Detroit's Next Headache: Dangerous Debt

(page 2 of 2)

Big Savings in 2010

With a better market, GM could handle the debt, Henderson said, but he conceded that right now, "our earnings power and cash flow is out of proportion" with the company's debt.

But getting that health-care deal done is no snap, either. Those debt numbers don't count what they owe the UAW to seed the health-care trust that will kick off the massive savings that the companies hope to get starting in 2010. On that score, GM owes $7 billion in January 2010, and Ford will pay $52 million a year for 15 years. Henderson says the $7 billion payment, "in the current environment, is a very tough number to deal with."

All of these obligations will cut into product spending. The Big Three already spend less than Japanese rivals on new product development. According to a report from Merrill Lynch (MER), GM, Ford, and Chrysler replace between 14% and 16% of their total sales volume with new models every year over the past decade. The Japanese replace 21% of their sales volume and the Koreans 28%.

Counting on the Volt

With more cash for R&D, the Asian carmakers can keep pumping out new models. For its part, GM has already cut product spending this year from a planned $8 billion to under $5 billion. And that number would be even smaller if it weren't for the company's push to bring the electric Chevy Volt to market by 2010 (BusinessWeek.com, 9/16/08).

That's why plenty of analysts think Detroit's carmakers—especially GM—need to renegotiate their debt. JPMorgan's Patel thinks GM needs to get concessions from both the UAW and its creditors to trim a total of $4.2 billion in costs.

GM's long-term bonds are already trading at about 20¢ on the dollar. So GM may be able to offer a swap for notes with a smaller principal or exchange them for zero-interest bonds. GM could also swap debt for equity, Patel wrote in the report. With the right cuts, GM could slash interest by $2.1 billion a year, he said.

A Tough Sell in Washington

The UAW would have to give some, as well. Patel says GM would need to get the UAW to agree to cut its total per-worker cost of $125,000, including benefits, by almost $33,000. That means GM would have to retire out more of the veteran workers to get new hires in under the two-tiered wage agreement settled in last year's labor pact. Or, the company needs to get workers to take a pay cut and accept weaker health-care benefits.

But here comes the Catch-22. Oline says GM would be positioned to negotiate with its bondholders on favorable terms if bankruptcy were a threat. But if the government gives the companies a bridge loan, creditors may not see a sense of urgency. "To be effective, it has to be coercive," Oline says. "But with government assistance, that would make a debt exchange a tougher sell."

It's a tough sell in Washington, too. Representative Thaddeus McCotter (R-Mich.) says the companies "will project out how much restructuring will continue into the future. The Big Three have never said they were done." They might be about to start another round.

Business Exchange related topics:
Bailout
U.S. Automakers
Global Auto Industry

Welch is BusinessWeek's Detroit bureau chief.