Alternative Insight

Beyond Bailout
Can the U.S. auto industry survive as private corporations?

The possible repercussions to the United States economy of failures of the automobile companies is well documented - 2.5 million job losses, pension plan problems, bankruptcies of auto sub-contractors and parts suppliers, closing of automobile dealerships - a spiraling catastrophe. With remedies for preventing the catastrophe exhausted, the catastrophe preventer of the last resort has sprinted in to action - 17.4 billion dollars of government loans to two of the ailing manufacturers General Motors and Chrysler, who must provide their Uncle Sam with warrants and options to buy their stock at a specific price. Debt to the government would be senior to all other debt. In addition, another $5 billion to GMAC, GM's financial arm, for preferred shares that pay an 8 percent dividend and for warrants to purchase additional shares.

Financial assistance by government intervention has worthwhile implications. However, can it be successful? Since Ford Motor is not part of a present rescue plan and expects to survive and Chrysler is a privately owned corporation, whose balance sheet is difficult to evaluate, the survival of the US automobile industry is equated with the survival of venerable General Motors. Can a short term rescue enable the future viability of close to bankrupt General Motors? Questions to be answered:

The answers to these questions are still not known. Nevertheless, the challenges posed by these questions indicate GM cannot be profitable for a long time, if ever. Added to the uncertainty is GM's concentration on potential production of the electric vehicle, the Volt. Is it conceivable that an automobile that has a range of 40 miles before either requiring charging or demanding use of its gas engine, and is anticipated to sell for $40,000, will be a market success? GM vice- chairman Bob Lutz, in an appearance on the CBS '60 Minutes' Oct. 5 show, plugged the Chevy Volt electric car with a nonchalant statement that despite the $40,000 price tag GM will still lose money; so a little help from friends would be helpful. The jaw dropper was a Lutz admission that he and his wife have him and her helicopters and two airplanes. Lutz won't need a Chevy Volt car.

And what about competition? When GM President Richard Wagoner boasted before a Congressional Committee that GM will enable the U.S. to lead the world in electric vehicles, he apparently neglected Chinese car manufacturer Build Your Dream (BYD). The upstart car manufacturer proposes a four passenger sedan with a 62 mile range on electric power and an additional 236 miles with a non-polluting gas engine. Already being sold in China, BYD forecasts entry into the U.S. market in 2011 with a $22,000 price tag. BYD credibility is reinforced by its proprietary "iron ferrous battery pack, which provides twice the power of NiMH batteries and is cheaper to produce." Report has Warren Buffet, already owning a 10 percent stake in the Chinese auto company.

So, what do we have? Wall Street average of earnings estimates predict GM to lose $21 billion for 2009. With some downsizing, worker sacrifices, and satisfactory cost controls the loss might possibly be halved and cash flow made not too negative. Nevertheless, there is little likelihood GM can be profitable without tapping the US Treasury for more cash. If that is a proper conclusion then an entity which can operate without profit and with a slight loss should take absolute control. That entity is the U.S. government. it's preferable that the government purchase GM and temporarily nationalize the automobile company.

Of course this suggestion leads to charges of socialism, which its detractors will casually say, "doesn't work." Note that the present status, call it capitalism, free enterprise, whatever; the present system has brought GM to near bankruptcy, isn't providing a solution other than by seeking government loans and has not proven workable. The issue is not socialism vs capitalism; the issue is the viability of a U.S. auto industry, which once it goes under has no means to revive, which will make the U.S. captive to foreign manufacturers.

From preliminary information, President-elect Barack Obama plans a $700 billion government investment bailout to create 2.5 million jobs. If the government can absorb, say an average of $5 billion dollars of loss for each of several years for ten years, then with a $50 billion dollar investment, the Obama administration immediately saves about 1.25 million jobs by preventing a GM demise.

On December 31, 2008, GM had a market value of about $2.2 billion and an enterprise value of about $31.58 billion. The enterprise value is the theoretical takeover price, which includes debts. The purchase price of only a majority position will probably not exceed several billion dollars.

Consider also that GM will undoubtedly request subsidies for its Volt vehicle, maybe $20,000 per car. If the company sells 200,000 Volt autos per year, the U.S. Treasury will kick over about four billion dollars per year to GM. Shouldn't the U.S. be able to more intimately evaluate the worth of the Volt auto and better protect its investment? Then there is the possibility the U.S. Pension Benefit Guaranty Corporation might be forced to rescue the automakers retiree pension plan. The U.S. will be forced to guarantee GM obligations witnout being assured of GM' s path to survival.

The die is cast. Isn't it preferable that General Motors be nationalized?

alternative insight
jan 1, 2009

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