As talks between General Motors Corp. and long-time rival Chrysler LLC continued over the weekend, a harsh reality has emerged: Without a merger and possibly an assist from the federal government, two of Detroit's Big Three auto makers could run out of cash within a year.WSJ Detroit Bureau Chief Neal Boudette and WSJ reporter John Stoll discuss the very real possibility of a General Motors Corp.-Chrysler LLC merger amid increasingly poor sales that could send the automakers to the poorhouse. (Oct. 27)
Though GM and Chrysler dismiss the notion, analysts and investors have begun to question whether one of the companies -- locked out of the credit markets and burning cash rapidly -- might have to seek bankruptcy protection. Such a filing could set off a chain reaction across the U.S. auto industry, choking off parts supplies to healthier Asian and European car makers and slamming thousands of local car dealers. It could also create a mess for the federal government, whose pension-guarantee program would be swamped by the addition of hundreds of thousands of retirees.
The auto makers and Michigan political delegations have proposed at least three plans in recent weeks to unlock federal cash for a merged GM-Chrysler, including seeking an equity investment from the government or unlocking funds from its Troubled Asset Relief Program, or TARP.
GM and Chrysler estimate that a combined entity would need $10 billion in new equity to lay off workers, close plants, integrate the two companies and provide liquidity, according to several people involved in the talks or briefed on them.
"Without external intervention, from consolidation or government assistance, we expect GM to reach its minimum cash position in under 12 months," Deutsche Bank auto analyst Rod Lache wrote last week. In an interview, Mr. Lache added that Chrysler is also running dangerously low on funds. "We believe Chrysler is in the same position. It's either August 2009 or December 2009 they run out. Both have a limited runway."
GM and Chrysler said publicly this month that bankruptcy proceedings are out of the question. Auto-industry executives have long said that seeking bankruptcy-court protection would destroy the reputation and desirability of their products. Automobiles are typically the second-biggest purchase for a family behind a house, so buyers want to make sure the manufacturer will be around for the life of the vehicle to provide parts or honor the warranty.
"We continue to hold the position that bankruptcy is not an option," said GM spokesman Steve Harris. Chrysler spokeswoman Lori McTavish said: "Bankruptcy is not an option for Chrysler -- it doesn't make sense for us."
Several people involved in the GM-Chrysler merger discussions say the companies have talked to federal officials about their proposed transaction. But there are no specifics yet about what role the government could, or will, play. There is no indication that Treasury, which oversees the TARP program, is currently considering proposals for anything but financial institutions.
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* Chrysler's Woes Are Partly the Result of Poor Quality
David Patton and Mathew Passy discuss whether these are the darkest months for the Detroit Three auto makers. Can GM, Ford and Chrysler survive the current slump that is hitting them from multiple angles. Will a deal help GM and Chrysler?
GM and Chrysler, through a network of 10,000 dealers, have combined U.S. sales of between $110 billion and $130 billion, a figure that approaches 1% of the U.S. gross domestic product. They employ an estimated 145,000 people in the U.S. at more than 110 assembly, stamping and parts plants. An additional 600,000 retirees depend on the two car makers for health care and pensions.
GM and Chrysler "are basically waiting on the government," said one person involved in the merger talks. "The three choices are bankruptcy, a big intervention from the government or some big deal like this that has massive cost-cutting possibilities," this person said. "That's it. And even the big deal may require government help."
People familiar with the GM-Chrysler talks said over the weekend that the sides are also considering forming a new company that could include a third auto maker.
Talk of a GM-Chrysler merger began in September, following brief discussions between GM and Ford Motor Co., the third major U.S. auto maker. Cerberus Capital Management, a private-equity fund that owns 81% of Chrysler and 49% of GMAC -- GM's lending arm -- approached GM about swapping GM's 49% stake in GMAC for ownership of Chrysler.
Such a merger would have been unthinkable in recent years because it would have only added more brands, dealerships and slow-selling models to GM's bloated structure. But with credit markets tightening and collapsing U.S. auto sales draining GM's cash, the auto maker is scrambling to keep itself afloat.
U.S. car and truck sales are down 13% through September this year. GM sales have fallen about 18%, while Chrysler's are down 25%. Ford's sales are down 17% so far this year. Ford's condition is not considered as grave as that of GM and Chrysler because it has more cash on hand.
In the next 12 months, U.S. auto sales could sink to levels last seen during the early 1980s recession, according to several forecasts, when there were 70 million fewer Americans. Sales peaked at 17.4 million in 2000 and remained near 17 million for five more years. This year, 13.6 million vehicles are expected to be sold, and sales are expected to fall by another half-million vehicles in 2009, according to consumer-researcher J.D. Power & Associates.
Today, the Big Three have the capacity to build three million more cars and trucks than they currently sell -- about 10 plants' worth of idle capacity. "These are truly unimaginable times for our industry," Chrysler Chief Executive Robert Nardelli told employees Friday in announcing 5,000 new white-collar-job cuts.
Investors' Worries
Investors and vendors to the auto makers believe bankruptcy proceedings for one of the Big Three are as likely as not, judging by a range of financial indicators. GM and Ford bonds trade between 20 to 40 cents on the dollar. Investors have valued $9 billion worth of Chrysler debt at about $3.4 billion. On Thursday, Daimler AG, which owns 19.9% of Chrysler, wrote its investment in the auto maker down to zero.
The GM-Chrysler plan would effectively scrap large parts of 83-year-old Chrysler. Even people involved in the deal concede a tie-up would be risky because consolidation would have to take place quickly.
In a merged company, GM would take the driver's seat in product-development activities, say several people involved in the talks. It would retool several existing Chrysler products to base them on GM-designed vehicles, or kill some products outright, these people said. GM is expected to save Chrysler's popular minivans and Jeeps. GM could also sell certain vehicle lines, such as the profitable Dodge Ram, to an auto maker seeking entry into the U.S. light-truck market.
The human toll of such a move could be high. The companies would slash duplicated functions from engineering to marketing. One internal estimate predicts at least 40,000 jobs could be cut from the roughly 166,000 people employed by the two companies in the U.S., Canada and Mexico.
GM's cash cushion has been eroding for some time. Each month, the company spends $1 billion more than it brings in. At that burn rate, GM could effectively run short of cash next summer, without even taking into account further sales declines.
The 100-year-old company has about $20 billion on hand today, but needs at least $11 billion to $14 billion of working capital at all times so it can keep paying its bills, GM has said. The company has been trying for months, without success, to raise at least $5 billion by selling assets, such as its Hummer brand, and by pledging unencumbered assets, such as profitable international operations, as collateral for loans.
But lenders are reluctant to invest. GM debt, once considered the highest investment grade, has tumbled to low-rated, junk status. Many lenders approached to invest in a combined GM-Chrysler have also balked. One large private-equity investor said it would take too many years for the combined entity to realize a forecast $10 billion in annual cost savings. Meanwhile, this person said, it's safer to invest in the company's debt instead of its shares, because creditors get better protection than shareholders in the event of a bankruptcy filing.
When Cerberus purchased Chrysler in the spring of 2007, the capital markets were at full throttle. The firm basically bought Chrysler for free, in exchange for taking on its considerable debt. Cerberus expected that once Chrysler was private, the fund could build a smaller, stronger company with the ready help of debt investors.
It hasn't turned out that way. In two years, Chrysler has fallen from third to fifth in U.S. auto sales. J.P. Morgan estimates it has $11 billion on hand. It uses $3 billion to $5 billion of that as working capital to meet payroll, pay vendors and pay other bills. Its monthly cash burn is estimated at $300 million to $400 million. That figure may grow as vehicle sales slow, suggesting that it could run out of money by late 2009. To conserve cash, Chrysler has halted certain new-product plans, a sign that it sees a deal with GM as the only path out.
The auto makers' huge obligations, meanwhile, are only growing as revenues and profits shrink. For decades, Detroit's Big Three have funded generous programs to take care of former workers and surviving spouses. GM says it provides health care and pensions to about 480,000 hourly and salaried retirees. Chrysler is obligated to support at least 125,000 hourly retirees and their spouses, plus tens of thousands more from the white-collar ranks.
Between 2009 and 2017, GM has committed to pay out $64.14 billion in pension benefits to U.S. retirees. Chrysler has estimated it has $14 billion in pension obligations between 2009 and 2017, and $10 billion in health care.
The manufacturers hope to transfer much of these health-care obligations to a trust they have agreed to establish with the main union representing its workers, United Auto Workers. While the auto makers will have to provide billions of dollars to the UAW trust before it launches in 2010, the arrangement will allow them to reduce billions of dollars in annual health-care costs.
Detroit's pension funds have also been hit hard as stocks -- in which they are heavily invested -- have declined. By the end of the year, GM's massive pension fund could drop to a funding level that would trigger federal mandates that the companies inject more money. The fund has enough money to meet obligations now, but a J.P. Morgan report estimates that given the market's recent performance, the GM pension could be underfunded by $18 billion at the end of 2008. Privately held Chrysler no longer discloses its pension funding levels.
Inside the merger negotiations, the growing feeling is that a combined GM-Chrysler effort, while daunting in its complexity, may be the best way to bring federal money into the mix. Those people have proposed at least three possibilities for a federal role in the merger they say are being discussed in Washington.
The first is to unlock some of the $25 billion from an energy bill passed last year that would compensate manufacturers for costs associated with new fuel-efficiency standards for the U.S. auto industry. It is not clear when the money would be released to auto makers. The manufacturers hope that some of the funds could be expedited to be used in this deal.
Another option would be for the government to take a stake in the entity, perhaps in the form of preferred shares, said several people involved in the talks. The Treasury took equity stakes in major banks earlier this month. It is unclear whether they would do the same for auto makers.
A third option would be using the Troubled Asset Relief Program to buy up troubled auto loans from the companies' financing arms, GMAC and Chrysler Financial. Michigan Senators Carl Levin and Debbie Stabenow, among others, have been told that TARP could be used to buy up troubled auto loans, according to congressional records.
The idea of this option, say people studying the deal, is that the aid would provide relief to Cerberus, which owns Chrysler Financial outright and holds 51% of GMAC. Cerberus would then plow more money into the combined GM-Chrysler.
Michigan lawmakers have pressed the Fed and Treasury to get involved. Last week, a congressional delegation headed by Michigan Rep. John Dingell sent a letter to Federal Reserve Chairman Ben Bernanke and Treasury Secretary Henry Paulson urging the pair to find money for U.S. auto makers.
"It is imperative that the government ensures that liquidity is restored so that the U.S. auto industry is able to function until normalcy is restored to credit markets," the letter said.
One of the biggest fears in Washington is how a bankruptcy filing by one or all of the auto makers would affect the federal agency that insures the retirement savings of almost 44 million Americans. The Pension Benefit Guaranty Corp. ended 2007 with a $14 billion deficit. Were GM to place its pension burden on PBGC, it would more than double the agency's current shortfall, a burden that could fall on taxpayers.
The fate of many suppliers and other auto makers are also tied to the health of GM and Chrysler. According to industry research, 60% or more of the industry's suppliers make parts for all three major auto companies. If one car maker ceases to pay some outstanding bills it could crimp the operations at suppliers and, by extension, healthier U.S. and foreign car makers.
Lear Corp., a seat manufacturer, gets 29% of its $15.3 billion in annual sales from GM, but it is also a large supplier to Ford, Toyota and BMW. Magna International Inc., a Canadian manufacturer of interiors and instrument panels, does more than $3 billion in sales annually with GM and Chrysler, but also provides parts in Europe to auto makers like Volkswagen and Daimler.
"The fall of one is the fall of all. If, say, Chrysler files [for bankruptcy-court protection] and doesn't pay its suppliers, those suppliers would go down and Ford or GM won't get their parts, shutting down some of their plants," said Kimberly Rodriguez, director at Grant Thornton and an adviser to Ford senior management.
"It just can't happen," said Ms. Rodriguez, who lives in suburban Detroit with her husband and two daughters. "It would be tens of thousands of jobs lost and not just in Michigan."
Last week, Michigan Gov. Jennifer Granholm began assembling a task force of cabinet officials who will build a contingency plan in the event of a merger, or if one of the Big Three seeks bankruptcy-court protection. A spokeswoman for Gov. Granholm said Sunday that the task force is talking to industry analysts and Michigan economic planners to develop a plan to deal with what could be massive job loss.
