chapter 11 protection: general motors

GENERAL MOTORS

Chapter 11 Protection:

General Motors

FIN441D

huilin hu

11/25/2013

General Motors

Executive Summary

As the previous No.1 Auto maker in the world, General Motors went from profitable to distress

within four years and filed for Chapter 11 in 2008. The internal reasons for GM’s distress are the

high labor cost and inappropriate development strategy. GM funded the development of the fuel

cell autos but the hybrid autos occupied the market. The external reasons for GM’s distress are the

increasing price of oil, the subprime crisis and the change of the accounting policy for the pension.

It is correct for general motors to file for Chapter 11 but it is not a panacea to save all the enterprise.

Introduction

General Motors before Filing for Chapter 11

General Motors Corp. (GM) is the world's largest automobile company. Its core automotive

business and subsidiaries spreads throughout the world, with a total number of 325,000 employees.

William Durant developed GM on the basis of the Buick Motor Company in September 1908,

establishing GM’s headquarter in Detroit. GM has become a leader in the global automotive

industry since 1931. In 2005, GM sold 9.17 million vehicles. 3 Until 2008, General Motors is the

holding company GM Daewoo Auto and Technology. GM's car and truck brands include: Buick,

Cadillac, Chevrolet, GMC, GM Daewoo, Holden, Hummer, Opel, Pontiac, Saab, and Saturn.4 GM

ranked fifth in the 2007 "Fortune" Global largest 500 companies ranked.

During the fourth quarter of 2005, GM lost $ 4.8 billion. At the end of 2005, annual loss was

cumulated up to $ 8.6 billion.3 In addition, by the end of 2005 General Motors has experienced the

fifth consecutive quarterly loss. Its sales in the U.S. market fell by 22.7%.3

In 2006, General

Motors Corporation continued to incur losses, but the situation has improved.5 In 2007, General

Motors, as the world's No.1 auto makers, sold more than 9.36 million vehicles a year, second only

to the record of 1978 during the 100 years.6 However, at the same time, General Motors also hit a

historical loss-net loss on a global scale as high as $ 38.7 billion.6 In 2008 , General Motors’ loss of

the second quarter was up to 155 billion dollars.4While domestic market performance continued to

decline, previously performed-well European market is also facing difficulties.4

During 2008, GM

share price fell 31.1 percent , to $ 4.76 , which is the first time since 1951 that shares price fell

below $6.7 GM's market value has reached its lowest level since 1929.

7 Issued on November 07

2008, the third quarter financial report showed that GM loss amounted to $ 2.5 billion. The cash,

marketable securities and other current assets was $ 16.2 billion in total. On November 10, 2008,

GM’s stock fell 24 percent. 7 The price was only $ 1.06 per share.

7 Deutsche Bank marked GM’s

stock from "hold” to” sell ". 8

On December 2, 2008 General Motors Group submitted to Congress a new plan to deal with the

crisis. They applied to use 25 billion government bailout loans to make a detailed description and

described the feasibility designed to maintain the long-term development. GM claimed that at the

end of this month it will need at least $ 4 billion to help them maintain their daily production. 9 In

the late March next year, GM will need $ 12 billion to help its loans through 2009. On December

19, 2008, the U.S. government said it will be in batches to General Motors and Chrysler to provide

short-term loans $ 13.4 billion.

On February 17, 2009 General Motors to the U.S. Ministry of Finance submitted a restructuring

plan detailed plan, elaborated severe economic downturn in the global market. General Motors

elaborated how to achieve sustainable, long-term viability of the development.

February 20, 2009, General Motors closing market value of only about $ 1 billion. On March 30,

2009 General Motors Corp. Chairman and CEO submitted his resignation. GM announced that

Fritz Henderson succeed Wagner work to become the new president and CEO. On April 27, 2009

General Motors announced a new restructuring plan, which means that it needs a government loan

of up to $ 11.6 billion. The debt negotiation with creditors is unsuccessful. At the same time, GM

declared that it would cut off more than 75 percent of the current dealers before 2010, close

thirteen global factories and reduce twenty-one thousand hours working time.

On May 11, 2009 General Motors CEO Fritz Henderson said the likelihood that U.S. old largest

car company would file for bankruptcy protection increased.

On May 29, 2009 General Motors shares fell to below $ 1. The same day, the United Auto

Workers union held a press conference, said, “Reluctantly " to make concessions to GM and agree

to reduce labor costs. This made the cost of universal spent on labor costs greatly reduced, to about

$ 1.2 billion lower cost per year.

As of June 2009, the company debt reached $ 172.81 billion, which far exceeds the $ 82.29 billion

of its own assets. Due to serious trouble insolvency, on June1, 2009, General Motors submitted an

application for bankruptcy protection in New York bankruptcy court to formally enter bankruptcy

protection.

Analysis

Why GM Get Distressed?

In order to specify the development of its financial difficulties, we can analyze financial indicators

in different periods.

Three internal reasons that led GM filed for bankruptcy protection.

First, long-term operation with high debt ratio is the direct cause of the insolvency. According to

the major economic data Forbes 500 list of the world General Motors announced from 1995 to

2008, in 1995, GM had the general revenue of $ 168.829 billion, the profits of $ 6.881 billion, and

the total assets of $ 217.123 billion. In 1996, its profit was up to $ 49.63 billion, reaching a peak.

And its profits have been hovering around 20-60 billion U.S. dollars in 2001. It was only $ 600

million profit in 2005 and from this year GM began to experience periodic losses. GM had a loss

of 10.567 in 2005, $ 1.978 billion in 2006, $ 38.7 billion in 2007, and $ 30.86 billion in 2008. The

total assets in balance sheet in 2004 were up to $ 479.603 billion. However, assets shrink to

$186.192 billion in 2006 and fell into insolvency situation.

The following table GM solvency indicators tables.

2006 2007 2008

current ratio 0.95 0.86 0.56

quick ratio 0.47 0.49 0.29

debt ratio 1.03 1.25 1.94

*the data comes from the 10k report for General Motors (2008).

Under normal circumstances, the higher the current ratio, the stronger short-term solvency of

enterprises. The high current ratio also showed that the enterprise has enough working capital to

cover the current debt. 2:1 current ratio is generally considered appropriate. And GM's liquidity

ratio has been below 1, and gradually decline to less than 0.6. Quick ratio trend is also declining.

This indicates that GM's solvency is very poor, unable to repay maturing debt and eventually led to

its bankruptcy.

Second, the high cost and lack of profitability is the root cause of insolvency. The operating cost

during 2005 to 2008 were very high, almost equal to its main business revenue in 2008 is even

lower than the operating income.3 4 5 6

GM focused more on expansion and did not do cost control

very well. The contribution margin decreased.

GM Auto Industry

Market average

Market value to Total revenue 0 0.45 6.06

Market value to Cash Flow -0.02 4.26 37.74

PE ratio -0.01 -17.12 22.83

PB ratio -0.01 1.43 5.83

The data comes from Bloombeg.com. Date: June 1, 2008

From the above analysis of data it showed that the auto industry was experiencing the declination.

The ratios are far behind the average level of the market, especially the majority of the industry's

earnings targets. The company is mired in losses. The GM performed worse than its peers in the

auto industry. The higher PE ratio does not mean that its price-earnings ratio is less negative than

industry operates, but stated that the profit of GM was negative while the stake price was very low.

The other three ratios were below the industry average also. This suggested that GM's profitability

was very poor.

Third, the important reason lead to high cost of low profitability: high labor costs. In 2004 General

Motors consumed $ 1,528 health insurance and$ 695 pensions in a car, which was a total of

$ 2,223.10

In comparison, Toyota was consumed health insurance of $ 50 and workers contribution

bonus of $ 201 in a car.10

In the amount of health insurance on a car was $ 1,850 and the pension

was $ 700, totaling $ 2,550. 3Toyota’s average health insurance remained at about $ 200 per

vehicle, to provide incentives for workers of $ 50.3 The cost gap between GM and Toyota on each

product to achieve a terrible $ 2,300. In 2006, General Motors workers an average hourly wage of

$ 73.26 and an annual salary of $ 146,000.For GM’s rival such as Toyota, Honda and other

company plants in the United States, the average hourly wage is only $ 48 , equivalent to an annual

salary of $ 96,000.5 Under pressure from unions , GM could not successfully lay off workers .

External Reasons:

First, oil prices make consumers change their taste. In the era of low oil prices, cars with large

displacement had contributed a lot of profit for the General Motors. However, since 2005,

international oil prices raised from about $ 60 / barrel continued to a maximum of $ 147 / barrel in

2008. Since the cost of driving big cars for Americans increased significantly, the demand of those

cars significantly reduced. Soaring gasoline prices seriously affected the sales of cars of GM.

People began to turn to fuel-efficient hybrid vehicles. General Motors focused on the development

of fuel cell vehicles since the late 1990s, while ignoring the development of hybrid vehicles. The

strategy led to lags in the current hybrid development far behind the Japanese auto company.

Second, the economic crisis led the U.S. auto sales dropped significantly. Problems were caused by

the U.S. subprime mortgage financial crisis. The impact spread to various parts of the world and

evolved into a more comprehensive world economic crisis. The credit crunch and the impact

significantly declined in consumer confidence. As durable consumer products industry, the

automotive industry bears the brunt of the winter sales. In north America, Europe, Japan and

several traditional automotive market, the sales declined quickly.7 In September 2008, the U.S.

auto sales month in fell below one million for the first time in 15 years, a decrease of nearly 27% .

Major European car sales in 18 countries experienced a downward trend of four consecutive

months. Japan was no exception. Several main car dealers in overall declined in domestic and

foreign markets. Toyota and Honda in September also decreased by 32 % and 24 %.7 Since the

second quarter of 2006, the U.S. real estate bubble burst and triggered the subprime crisis.

Third, the introduction of a new pension accounting standard, the Statement of Financial

Accounting Standards ("SFAS") No. 158, is expected to further deteriorate the financial

performance of GM by recommending full recognition of pension surplus or deficit on the

company's balance sheets. The new pension accounting standard does adversely affect GM's

financial performance.

Chapter 11: Opportunity of Restructuring

When a corporate debtor filed for bankruptcy, it usually submits a “Chapter 11 reorganization

plan" to the bankruptcy court under Chapter XI of the form. Deterioration of the financial position

of the company can take advantage of Chapter XI bankruptcy law. Under Chapter 11 bankruptcy

process, company can negotiate with creditors on restructuring the debt, and then voted on by all

creditors to decide whether to accept the debtor’s reorganization plan.1

Chapters VII and XIII and bankruptcy proceedings as soon as the debtor's Chapter 11 bankruptcy

protection, “automatic stay” began to take effect. At this point, if the creditors want their claims

against the debtor, they must apply for a court to lift the automatic stay of proceedings.2

Unlike Chapters VII and XIII, Chapter XI bankruptcy reorganization proceedings was rarely

intervened by trustees. The current bankruptcy law allows the management of the company

continued to manage the company after the company declared bankruptcy. In bankruptcy

proceedings, the company retained management is called "possession of the debtor", meaning

"debtor" is considered to continue to occupy their company and business. Almost any company can

apply for a U.S. Chapter XI bankruptcy proceedings. The company applied does not have to reach

the limits of losing solvency (insolvent). The reason for this provision of bankruptcy law is mainly

based on the following points:

First, encourage the distressed companies to seize the opportunity of restructuring as soon as

possible. If a company filed for bankruptcy reorganization in advance in accordance with Chapter

XI, more conducive to satisfy creditors' claims, to protect the interests of creditors; second, avoid

forming an opinion that the companies applying for the bankruptcy are hopeless. This kind of

concept is not conducive to companies and the whole economy.

Although many detailed legal terms regulated in Chapter XI, it still gives creditors and corporate

debtors vast bargaining space on the restructuring plan. We can see that the courts want to creditors

and debtors to continue its business with each other and to reach agreement on a voluntary debt

settlement plan.

It is understood that the U.S. Congress when formulating bankruptcy law. It tends to encourage

corporate restructuring and debt restructuring, rather than compulsory liquidation, primarily based

on the following understanding:

First, the liquidation value of the enterprise is usually lower than value of the business to survive in

the long run. If allowing the corporate debtors to be restructured and reorganized, it will have a

chance to debtors continue to operate. As its value will be higher, then there is no need to be

liquidated and the creditors get more settled. Let the corporate. Second, the restructuring of

corporate debt could avoid employees losing their jobs and peace the increasing unemployment

rate. Third, as companies will encounter difficulties due to the poor business condition but not the

management, Chapter 11 could offer a great chance for revival.

Is it a good business?

Bankruptcy can be a good choice for companies that have a good brand and a product that people

want, but face severe funding problems that make them unable to pay their obligations under the

current structure. Filing for bankruptcy allows the company to restructure its debt and other

obligations to a sustainable level. More than two-thirds of firms that declare bankruptcy come out

of the process as intact companies. As I said before, the companies could file for Chapter 11

usually doesn’t have to file for Chapter 11. A hopeless company would only have the chance to file

for the chapter 7. As I mentioned before, the main reason that led to the GM’s bankruptcy is its

human cost. For General motors, filing for Chapter 11 offers General Motors an opportunity to

restructure, to terminate the unprofitable contract and lease, to negotiate with the employees about

the salary and to reduce the overly cost.

GM After Bankruptcy

GM exited bankruptcy in July 2009 a stronger, leaner company. Money-losing brands such as

Pontiac, Hummer, Saab and Saturn were either dropped or being wound down, leaving GM with

its core Chevrolet, GMC, Buick and Cadillac divisions. Its reduced debt obligations and health care

payments allowed GM to focus on the product rather than the crushing debt burden. Other

companies in a similar position should study the GM bankruptcy.

The Downside

First, for General Motors, how to maintain the image and trust in the minds of consumers will be a

tricky issue. Since the end of 2008, the GM’s sales showed a significant decline.11

Although the

Obama administration said that during the bankruptcy protection period the government would be

responsible for service, but still cannot completely eliminate the concerns of consumers. Compared

with Ford, GM’s sales decline was significantly. As it would take a long time to train consumers

trust, problem caused by GM bankruptcy was how to regain the trust of consumers.

Second, GM filing for bankruptcy protection caused a negative impact to the automotive related

industries. Since bankruptcy protection lead to the break of the production chain, suppliers and

dealers had been hit more deadly. In Detroit , the direct reach 250,000 as the number of employees

working in three major car manufacturers.7 If you count the parts supply, distribution and other

related industries, the impact of the total population could reach between 1.5 to 2.5 million.

Conclusion

The internal reasons for GM’s distress are the high labor cost and inappropriate development

strategy. GM funded the development of the fuel cell autos but the hybrid autos occupied the

market. The external reasons for GM’s distress are the increasing price of oil, the subprime crisis

and the change of the accounting policy for the pension. It is correct for general motors to file for

Chapter 11 but it is not a panacea to save all the enterprise.

References

1. Edward I. Altman & Edith Hotchkiss. (2006). Corporate Financial Distress and

Bankruptcy. Hoboken, New Jersey: John Wiley & Sons.

2. US Court. How Chapter 11 Works?

Web:

http://www.uscourts.gov/FederalCourts/Bankruptcy/BankruptcyBasics/Chapter11.aspx

3. General Motors, Inc. (2005). Form 10-K 2005. Retrieved from SEC EDGAR website

http://www.sec.gov/edgar.shtml







7. Norgate Investor Services. Web:

http://www.premiumdata.net/products/premiumdata/ushistorical.php

8. Simon Kennedy & Christopher Hinton, Deutsche Bank sees GM shares as likely worthless.

MarketWatch. Retrieved 10 Nov 2008.Web: http://www.marketwatch.com/story/deutsche-

bank-cuts-gm-to-sell-shares-seen-likely-worthless

9. Chris Isidore. Big Three want more money in bailout. CNN. Retrieved December 4, 2008:

10:40 AM ET. Web: http://money.cnn.com/2008/12/02/news/companies/automakers_plans/



http://www.uscourts.gov/FederalCourts/Bankruptcy/BankruptcyBasics/Chapter11.aspx





http://www.premiumdata.net/products/premiumdata/ushistorical.php

mailto:[email protected]

mailto:[email protected]

http://www.marketwatch.com/story/deutsche-bank-cuts-gm-to-sell-shares-seen-likely-worthless

http://www.marketwatch.com/story/deutsche-bank-cuts-gm-to-sell-shares-seen-likely-worthless

http://money.cnn.com/2008/12/02/news/companies/automakers_plans/


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