GMs Emergence from Bankruptcy – The Rehab Can Be Tougher Than the Surgery

On July 10 General Motors emerged from bankruptcy – 40 days after its June 1 filing for protection from creditors under Chapter 11 of the U.S. Bankruptcy Code. GM’s bankruptcy filing and emergence were significant in three respects:

– the degree to which the potential fallout of the filing was contained;  

– the speed with which GM emerged from bankruptcy;

– the extensiveness of the company’s operational and financial restructuring. 

Notwithstanding the containment, speed, and breadth of GM’s reorganization, the company will continue to face considerable challenges in reestablishing the competitiveness and sustainability of its business model. The company’s principal challenge will be achieving an adequate level of market acceptance and pricing power for its cars and crossover vehicles in North America. The reorganization has resulted in a significant improvement in GM’s operating cost and capital structure, but it has not fundamentally improved two factors that will remain critical to the company’s long-term success – consumer perception of the value proposition afforded by GM vehicles, and the near-term pace at which the company will be able to shift its product portfolio away from trucks and SUVs toward cars and crossover vehicles.

GM’s bankruptcy did not directly contribute to material rating downgrades for issuers in related sectors which include: parts suppliers, automotive dealer groups, car rental companies, and retail and wholesale securitizations. Our ratings within these sectors already reflected: the high degree of bankruptcy risk for GM and for the other domestic OEMs; the core fundamental weaknesses within the domestic automotive industry; and, the very substantive initiatives undertaken by the Obama administration to support a comprehensive restructuring of the U.S. automotive industry in a manner that avoided an uncontrolled collapse of the sector, and minimized collateral damage to the broader economy. 

Contrary to broad expectations that the potential complexity of a GM bankruptcy would result in a protracted reorganization process, the company was able to emerge relatively quickly and thereby avoid an erosion in value that would likely have accompanied a more drawn out process. 

The reorganized GM will benefit from significant improvements in its capital structure and its cost position. The company’s debt has been reduced from about $43 billion to $26 billion; its liquidity position (including cash on hand and the commitments of additional Treasury funding) approximates $33 billion; and, GM estimates that the revised UAW agreement, combined with other restructuring initiatives, could enable its North American operations to break even on an EBIT basis with U.S. industry sales of 10 million units and a market share position of 18.4% to 18.9%. The U.S. industry SAAR for the month of June was 9.5 million units, the company’s share was 19.7%, and Moody’s Base Case Scenario for 2010 U.S. automotive shipments is 11.5 million units (see Moody’s May 2009 Industry Outlook for Global Automotive Manufacturers). Finally, GM will be able to implement its plan to reduce its U.S. dealer count from approximately 6,200 to 3,600. 

Despite the highly significant and beneficial cost reduction elements of GM’s reorganization, the plan does little to address the revenue component of its business model. GM continues to face critical challenges in this area. The first is the need to shift its product lineup to more effectively address the move in consumer demand toward more fuel efficient cars and crossover vehicles. The urgency of shifting the profile of its product portfolio will be heightened by more challenging CAFÉ requirements. However, we believe that GM’s intermediate-term new product line-up has only a modest contribution from small cars. Additionally, GM’s sale of a majority interest of its European subsidiaries may hinder its longer-term ability to tap the small-car capabilities of these operations. 

An additional challenge will be GM’s ability to convince consumers to pay higher prices for the vehicles in its car portfolio. Historically, GM and the other domestic OEMs have had to price their cars $4,000 to $5,000 less than comparably equipped Japanese vehicles because of consumer perceptions of material differences in value and quality. Given the growing importance of car and crossover vehicles in the U.S., a critical long-term challenge for GM will remain convincing consumers that its non-truck and non-SUV vehicles offer a competitive value proposition. 

Absent adequate progress in the areas of product portfolio and price realization, the pace of GM’s revitalization, unlike that of its government-supported passage through the bankruptcy process, could be long and difficult.