to fund its obligations. The company’s balance sheet has deteriorated significantly in the past 15 years as the company has relied more on finance operations to boost the auto division’s results:
That’s right! Debt has tripled while stockholder’s equity has actually gone down over the past 15 years. Again, this is not a company being run for stockhoders – its being run for current and former employees. In addition, GM has $56 billion of debt coming due between now and 2007. It seems unlikely to me that the debt market will allow the company to issue additional debt on top of the existing amounts it already has to roll over. Therefore, it seems that the company could issue equity at these prices but I view that as unlikely given that the stock would collapse even further. I believe the only other choice for GM is to try to renegotiate its obligations.
However, I believe the company will be unable to negotiate with much leverage given that GM is locked into its current union contract until 2007. Therefore, the only way I see for GM to remain a competitive force in the auto industry is to enter into bankruptcy. From bankruptcy the union should feel pressure to come to a more reasonable compromise on healthcare obligations to help the company exit bankruptcy. Otherwise, neither the shareholders nor the employees will have anything – just like Play Now –
(Scene: At Monk’s Café)
Jerry: Gee, Play Now is filing for bankruptcy. I guess you’re not going in anymore.
George: Yeah.
Jerry: So they’re not paying you your…
George: No.
Jerry: So you’re pretty much…
George: Yeah.