The Bridge Loan From Hell

Have you ever been in a situation where you’re running a company, and you’re lining up a round of financing, but you run short of time? And you need to complete some kind of near-term funding to avoid doing something really painful, like a layoff?

Welcome to bridge-loan hell. Bridge financing is pretty normal and standard in many cases, but when done out of necessity, it’s not something you ever want to face. You’re asking someone to put capital into a business which is in obvious distress. Speaking figuratively, you’ll have done well if you can get terms that only require you to give up your first child and not all the rest of them.

That’s kind of where General Motors is, right about now.

Every time we get into the subject of GM, and the US automakers generally, several points get made vociferously which I won’t engage here. First, their quality is said to suck (it doesn’t). Second, their health and pension costs are killing them (there’s some truth to that). Third, they can’t market their way out of a paper bag. (Except for one little thing: Americans love driving trucks and big SUVs, so who’s stupider? The people who demand those things, or the people who give them what they want?)

The problem facing GM is that they’re running out of cash. You can only lose money for so long before this happens, and they’ve done all the things they can think of to forestall this day. (Asset sales, a certain amount of debt restructuring, internal cost-cutting, marginal concessions from the UAW, etc.)

The auto business has run on a roughly five-to-seven year cycle for decades now. People are used to boom and bust in this industry. And in its recent history, GM has always played the game for cash flow rather than for profitability. Their operating costs and capital requirements (which include financing their customers) have always been so high that they’ve just cranked out as many vehicles as possible just to stay solvent. (Ford Motor has long played the same game, but they haven’t been as close to the edge. Although that may be changing.)

So now that the bottom is falling out of the consumer economy, the problem with GM’s high-wire act is becoming apparent: if North American unit vehicle sales crash along with consumer demand, you can’t generate enough cash flow to stay alive.

And this has happened with remarkable speed. A couple of months ago, many people (including myself) figured that GM had until maybe the third quarter of 2009 before they ran out of runway. And if an economic turnaround materialized in that time, GM would be able to muddle through.

But now GM’s CEO Rick Wagoner is being forced to admit that there is nothing potentially good which can happen to turn things around for GM in that time. They are no longer in control of their destiny.

A Chapter-11 bankruptcy (in which the business continues to operate under court protection from creditors) might have been an option for GM. Except for the impairment in cash flow. It appears they will not only will have trouble servicing their debt, but indeed may not even be able to keep their doors open.

That’s why I started this piece off talking about bridge financing. GM is facing a crash, in which they may possibly be forced to stop operating. There really isn’t any time to arrange sales of massive chunks of their capital-asset base to foreign automakers, who are facing their own credit-availability problems.

And besides, how do you think Congress would react if tomorrow’s headlines announced that GM was going to sell half of its production plants to Toyota and Volkswagen for one dollar plus assumption of debt and labor contracts? And even if they did that, it still would do nothing to address their cash squeeze.

So let’s take a look at the key stakeholders in this mess.

First, the common stockholders. Ordinarily they wouldn’t matter, except that many of them are pension funds that benefit state and local governments. These people already have the Federal government’s attention.

Then, the long-term debtholders. People who have lent money to GM need to come out of this with something. You never want to kick debt investors in the teeth, because in the game of Global Economy, they’re the kids who own the ball. You don’t want them to give up on the game and take the ball home with them. The world is already credit-crunched as it is.

Next, the unions. It’s easy to make these people the bad guys, because they’re patently overpaid. And being unions, they negotiate like children. To a certain extent, they’re happy to shoot themselves in the head if they can land a punch on management at the same time. Having said this, though, the UAW leadership is starting to see a certain amount of reason. They need to seriously consider the possibility of across-the-board reductions in pay and benefit levels. It’s not economically realistic for autoworkers to retain their current compensation.

Next, the three tiers of suppliers. Over the last 30 years or so, the large automakers have dealt with their top-heavy, union-driven cost structures by pushing as much value-creation down to smaller companies and contractors as possible. These companies, which dot nearly every square mile of the upper Midwest, operate on thin capitalization and thin margins in the best of times, and they often have no customers other than the big automakers. A major disruption at GM is going to make Christmas bleak for millions of people.

Finally, the taxpayers. We’re the people who have guaranteed GM’s pension and health-insurance obligations to their current workers, their vast army of retirees, and all their families and dependents.

Who’s going to bridge GM? It sure as hell won’t be any syndicate of banks that I can think of. And the lack of bank credit takes the private equity players out of the game too.

It’s going to be the Federal government. There’s really no way out of this.

And whenever you give someone a bridge loan that they absolutely need to survive, you bend them over and force them to accept truly onerous terms.

If I were handling this for the US Treasury, I’d insist on a total wipeout of GM’s shareholders and management, force them to liquidate assets over perhaps a two-year period, and take a slug of preferred stock with a very large annual interest rate. Because you know there will be no possibility of making money on this bailout. The auto industry has too much of the wrong kind of production capacity, and it needs to disappear.

Are there any crown jewels? Most emphatically yes. Do you happen to know who the largest-selling automaker in China is? None other than General Motors. Their overseas businesses (including Europe and LATAM) are strong and full of growth potential. American taxpayers need to be exposed to this upside as part of owning a reorganized GM.

Instead, what do you think Obama is likely to do?

As with all things Obama, we’ve heard every side of the argument, with no suggestion that he’s made up his mind what he actually thinks. But just judging from volume, it looks like he wants General Motors to become a ward of the state, and an investment platform for all kinds of alternative-energy-using vehicles. In the process, he’ll probably avoid rationalizing and shrinking GM’s antiquated labor contracts, healthcare obligations, and other cost structures.

Sorry to reach for a hackneyed metaphor, but there are two things you can do when someone has a life-threatening cancer. You can yank the cancer out. The patient either dies on the table, or he starts recovering. Or you can keep feeding the cancer and applying expensive palliatives for years and years until he just rots away.

It’s too soon to tell, but the latter course is the one that Obama appears inclined to follow with General Motors.

It’s also possible that GM’s management themselves will push the situation to a boil now, and force the outgoing Bush people to deal with it. That would probably suit Obama just fine, as it would allow him to keep looking graceful and not have to make a decision.

-Francis Cianfrocca