GM’s Magical Thinking
I’ve been working my way through GM’s much-heralded restructuring plan that is being submitted to Congress tomorrow. It’s a lot less work than I thought it might be (though I’m blogging late at night as I’m reading it, so all of my comments are subject to revision).
It makes at least one point very effectively: GM has an incredible short-term cash problem. While I am skeptical of bankruptcy in the next 27 days – which GM claims will happen without a $4 billion government cash infusion by the end of the month – it is surely true that at current course and speed, this company is going to run out of money within a few months.
And even worse, if we look out over the next 6 – 9 months, it’s very discouraging, even if they get the bailout. GM has requested $18 billion in loans from the government, in addition to the $8.3 billion they are already getting under the fuel-efficient cars program (which, in practice, will provide a ton of general financial support – I’m willing to bet a lot of money that the green cars program at GM is soon going to find that it simply can’t do without a huge number of accounts payable clerks, market research managers and prime Warren, Michigan office space that just happens to be paid for today out of GM’s general treasury). GM’s base case restructuring plan calls for them to use $4 billion dollars of this $18 billion in December, $4 billion more in January and $2 billion more by the end of March. That’s about a $10 billion drawdown. They also present a far from unthinkable “downside scenario” in which industry auto demand is 10 – 15% lower than in their base case. In the downside scenario, they would draw down about $15 billion instead of $10 billion by the end of March, and have a cash balance at that time of about $13 billion. If industry demand stays at this lower level for the next quarter, they would burn through another $6 billion of cash in the second quarter, and would therefore consume the last $3 billion of the $18 billion they have requested, plus drive their cash balance down by $3 billion, to about $10 billion, or right where it is now. In other words, even if they got everything they asked for and achieved whatever short-term operational and asset sale plans they have, but consumer demand were soft over the next six months, we’d be right back to same place by the end of June.
However, if GM got the loans, and if we have a decent consumer auto purchase market for the next year or two (how’d you handicap that?), and if GM is able to improve its operations sufficiently, then they could squeak by. The point of this document was supposed to be the presentation of the plan to achieve these operational improvements. But there’s no there there. I guess somebody who’s never read a real business plan might mistake this document for one, but it’s a joke. It’s basically a list of assertions of amazing improvements, entirely discontinuous with actual performance to date, that they will achieve. What’s missing is any real indication of how they will go about accomplishing this.
Here are four huge examples:
1. As a practical matter, the core of any GM restructuring plan to achieve sustained cash profitability is unit cost reduction. GM simply asserts that they will do this, and lays out the targets. The only support is a bunch of rhetoric and cherry-picked facts about the recent past designed to lend credibility to these assertions. Consider the chart of historical and projected U.S. active hourly manufacturing costs shown in Figure 3. This total cost has been reduced from $12.8 billion in 2004 to $7.4 billion in 2008. This makes the projected reduction from $7.4 billion to $4.5 billion from 2008 to 2012 seem pretty reasonable – it’s fairly close to a continuation of the pre-existing cost trend. But consider this in context of (as per Table 6) total employment of 167,465 in 2004 and 96,537 in 2008. If we calculate the crude productivity measure of active hourly manufacturing cost / employee, this was $76,434 in 2004. In 2008, it was…$76,655. In other words, the reduction in aggregate active hourly manufacturing costs between 2004 and 2008 appears to have been driven by simply having fewer workers, with unchanged productivity. If we apply this same productivity assumption to the projected headcount of 67,500 for 2012, we get total active manufacturing costs for 2012 of about $5.2 billion, instead of GM’s plan of $4.5 billion. Where does this $700 million dollars of productivity improvement that seems to have heretofore escaped management come from? – No idea.
2. Similarly, look at Figure 4. It is an assertion that so-called structural costs will decline from 34% of revenue today to 25% of revenue within 4 years. That’s close to a nine-point gain in margin in four years, which would be pretty awesome operational performance improvement. Actual structural costs have fluctuated between 30 and 35 percent of revenue over the past five years – so how is GM going to get this huge improvement? They provide one sentence that claims that already-negotiated reductions in legacy costs will do this, and provide a chart in the appendix (Exhibit C-2) that breaks this cost reduction into four big categories. That’s it, as far as I can see. What a coincidence – GM just happens to be at he moment when their fixed cost problems, which have plagued them for decades, are about to go away, if they can just get a bridge loan.
3. In Exhibit B-1, GM notes that last year they forecast that GM would achieve a 2009 unit market share of about 20.6% (3.3M / 16MM), but now project a 2009 unit market share of 22.5% (2.7M / 12MM). Are they really asserting that their competitive position has improved over the past year, in direct contradiction to all external evidence and their own statements elsewhere in the plan? Of course, we have no idea what market share their plan assumes going forward, since they don’t provide this. They also don’t provide any serious financial statements or projections, only a projection for ultimate cash flow by year, without any useful description of the assumptions that generate this forecast.
4. In Table 4, GM claims that total debt will go down from $62 billion to $30 billion, or be reduced by $32 billion. They are asking for a loan of $18 billion. How do they get the extra debt reduction of $16 billion? They don’t say in the plan, but they appear to be basically assuming that their debt holders are going to “restructure” too, which is a 50 cent Wall Street word for agreeing to give up a lot of the debt in the hopes of getting paid at least something. This is like your brother-in-law’s plan to get out of credit card debt by getting Visa to just agree to forgive a lot of what he owes. Felix Salmon made the same observation, and called Troy Clarke, the head of GM’s North America business. Clarke confirmed that GM is assuming exactly this.
Now, the most obvious response to all of this is to say that I’m the fish at this table, because this is not a real business plan, but simply a political document. It exists to provide political cover to members of Congress. But if that’s the case, it’s an unintentionally beautiful illustration of why industrial policy fails. It’s both economically crucial and very hard to allocate capital well; that’s why people who are good at it make so much money. Businesses struggle to do this well, and they’re really trying. What do you think the odds are that this is a wise use of money, when the people involved are barely pretending to try?
Excellent post, Jim.
— JA · Dec 4, 04:48 PM · #
Y’know, Mr. manzi, the thing i’ve been most confused on is the role Ford has been playing. As far as I can tell, Ford looks, well, not so bad. Or, well, bad, but not doomed, and standing next to GM looks positively hale and hearty.
So as far as I can figger the only reason Ford much gives a fig for saving GM is some idea that the death of GM/Chrysler will cripple their suppliers, who happen to also be Ford’s suppliers, and whatever gain you get from being suddenly a monopsony buyer — and having put the fear of God into your suppliers and creditors and unions and whoever else to whom you have to pay cash money — is eclipsed by the possibility of there not being suppliers at all.
But then I’d imagine what Ford wants to do is lobby not for bailing out GM, but for conditional aid to its supplier network (maybe even holding its activity for same over the heads of those suppliers). I mean, especially with public sentiment running as it seems to, I’d think Ford would be deliberately and publicly distinguishing itself from “them other, screw-up car companies.” Like maybe changing its ad campaigns from “Quality is Job 1” or “Ford Tough” or whatever to some version of the old Reese’s commercials (“You got quality in my American car!” “You got American car in my quality!”)
Looking at what’s actually happening though it’s pretty clear I got no idea what the hell is going on. So I’d be intrigued to hear people explain to me why Ford seems so eager to throw itself in among its Detroit competitors. I really don’t understand it.
— Sanjay · Dec 4, 05:01 PM · #
They should crank up the Hummer assembly line that they shut down and sell a lot of high profit margin vehicles. They could advertise them as the perfect vehicle for our post-apocalyptic Mad Max future.
— Steve Sailer · Dec 4, 11:44 PM · #
Seriously, what if the Obama administration dropped all this Green whoop-tee-doo and let GM sell high margin Escalades and Hummers flat out into a 1.80 per gallon market. Forget CAFE and carbon all that stuff. Move some metal. That should generate some cash to get by, no?
— Steve Sailer · Dec 4, 11:46 PM · #
If Cerberus Capital is not willing to invest more money in Chrysler, why should the taxpayer? Can someone explain that? Why not at least demand matching funds from Cerberus?
Also I’m still skeptical that GM will go bankrupt that quickly without a bailout. How much of it is just seeing the TARP program and wanting a chunk of it for themselves?
— h · Dec 5, 12:25 AM · #
I think I now agree with you Jim Manzi. There are two “facts” that I somehow got ahold of that may or may not be true, but they are scary: 1. GM has to sell 15 million cars a year to make money, and 2. GM has been losing $2000 per car. I probably go that wrong but if I didn’t or I am close, then GM needs amassive resturctuing to make money and I’m not seeing anything about massive restructuring. THat deal about cutting per unit cost is total bs in my opinion. If they could cut per unit cost in the actual manufactuing process that would have already happened (or if there is still unit cost to be cut then GM really needs to go). But maybe they are talking about concessions from the union or dumping the pension plan or something.
In an ideal world, GM would drop all but one or two product lines, sell off the foriegn companies like Saab, pick five or six products that they really do well and focus on those. Make those better. THe volt should be one of them. Congress should insist on something like this. Drastic resturcturing in return for the money. But again, Jim Manzi, you are most likely exactly right that congress doesn’t have the knowledge or the institutional process to direct a successful restructuring.
SO, I tenetivly agree with you Jim Manzi. THe only caviat is that there may be a cost/cost calculation to be made along the lines of Cost to US Taxpayers as a Result of GM Collapse vrs. Cost to US Taxpayers to Keep GM Limping Along Until Economy LOoks Up. THis is the kind of caluculation that I’m pretty sure the Obamas are working on right now.
— cw · Dec 5, 12:57 AM · #
Jim makes the same mistake that a lot of people parachuting into the auto issue make. He fails to realize how complex the industry is, and consequently doesn’t do the research needed to really understand it. As a publicly traded U.S. corporation, GM has made extensive financial filings that provide the depth that, inevitably, is missing from a document like the one we filed with Congress. For example, a two-tiered wage and health care trust fund included in the 2007 UAW agreement makes the structural cost projections realistic. The fact is that GM’s hours-per-vehicle productivity is very close to Toyota’s (Harbour Report, available online), and closing the average wage gap, which the 2007 agreement will do, brings total labor costs very close within a couple of years. I could go on, but instead, I will suggest that anyone who really wants to understand what is going on spend some time on the GM investor site, as well as with the analyst reports from the buy-sell analysts who track the auto industry on a day-to-day basis. The modern global auto industry is a tough place for armchair pundits.
— Tom Wilkinson at GM · Dec 5, 03:00 AM · #
One more thing — the cost/cost calculation has been done by the Center for Automotive Research (visit cargroup.org, then go to recent publications). The three-year tax loss (income and social security) to state and federal governments of the collapse of just GM is in the neighborhood of $108 billion. That doesn’t even count the increase in transfer payments (unemployment, food stamps) or other economic dislocations caused by putting several million workers on the street. Again, this data is widely understood within the industry.
— Tom Wilkinson at GM · Dec 5, 03:14 AM · #
“If Cerberus Capital is not willing to invest more money in Chrysler, why should the taxpayer? Can someone explain that? Why not at least demand matching funds from Cerberus?”
A few months ago GM wanted to merge with Chrysler and one reason mentioned in the press was that Chrysler was sitting on $11B in cash. Now Chrysler says they need $7B by the end of the month or the lights will get shut off. Where pray tell is the $11B, did Cerberus vacuum the cash out and now wants the tax payer to fund the company? Heck they can reinvest the money that originally there.
Now perhaps Chrysler never had $11B, but due diligence on this needs to happen. How about a look at Chrysler’s and Cerberus books?
— Jim · Dec 5, 03:24 AM · #
When GM, Ford, and Chrysler are gone I wonder what the price of a Toyota will be?
— Ian Fraser · Dec 5, 05:01 AM · #
You really can’t understand the issues here without a good grasp of the 2007 UAW agreement, which made massive concessions on the legacy labor costs (mostly retiree health) that were dragging GM down. It doesn’t appear Jim has that.
Of course this is a political document. That doesn’t mean people don’t have a sense for what’s going on. It’s still going to be a rough ride for GM, but if we want to make cars then it’s dumb to let GM go down. Look at it this way, what do you think will have a higher return: the marginal dollar invested in “infrastructure” in Obama’s $500 billion+ stimulus plan, or a dollar invested in GM? Seriously, think about it.
— MQ · Dec 5, 05:31 AM · #
Cerberus and Chrysler — whole other story. I really wonder about that.
— MQ · Dec 5, 05:32 AM · #
ahmed sells bad, putrid hot dogs, with suspect beef and nitrites, and as a result, folks ain’t buying his dogs..oh yeah, they are more expensive than other dogs, cause Ahmed has a really good first aid kit in the hot dog cart…and his dog cart is falling to pieces, he can’t afford mustard inventory, his rolls are stale cause he keeps them extra days to save money. Ahmed needs a bailout…but meanwhile, across the street on 5th and 57th street, Hasaan is selling chicken based dogs, fresh, no preservatives, cheaper than ahmed, fresh rolls, etc…
Ahmed should find another job…even if he learns to make chicken based healthy dogs, it will take him so long to get his new recipe together, the new cart, the organic rolls, the upgraded mustard, all at a competitive price…he is history…folks will forget the corner he used to sell on…
Ahmed should find another job
— marc jacoby · Dec 5, 05:36 AM · #
Tom Wilkinson, what kind of restructuring do you think GM needs to do?
— cw · Dec 5, 06:49 AM · #
This is a fascinating, frustrating, and ultimately infuriating post, Jim.
When I put together and posted my layman’s Auto Rescue/Bailout Plan last night I had no idea what GM’s proposal would end up looking like…
It appears I spent more time and effort on mine than GM did on theirs.
— Mr Furious · Dec 5, 07:14 AM · #
Absolutely excellent post, Jim. Looking forward to your response to the GM flack.
— PEG · Dec 5, 11:42 AM · #
— cw — Please look at the plan online. Jim provides a link to a GM website where it is posted. It is pretty clear and pretty brutal. There is a lot of additional info on the GM investor site, in various quarterly earnings reports and two liquidity announcements we did earlier in the summer, but the plan is a good summary and pulls no punches.
Again, please keep in mind that GM is asking for loans, and lays out a reasonable path for repaying them.
— Tom Wilkinson at GM · Dec 5, 02:45 PM · #
Tom Wilkinson:
Thanks for your comments. Let me see if I can try address them one at a time.
GM had an open opportunity to present whatever information they wanted to the investors (i.e., you and me) into an $18 billion loan that they have requested. I don’t think I’m the guy to blame if the document they present is so incomplete – not at a high level of abstraction because of its brevity vs. the complexity of the issue, but incomplete – that I’m supposed to go to other sources unnamed in this document to understand their request for funds.
This agreement is well-known, and referenced at this level in the document. What portion of cost reduction does it represent? Which cost categories will it impact vs. others? To simply wave your hands (as GM did in this report) and say “trust me” when I provide four numbers per year on total costs, without any reference to more detailed reports that doucment any of these cost reductions, is risible.
For a guy who complains that I have not reviewed all of GM’s SEC filings, you might have looked at a prior post that I did on this site about this very issue.
I’ve done a lot of manufacturing benchmarking-and-improvement analyses, and while this is a frequent interpretation of the numbers in that report, it is very misleading. The statement is true as made, as long as we define “productivity” as labor-hours / vehicle. What are some of the problems with this definition if we use it as a synonym for “profitable” or “good” or “successful”? Here are several off the top of my head (even accepting that Harbour attempts to adjust for differing total loaded cost of an hour of labor across companies): labor-hours / vehicle ignores the issues of the relative gross margins of the cars this labor is used to produce, product line complexity, plant utilization and non-production costs (especially dealer network costs) attributable to each plant. Guess who is disadvantaged on these metrics?
It would be complicated to combine all of these metrics to a better summary metric of profitability; luckily, I really don’t have to, since this exact report does it for me by reporting pre-tax profit per vehicle for North American sales for each major company. It turns out that GM loses about $700 per vehicle, while Nissan and Honda make about $1,600 per vehicle. This is according to the exact report that you cite.
Yes, presumably the same buy-sell analysts who have observed GM’s market value of equity decline by 90% in about a year (from about $42 per share last October to a little over $4 per share today).
Maybe you’re right, and I’m a moron way out of my depth who just doesn’t understand the incredible excellence of General Motors. But if so, I’m in good company. The reason GM is coming to Congress to look for money is that they can’t get it from private investors. Apparently, every possible investor in either GM equity or debt is equally uniformed.
— Jim Manzi · Dec 5, 03:23 PM · #
Tom,
Are there any impartial industry experts who think GM’s plan is realistic? I would really like for GM to succeed, but as an outsider, I am worried by the fact that everyone who doesn’t have a stake in Detroit’s success seems to be extraordinarily bearish on GM’s chances.
Thanks – I appreciate your input.
— J Mann · Dec 5, 03:43 PM · #
If you look at the testimony yesterday and today, there is a consensus emerging that the plan is solid. Keep in mind that GAO, Treasury, etc. have had it since Tuesday. (What is still not clear is where the money might come from, or what kind of government oversight should be set up.) We have also reviewed it with buy-sell analysts. Don’t forget that many of the harshest critics either aren’t looking at the information available, or have a opposing position to promote (i.e. bankruptcy lawyers, etc.)
The plan lays out a harsh and difficult path. But given the global crash in auto demand, it is the only path possible.
— Tom Wilkinson at GM · Dec 5, 05:18 PM · #