Tuesday, April 28, 2009

Chrysler, Treasury Dept. and Lenders Reach Tentative Deal
Combined with UAW Agreement - Chrysler is Making Progress But Still Faces Rough Road

Multiple sources are reporting that there is a tentative deal between Chrysler, the Treasury Department and Chrysler's secured creditors that involves the creditors taking $2 billion and writing off the remainder of their $6.9 billion debt.

News reports about yesterday's UAW deal with Chrysler focus on the fact that the UAW will own a 55% equity stake in Chrysler. The news reports don't mention something that I'm assuming has to be a fact but has not been confirmed, that this equity stake will be divided into multiple trust funds. Some funds will belong to the general membership, some will belong to the healthcare VEBA, and some will belong to the pension plan. Each of these entities has a different trust structure and subtly different fiduciary duties. If this type of ownership continues it could be problematic at the time of the next collective bargaining agreement.

With fires put out concerning the secured creditors and the unions, Chrysler's and PTFOA's attention can shift to issues concerning Chrysler's cash needs and long term viability. Integral to that is the Fiat/Chrysler combination. The government has indicated a willingness to put $6 billion into Chrysler if it can demonstrate viability. The problem is that Chrysler has been losing $1 billion a month in recent months. It can take half a billion or a billion dollars to retool a factory to build a new model. Chrysler will have to retool three or four plants to build Fiats to make the merger worthwhile. The first Chryslerfiats won't be ready until 2011 at the earliest. It becomes readily apparent that $6 billion is just a drop in the bucket.

How much more cash will Chrysler need - from the government or elsewhere? How much is rational to spend? Let's assume for the sake of argument that Chrysler turns its operations around and starts making half a billion a month in profit, or $6 billion a year. The auto industry in good tiems supports a 7.5 price/earnings ratio, so a fully functioning Chrysler would support a market cap of $45 billion. To get there, you might have to come up with $15 billion for interim losses, $8 billion in retooling, $8 billion in R&D for a couple more mainstream domestic models. That's $31 billion. Keep in mind though, you aren't going to be able to sell all the stock to raise money for the company. Fiat will have 20 to 35%. UAW trusts will have up to 55%. Treasury will have ?
The bottom line: the math is still tough.

If the math doesn't work, I don't think PTFOA should force it. Instead, they should step back from the Fiat plan and look back at the possibility of combining General Motors with Chrysler. If we're going to have an automaker that is nationalized for public policy reasons, you might as well be honest about it. By combining the two, you can make more strategic decisions regarding capital budgeting and eliminate duplicate costs. One bureaucracy can handle such necessary tasks as repurposing shut down plants and retraining displaced workers. You would also minimize the situation that we have now, and that's the problem with Chrysler selling its vehicles at firesale prices just to move them of the lot, contributing to a problem with gross margins across the industry.

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