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With the Treasury Dept. directing Chrysler to prepare to file for bankruptcy, it might be expected that the bondholders who own $28 billion in General Motors (GM) debt might be scared into cutting a deal. Don't be so sure.
The barriers to getting a deal done with GM bondholders, and negotiating away enough of that debt to strike a deal and avoid a planned, government-assisted bankruptcy, remain very big, with five weeks to go before the deadline.
First, all of the constituents may be willing to take a piece of equity in place of the cash they are owed. But even with a restructured GM that carries less debt and has more value, there is only so much equity to go around. It may be impossible to give everyone the equity stake that they want, say two sources close to the talks. And second, some of the bondholders own credit default swaps, which amount to an insurance policy against the debt and pay them in full if GM defaults. Those bondholders actually fare much better if GM goes into bankruptcy.
If enough bondholders refuse to budge, GM and the U.S. Treasury Dept.'s auto task force will likely see bankruptcy as the best option to dispose of the debt and solve other issues like cutting labor costs and getting more than 1,500 car dealerships to go away. "When you look at the pros and cons, there are a lot of benefits for GM bankruptcy," says Michael Robinet, vice-president of CSM Worldwide, an auto industry research and consulting firm in Northville, Mich.
It may be the only way to accomplish the government's goal of getting rid of most of the $28 billion in bond debt. GM wants the bondholders to take most, if not all, of their debt in stock. But how much stock is a big issue.
That's problematic. GM also owes the United Auto Workers $20 billion for a retiree health-care trust that will pay medical benefits. Treasury and GM want to give the union a big chunk of that in stock.
And there's one more player likely to own a big chunk of GM: the feds. The government has loaned GM $15.4 billion, including $2 billion more given to the automaker on Apr. 24. In or out of bankruptcy, GM's debt to the government could easily reach $30 billion. And that doesn't count the possible $8 billion from the Energy Dept. to GM for fuel economy improvements.
The auto task force doesn't want to replace $48 billion in bond and union debt with government loans, so the government could take a big piece of equity, too. The $9 billion owed to secured creditors, by the way, wouldn't be touched, sources say.
That raises some very thorny questions at the bargaining table. First, how much is GM worth once you scrub away much of the debt and union obligations? That depends on your assumptions about the size of the car market, what GM's share of it will be, and what kind of pricing the company's models can command. All of that is very subjective and complicates negotiations, say sources close to the talks.
There's another huge catch. Internally, GM has been trying to find out how many of its bondholders hold the credit default swaps that will pay them in full if the automaker goes bankrupt. But the company has not reached a conclusion.
But it could be big enough to keep a deal from happening. Put it this way: Treasury wants to get about 90% of the bondholders to take the debt-for-equity exchange. So you only need about $2.8 billion worth of debt in the hands of people who also own the swaps and a few others who won't take the deal to hold things up.
There are some $2.7 billion worth of GM credit default swaps swimming around in the market, says Tim Backshall of Credit Derivatives Research. Swap owners are not required to own the debt as well, so some may own swaps but not bonds. But if all of them hold GM debt and decide to get repaid in full through insurance policies in bankruptcy, it won't take too many more recalcitrant bondholders to get a deal done. "That's why you'll probably have to have a bankruptcy," says Richard Christopher Whelan, senior vice-president and managing director of Institutional Risk Analytics.
While GM is preparing an offer for its bondholders, the company is also mulling the fate of its brands. GM has resisted suggestions to ditch its GMC truck brand, and two GM executives say the company has won the argument. News reports from Australia, where GM's Holden unit makes the Pontiac G8 sports car, suggest that GM may ditch Pontiac instead of keeping it around as a one- or two-car niche brand. Insiders say GM may dump it since the company has no new Pontiac models in the works.
At the same time, GM has several interested bidders in the Saturn retail network. One is a dealer group affiliated with private equity firm Black Oak Partners. Another is Renault-Nissan (NSANY). The French-Japanese auto alliance has been approached and gave it a look.
But any European carmaker may have trouble entering the U.S. even with Saturn's network, says James N. Hall, principal of 2953 Analytics, a Detroit-area auto consulting firm. European models are made with more expensive content because their buyers pay more for smaller cars due to expensive fuel. Plus, exchange rates hurt their profit potential, Hall says.
In any case, if GM enters bankruptcy, it could dispose of the unwanted brands more easily, says CSM's Robinet. Dealers could still sue under state franchise laws, but good luck getting any cash when the secured creditors, parts makers, government, UAW, and bondholders are already in line.
Click here to read BusinessWeek's complete coverage of the U.S. auto industry in our Special Report: Detroit in Crisis.
Welch is BusinessWeek's Detroit bureau chief.