Are the Taxpayers on the Hook in the GM Deal?
M.P. Narayanan details how well GM must perform for the government to break even on its loan.
ANN ARBOR, Mich.— Is the General Motors bankruptcy a good deal for U.S. taxpayers?
The Obama administration has stated its intention to facilitate a speedy bankruptcy process similar to the one it is implementing for Chrysler. The bankruptcy plan entails splitting GM into a “New GM” with continuing operations and an “Old GM,” which will primarily include the brands that are to be sold or shut down (Pontiac, Saturn, Saab, and Hummer).
The government’s plan involves the UAW and the unsecured creditors restructuring their claims by taking haircuts and accepting equity in the new GM. The government, too, will forgive some of its loans in exchange for equity. The Obama administration will pump in at least $30 billion (and the Canadian government will add $9.5 billion) to enable GM to function in bankruptcy and to emerge as a viable business, in addition to the $20 billion it has already lent to GM. This means that the United States would have contributed at least $50 billion in total by the time GM comes out of bankruptcy.
The question is whether this is a financially sound investment of taxpayer money (we are ignoring, here, any social welfare issues such as reduced unemployment because of this assistance). We can get some sense of the answer by finding out how well GM needs to perform in order for the government to break even.
To do this, consider what the government gets in return for $50 billion: 60 percent equity stake in the new GM, $8.8 billion in GM debt and preferred stock. Valuing the debt and preferred stock at face value, the equity value of the new GM needs to be about $68 billion for the government to break even (68 x 0.6 + 8.8 = 50). The new GM will owe the U.S. and Canadian governments ($8 billion), the UAW ($2.5 billion), and others ($6 billion) for a total of $16.5 billion. There also is $9 billion in preferred stock, held by the governments ($6.5 billion) and the UAW ($2.5 billion). This means that the enterprise value (the value of business operations of new GM and old GM put together) needs to be at least $93.5 billion (68 + 16.5 + 9 = 93.5). This ignores the warrants that the unsecured creditors are expected to receive in lieu of debt forgiveness.
Can GM’s (new plus old) enterprise value be over $93 billion when it comes out of bankruptcy? This, of course, is the million-dollar question, the answer to which is anyone’s guess. We can get a sense of whether GM can reasonably achieve this target by comparisons to GM and other auto companies. Note that GM may be able to generate part of this enterprise value by selling some of its assets (Pontiac, Saturn, Hummer, Saab, and Opel are the candidates).
The enterprise value of GM at the end of 2005 was about $175 billion, roughly twice the break-even enterprise value. The enterprise value of Ford today is about 1.5 times that of the break-even value. While it is impossible to be sure, it is not outside the realm of possibility that the new GM can achieve this break-even value, especially after including the sale proceeds from the brands slated for divestitures.
Another way to assess the taxpayers’ exposure is to estimate the operating profit GM needs to make annually to achieve an enterprise value of $93 billion. GM (including the units for sale) will have to make an after-tax operating profit of approximately $9 billion annually for taxpayers to break even.
How reasonable is it to expect GM to meet this goal? Before sliding into loss in 2005, GM’s auto operations eked out a miserly $25 million in average annual earnings before interest and tax (EBIT) during 2001-2004 on about $155 billion average annual revenue. As a comparison, Honda’s EBIT during 2006 and 2007 averaged about $7 billion, which translates to an annual after-tax operating profit of about $5 billion. So, GM (including the units for sale) has to go from nothing to about twice as good as Honda in profitability before the taxpayers see a dime---that, too, under the potent combination of GM management overseen by the government as shareholder.
The “good news” is that GM has considerable tax-loss carry-forwards from its gigantic losses in recent years. So if they achieve an EBIT of $9 billion it will all flow into our pockets---since they will not be paying us any taxes!!
Written by M.P. Narayanan, the Robert Morrison Hoffer Professor of Business Administration; Professor of Finance; and Chair of Finance at Ross.
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Bernie DeGroat, (734) 936-1015 or 647-1847, email@example.com