Last night, senior administration officials gave us all the salient details on the Obama administration's auto industry restructuring plan and new "Warranty Commitment Program." The entire plan and our quick analysis is below the jump.
The most important details are that the U.S. government plans to back the warranties of both Chrysler and GM. The administration's calling it the "Warranty Commitment Program." In addition, the administration plans a separate level of commitment to each automaker. Chrysler gets $6 billion and a requirement that they figure out a deal with Fiat. GM, on the other hand, gets 60 days to figure things out with bondholders and the UAW. If they're unable to do so, they must declare bankruptcy. Stiff terms? You betcha, but it's warranted given how much money's already been sunk into saving these two automakers.
What's really interesting is the auto task force has left the door open to Ford with the Warranty Commitment Program. The verbiage of the relevant section says: 'Any domestic auto manufacturer is eligible to participate in the program." Obviously, the administration wants to make sure that Ford's attempts to distance themselves from the other two domestics now for purposes of sales retention doesn't negatively impact their ability to go after entry into the program later on down the road. Kudos to the administration for the foresight. Here's the full plan:
These documents are broken down into 4 parts.
First, the viability study for GM, then Chrysler.
Next, it's an overall look at both companies and finally, the Obama Administration's new warranty committment program.
VIABILITY STUDY: GM
The Loan and Security Agreement of December 31, 2008 between the General Motors Corporation and the United States Department of the Treasury ("LSA") laid out conditions that needed to be met by March 31, including the approval of Labor Modifications, VEBA Modifications, and the commencement of a Bond Exchange (all as defined in the LSA).
As of the date of this memo, the above steps have not been completed, nor are they expected to be completed by March 31.
As a result, General Motors has not satisfied the terms of its loan agreement. Additionally, after substantial effort and review, the President's Designee¹ has concluded that the GM plan, in its current form, is not viable and will need to berestructured substantially while GM operates under an amendment to the existing LSA. It is strongly believed, however, that such a substantial restructuring will lead to a viable GM.
This determination of viability was based on a thorough review, as conducted by the Task Force and its outside advisors and as summarized below, of the Company's submitted plan and prospects. While there were many individual considerations, no single factor was critical to the assessment. Rather, the ultimate determination of viability was based upon a total consideration of all relevant factors, taken as a whole.
General Motors is in the early stages of an operational turnaround in which the Company has made material progress in a number of areas, including purchasing, product design, manufacturing, brand rationalization and its dealer network.
Despite these steps, a great deal more progress needs to be made, and GM's plan contemplates initiatives that will take many years to complete. In the end, GM's plan is based on a number of assumptions that will be very challenging to meet without a more dramatic restructuring in which many of its planned changes are accelerated. A few highlights:
• Market Share: GM has been losing market share to its competitors for decades, yet its plan assumes only a very
moderate decline, despite reducing fleet sales and shuttering brands that represent 1.8% of its current market share.
• Price: The plan assumes improvement in net price realization despite a severely distressed market, lingering
consumer quality perceptions, and an increase in smaller vehicles (where the Company has previously struggled to
maintain pricing power).
• Brands/Dealers: The Company is currently burdened with underperforming brands, nameplates and an excess of
dealers. The plan does not act aggressively enough to curb these problems.
• Product mix: GM earns a large share of its profits from high-margin trucks and SUVs, which are vulnerable to a continuing shift in consumer preference to smaller vehicles. Additionally, while the Chevy Volt holds promise, it will likely be too expensive to be commercially successful in the short-term.
• Legacy liabilities: In GM's plan, its cash needs associated with legacy liabilities grow to unsustainable levels, reaching approximately $6 billion per year in 2013 and 2014.
Moreover, even under the Company's optimistic assumptions, the Company continues to experience negative free cash flow (before financing but after legacy obligations) through the projection period, failing a fundamental test of viability.
In short, while the Company has made meaningful progress in its turnaround plan over the last few years, the progress has been far too slow, allowing the Company to continue to lag the best-in-class competitors. As a result, the President's Designee has found that General Motors' plan is not viable as it is currently structured. However, because of GM's scale, franchise and progress to date, we believe that there could be a viable business within GM if the Company and its stakeholders engage in a substantially more aggressive restructuring plan.
The Loan and Security Agreement of December 31, 2008 between the General Motors Corporation and the United States Department of the Treasury ("LSA") laid out various conditions that needed to be met by March 31, including: (a) Approval of the Labor Modifications (Compensation Reductions, the Severance Rationalization and the Work Rule Modifications) by the members of the Unions; (b) Receipt of all necessary approvals of the VEBA Modifications other than regulatory and judicial approvals; provided, that the Borrower must have filed and be diligently prosecuting applications for any necessary regulatory and judicial approvals; and (c) The commencement of an exchange offer to implement a Bond Exchange.
As of the date of this memo, none of the above steps has been completed. As a result, General Motors has not satisfied the terms of its loan agreement.
The LSA also requires that the President's Designee review the Restructuring Plan Report in order to determine whether General Motors has taken all necessary steps to achieve and sustain the long-term viability, international competitiveness and energy efficiency of the Company and its subsidiaries
Since receiving the Company's plan on February 17th, the Government has engaged in substantial efforts to assess its viability. This work has involved staff from the Department of the Treasury, National Economic Council, Council of Economic Advisors as well as the numerous other Cabinet agencies involved in the President's Task Force on the Auto Industry. The working group has also worked extensively with several dozen individuals at industry-leading consulting, financial advisory and law firms. Numerous outside experts and affected stakeholders have been consulted. As a result of this work, the President's Designee has concluded that the General Motors plan, in its current form, is not viable and will need to be restructured substantially in order to lead to a viable General Motors. It is strongly believed, however, that such a substantial restructuring will lead to a viable General Motors.
While the President's Designee considered many factors when assessing viability, the most fundamental benchmark was the following: for a business to be viable, it must be able – after accounting for spending on research and development and capital expenditures necessary to maintain and enhance the company's competitive position — to generate positive cashflow and earn an adequate return on capital over the course of a normal business cycle.
Progress to date:
General Motors is in the early stages of an operational turnaround in which GM has made material progress in a number
o Purchasing: GM has organized its purchasing globally, with its purchasing organization taking advantage of GM's global scale, and has put into place a rigorous, metric-oriented approach to drive supplier quality and cost improvements.
o Product design: GM has refined its product design process to create global vehicle platforms, thus allowing GM to reduce engineering costs and improve the content of its cars. These global platforms leverage the scale of the business and allow GM to amortize product development costs over a large range of models. GM has also, since 2005, focused on customer needs, interior designs, styling and quality to provide more attractive products. Examples of successes of this initiative include the 2008 North American Car of the Year Chevy Malibu and the 2008 Motor Trend Car of the Year Cadillac CTS(though they constitute a modest share of GM's portfolio today).
o Manufacturing: GM has worked to create greater flexibility within its facilities, allowing for increased
capacity utilization and an enhanced ability to spread its significant fixed costs across a broader car base.
o Brand rationalization: The recently announced decisions to divest or shut down Saab, Saturn and Hummer, while late, were important steps in reducing the Company's brand portfolio and allowing it to focus its financial and human resources on a smaller number of higher quality brands.
o Dealer network: GM has been eliminating dealers from markets where it is oversaturated, as well as eliminating dealers who are either unprofitable or create a poor customer experience.
However, it is important to recognize that a great deal more progress needs to be made, and that GM's plan is based on fairly optimistic assumptions that will be challenging in the absence of a more aggressive restructuring.
• The plan contemplates that each of its restructuring initiatives will continue well into the future, in some cases until 2014, before they are complete.
o The slow pace at which this turnaround is progressing undermines the Company's ability to compete against large, highly capable and well-funded competitors. GM's plan forecasts it to catch up to (and, in some cases, surpass) its competitors' current performance metrics; however, its key competitors are constantly working to improve as well, potentially leaving GM further behind over time.
• Given the slow pace of the turnaround, the assumptions in GM's business plan are too optimistic.
o Market Share