April 28, 2009 Edition, Volume III
Inside Signature Update
- 1st Quarter 2009 GDP Results
- A Politically Correct Alternative to Bankruptcy for GM?
1st Quarter 2009 GDP Results
Gross Domestic Product (GDP) results are in for the 1st Quarter of the year reflecting a lower than expected level of -6.1% to a domestic output rate of $14.01 trillion. Accompanying the decline was a decline in manufacturing and retail inventory levels of $103.7 billion - accounting for 2.8% of the 6.1% slippage in GDP. Economist projections had expected a decline of 4.7% – 5%, but had not expected to see inventory levels dip to such low levels. The lower inventory levels suggest that future quarter GDP levels may actual beat expectations as manufacturing will need to increase output at a higher than expected level to keep up with consumer demand in the face of low inventories. Likewise, as manufacturing increases, the labor markets improve and may slow the pace of unemployment for the 2nd Quarter to better-than-expected levels.
The 1st Quarter GDP decrease marks the first time since 1975 that the US economy has had three consecutive quarters of declining output; it also marks the worst two back-to-back declines in fifty years. For the four quarters ending March 31, 2009, US domestic output decreased by a total of 2.6%.
On a more positive note, consumer spending rose for the quarter by 2.2% after having dipped by 4% in the 4th Quarter 2008; consumer and business spending are both expected to show meaningful increases for April and the 2nd Quarter. The household savings rate increased to 4.2% after years of negative savings rates. The combination of these data sets suggest that our consumer economy has successfully made the shift from net consumption to net savings and that normative consumer spending is likely to resume, albeit to levels below those seen in 2005-2007.
What continues to surprise many is how slight changes in national economic figures can provide such substantial changes at the household and individual business levels. For all of the negativity expressed by consumers, businesses, government officials, and the media over the last six to nine months, many have supposed that the US economy has taken a hit from which we may never recover. When we stop to rationally consider that a dip of 6% in GDP or 8% in employment still represents that the economy is operating at 94% or 92% of prior levels, respectively, it takes on an entirely different outlook. It then becomes a much easier thing to see how we can go from 94% GDP back to 100%, and then upward to 104%, as would be reflective of two or three years of moderate GDP gains.
For the vast majority of households, incomes haven’t changed and spending has only been altered out of a sense of fiscal prudence. Though this may have exaggerated the national economic malaise as consumer spending slowed, it will ultimately bring the longer-term benefit of lower levels of debt. As employment levels improve and consumer spending returns to appropriate levels, confidence will return to the economy and markets – the benefits of which will be seen as debt is moderated and equity markets regain value previously lost.
We have seen these cycles before and though it may be terribly difficult to forecast exactly what will happen when, it rarely becomes a question of if. The markets attest to this on days like today when in mid-day trading, the DOW and S&P are up sharply, extending gains in the face of what some might consider as simply more bad news.
A Politically Correct Alternative to Bankruptcy for GM?
In a traditional bankruptcy, a company may be ‘restructured’ as shareholder equity is dissolved and debts are either eliminated or negotiated down to a level acceptable to the business owner, secured debt holders and creditors and in some cases unsecured creditors, thus allowing the company to continue to operate. Absent the presence of a labor union, in most cases employees are prepared to continue working as though nothing had changed unless they had to give up substantial benefits in the negotiation process which may motivate them to seek employment elsewhere. In today’s economy, with unemployment in excess of 8.5%, most employees are grateful to have a job to go to, even if it means losing some ground.
Now comes the case of General Motors. Having been bolstered by $15.4 billion in federal loans since the beginning of the year, GM may have worked out a non-bankruptcy reorganization wherein the UAW (United Auto Workers) will offer some concessions in exchange for an equity stake in the company of close to 40%, and the government will exchange $10 billion in debt for a 50% share of common stock This is predicated on the company being able to get at least 90% of the bondholders to convert their holdings for 10% of the company’s common shares – which may be a difficult feat.
This non-bankruptcy restructuring would then allow the company to retain some minimal value for current shareholders while disbursing additional shares of stock to the UAW and federal government. But an examination of the relative fairness of the plan discloses interesting inequalities – and perhaps political agendas as well.
For example, the holders of $27 billion in GM bonds will receive a 10% stake in the company while the federal government would exchange $10 billion dollars for 50% of the company. The UAW, which represents the company’s hourly workers and retirees, has agreed to exchange approximately $10 billion in benefits, or 50% of the outstanding retiree healthcare fund, for what is expected to be no more than 39% of the company’s common stock.
In this restructuring, the UAW’s $10 billion equates to 39%, the federal government’s $10 billion equates to 50%, the bond holders $27 billion equates to 10% and the current shareholders are left with 1%. At Monday’s market close the outstanding shareholder value of 610.5 million shares was approximately $1.25 billion ($2.04 per share). Now, I’m not a mathematician, but I just can’t find the algebraic calculation that equates $27 billion to 10% and $10 billion to 50%.
So who comes out ahead in this transaction? Let’s see:
· The current shareholders? No, but if the alternative is bankruptcy and the total elimination of shareholder equity, then this may be a better solution – one can argue that the shareholders have knowingly born the risk associated with stock ownership and concerns over share value have already been realized with the stock price down by some 96% over the last five years.
· The bondholders? Not at all. Their value is proportionately similar to that of the shareholders even though bondholders typically are considered to have a more secure position in the debt and equity structure of a company. Though GM has yet to default on its payments to bondholders, the company has announced that it will do so when the next $1 billion payment is due on June 1st.
· The federal government and taxpayer? Yes, but then we’ve not only pumped billions into GM; and in all fairness, the government has agreed to extend an additional $11.6 billion in loans on top of the $5.6 billion not being converted to common stock. Without these loans, even a scaled down GM wouldn’t have enough capital to operate; and in the capital markets, it is common for those extending loans to a struggling company to do so in exchange for a healthy equity stake in the company.
· The UAW (and its nearly 400,000 members, including retirees)? Certainly! They are expected to be offered four times the proportional value expecting to be received by current holders of GM’s common stock and bonds. Additionally, they’re the same workers, current and retired, who profited from the onerous union contracts – including pension, healthcare, and ‘jobs bank’ benefits well beyond what the market can reasonably bear.
So why does the bulk of the economic advantage go to the UAW and the federal government? A good question with a politically expedient, if not correct, answer.
The April 27th issue of New Yorker Magazine includes a well-written article regarding Nissan’s Smyrna, Tennessee plant - the first Japanese auto manufacturing plant in the US, and offers an excellent portrayal of what ails the domestic automobile industry - bloated labor contracts. The New Yorker isn’t exactly a conservative apologist; in fact, more often than not, the magazine’s contributing journalists and editors reflect a decidedly liberal point of view.
Nissan’s story, similar to that of Toyota and Honda, represent that an automobile manufacturer can remain profitable and competitive as long as labor costs are kept within reason. Though non-union Nissan workers are paid less than those represented by the UAW, they continue to earn wage and benefits sufficient to support a labor supply well in excess of demand. Additionally, the worker vs. management dynamic of the unionized auto manufacturers has long been one of distrust and resentment as opposed to the cooperative relationship observed by their non-union counterparts.
Few would argue that the leverage exercised by the labor unions hasn’t created many of the problems present at the ‘Big Three’ domestic automobile manufacturers and this as the union has sat on the opposite side of the bargaining table from management and shareholders. What will the dynamic yield when the union takes both side of the table – as both 39% plus equity holders and employee representatives? It’s difficult to stick it to the man when you are the man; and can you imagine what might be included on the placards of future picketers?
According to Reuters UK Online (Details of GM's Accelerated Restructuring Plan – April 27, 2009), GM plans to reduce its hourly workforce to 38,000 by 2011 from the 2008 level of 61,000. Not a bad outcome for the UAW and its members compared to risking the loss of the UAW’s control of all 61,000 jobs and benefits afforded to literally hundreds of thousands of retired workers and their dependents in the event of a bankruptcy - especially when the bulk of those jobs will be lost to retirement and attrition. Otherwise, why wait for an additional two years to solve an expense problem choking GM today?
In this labor market, the UAW has little real bargaining power aside from political influence, of course. Were GM to file bankruptcy, thus rendering its labor contracts null and void, GM’s workers would almost certainly be grateful to resume employment for the newly restructured company or at least 38,000 of them would, rather than be forced to seek employment elsewhere.
Without the encumbrance of UAW contracts, the restructured company would be free to compete and innovate. But just how innovative can we expect a GM owned by a labor union and the federal government to be? Innovative isn’t exactly the word that comes to mind when talking about bureaucracies and union officials.
If one were to ask former GM CEO Rick Wagoner, who resigned his position at the request of the Obama administration after a lengthy battle to protect shareholder value (exactly what a CEO is responsible for doing), to express his opinion of the influence being wielded by big labor and the presidential administration, he might choose to defer rather than risk further pressure from Washington. GM’s newly appointed CEO Fritz Henderson had a seat at the bargaining table wherein the problematic labor contracts were structured - while responsible for GM’s ongoing operations rather than having a fiduciary responsibility to protect shareholders, and helped lead the company down the path on which it has ended up today. Is innovation and competitiveness Henderson’s first priority? Normally, one would think so as the CEO is responsible to the shareholders; but when those shareholders are represented by labor union officials and members of the US House and Senate, one can only imagine what the shareholder agenda might include.
We’ll have to wait to hear what the UAW and Congress have to say, but one thing is certain if this proposed restructuring is successful. Those who have invested the most, current bond and equity stake holders, will have the least to say and those who have profited the most, hourly workers and the UAW, bolstered by elected officials long beholding to both, will be heard loud and clear.
Signature Update is offered by Richard Haskell, Managing Director of Signature Wealth Management and CEO of Signature Management, LLC
Inside Signature Update
- 1st Quarter 2009 GDP Results
- A Politically Correct Alternative to Bankruptcy for GM?
1st Quarter 2009 GDP Results
Gross Domestic Product (GDP) results are in for the 1st Quarter of the year reflecting a lower than expected level of -6.1% to a domestic output rate of $14.01 trillion. Accompanying the decline was a decline in manufacturing and retail inventory levels of $103.7 billion - accounting for 2.8% of the 6.1% slippage in GDP. Economist projections had expected a decline of 4.7% – 5%, but had not expected to see inventory levels dip to such low levels. The lower inventory levels suggest that future quarter GDP levels may actual beat expectations as manufacturing will need to increase output at a higher than expected level to keep up with consumer demand in the face of low inventories. Likewise, as manufacturing increases, the labor markets improve and may slow the pace of unemployment for the 2nd Quarter to better-than-expected levels.
The 1st Quarter GDP decrease marks the first time since 1975 that the US economy has had three consecutive quarters of declining output; it also marks the worst two back-to-back declines in fifty years. For the four quarters ending March 31, 2009, US domestic output decreased by a total of 2.6%.
On a more positive note, consumer spending rose for the quarter by 2.2% after having dipped by 4% in the 4th Quarter 2008; consumer and business spending are both expected to show meaningful increases for April and the 2nd Quarter. The household savings rate increased to 4.2% after years of negative savings rates. The combination of these data sets suggest that our consumer economy has successfully made the shift from net consumption to net savings and that normative consumer spending is likely to resume, albeit to levels below those seen in 2005-2007.
What continues to surprise many is how slight changes in national economic figures can provide such substantial changes at the household and individual business levels. For all of the negativity expressed by consumers, businesses, government officials, and the media over the last six to nine months, many have supposed that the US economy has taken a hit from which we may never recover. When we stop to rationally consider that a dip of 6% in GDP or 8% in employment still represents that the economy is operating at 94% or 92% of prior levels, respectively, it takes on an entirely different outlook. It then becomes a much easier thing to see how we can go from 94% GDP back to 100%, and then upward to 104%, as would be reflective of two or three years of moderate GDP gains.
For the vast majority of households, incomes haven’t changed and spending has only been altered out of a sense of fiscal prudence. Though this may have exaggerated the national economic malaise as consumer spending slowed, it will ultimately bring the longer-term benefit of lower levels of debt. As employment levels improve and consumer spending returns to appropriate levels, confidence will return to the economy and markets – the benefits of which will be seen as debt is moderated and equity markets regain value previously lost.
We have seen these cycles before and though it may be terribly difficult to forecast exactly what will happen when, it rarely becomes a question of if. The markets attest to this on days like today when in mid-day trading, the DOW and S&P are up sharply, extending gains in the face of what some might consider as simply more bad news.
A Politically Correct Alternative to Bankruptcy for GM?
In a traditional bankruptcy, a company may be ‘restructured’ as shareholder equity is dissolved and debts are either eliminated or negotiated down to a level acceptable to the business owner, secured debt holders and creditors and in some cases unsecured creditors, thus allowing the company to continue to operate. Absent the presence of a labor union, in most cases employees are prepared to continue working as though nothing had changed unless they had to give up substantial benefits in the negotiation process which may motivate them to seek employment elsewhere. In today’s economy, with unemployment in excess of 8.5%, most employees are grateful to have a job to go to, even if it means losing some ground.
Now comes the case of General Motors. Having been bolstered by $15.4 billion in federal loans since the beginning of the year, GM may have worked out a non-bankruptcy reorganization wherein the UAW (United Auto Workers) will offer some concessions in exchange for an equity stake in the company of close to 40%, and the government will exchange $10 billion in debt for a 50% share of common stock This is predicated on the company being able to get at least 90% of the bondholders to convert their holdings for 10% of the company’s common shares – which may be a difficult feat.
This non-bankruptcy restructuring would then allow the company to retain some minimal value for current shareholders while disbursing additional shares of stock to the UAW and federal government. But an examination of the relative fairness of the plan discloses interesting inequalities – and perhaps political agendas as well.
For example, the holders of $27 billion in GM bonds will receive a 10% stake in the company while the federal government would exchange $10 billion dollars for 50% of the company. The UAW, which represents the company’s hourly workers and retirees, has agreed to exchange approximately $10 billion in benefits, or 50% of the outstanding retiree healthcare fund, for what is expected to be no more than 39% of the company’s common stock.
In this restructuring, the UAW’s $10 billion equates to 39%, the federal government’s $10 billion equates to 50%, the bond holders $27 billion equates to 10% and the current shareholders are left with 1%. At Monday’s market close the outstanding shareholder value of 610.5 million shares was approximately $1.25 billion ($2.04 per share). Now, I’m not a mathematician, but I just can’t find the algebraic calculation that equates $27 billion to 10% and $10 billion to 50%.
So who comes out ahead in this transaction? Let’s see:
· The current shareholders? No, but if the alternative is bankruptcy and the total elimination of shareholder equity, then this may be a better solution – one can argue that the shareholders have knowingly born the risk associated with stock ownership and concerns over share value have already been realized with the stock price down by some 96% over the last five years.
· The bondholders? Not at all. Their value is proportionately similar to that of the shareholders even though bondholders typically are considered to have a more secure position in the debt and equity structure of a company. Though GM has yet to default on its payments to bondholders, the company has announced that it will do so when the next $1 billion payment is due on June 1st.
· The federal government and taxpayer? Yes, but then we’ve not only pumped billions into GM; and in all fairness, the government has agreed to extend an additional $11.6 billion in loans on top of the $5.6 billion not being converted to common stock. Without these loans, even a scaled down GM wouldn’t have enough capital to operate; and in the capital markets, it is common for those extending loans to a struggling company to do so in exchange for a healthy equity stake in the company.
· The UAW (and its nearly 400,000 members, including retirees)? Certainly! They are expected to be offered four times the proportional value expecting to be received by current holders of GM’s common stock and bonds. Additionally, they’re the same workers, current and retired, who profited from the onerous union contracts – including pension, healthcare, and ‘jobs bank’ benefits well beyond what the market can reasonably bear.
So why does the bulk of the economic advantage go to the UAW and the federal government? A good question with a politically expedient, if not correct, answer.
The April 27th issue of New Yorker Magazine includes a well-written article regarding Nissan’s Smyrna, Tennessee plant - the first Japanese auto manufacturing plant in the US, and offers an excellent portrayal of what ails the domestic automobile industry - bloated labor contracts. The New Yorker isn’t exactly a conservative apologist; in fact, more often than not, the magazine’s contributing journalists and editors reflect a decidedly liberal point of view.
Nissan’s story, similar to that of Toyota and Honda, represent that an automobile manufacturer can remain profitable and competitive as long as labor costs are kept within reason. Though non-union Nissan workers are paid less than those represented by the UAW, they continue to earn wage and benefits sufficient to support a labor supply well in excess of demand. Additionally, the worker vs. management dynamic of the unionized auto manufacturers has long been one of distrust and resentment as opposed to the cooperative relationship observed by their non-union counterparts.
Few would argue that the leverage exercised by the labor unions hasn’t created many of the problems present at the ‘Big Three’ domestic automobile manufacturers and this as the union has sat on the opposite side of the bargaining table from management and shareholders. What will the dynamic yield when the union takes both side of the table – as both 39% plus equity holders and employee representatives? It’s difficult to stick it to the man when you are the man; and can you imagine what might be included on the placards of future picketers?
According to Reuters UK Online (Details of GM's Accelerated Restructuring Plan – April 27, 2009), GM plans to reduce its hourly workforce to 38,000 by 2011 from the 2008 level of 61,000. Not a bad outcome for the UAW and its members compared to risking the loss of the UAW’s control of all 61,000 jobs and benefits afforded to literally hundreds of thousands of retired workers and their dependents in the event of a bankruptcy - especially when the bulk of those jobs will be lost to retirement and attrition. Otherwise, why wait for an additional two years to solve an expense problem choking GM today?
In this labor market, the UAW has little real bargaining power aside from political influence, of course. Were GM to file bankruptcy, thus rendering its labor contracts null and void, GM’s workers would almost certainly be grateful to resume employment for the newly restructured company or at least 38,000 of them would, rather than be forced to seek employment elsewhere.
Without the encumbrance of UAW contracts, the restructured company would be free to compete and innovate. But just how innovative can we expect a GM owned by a labor union and the federal government to be? Innovative isn’t exactly the word that comes to mind when talking about bureaucracies and union officials.
If one were to ask former GM CEO Rick Wagoner, who resigned his position at the request of the Obama administration after a lengthy battle to protect shareholder value (exactly what a CEO is responsible for doing), to express his opinion of the influence being wielded by big labor and the presidential administration, he might choose to defer rather than risk further pressure from Washington. GM’s newly appointed CEO Fritz Henderson had a seat at the bargaining table wherein the problematic labor contracts were structured - while responsible for GM’s ongoing operations rather than having a fiduciary responsibility to protect shareholders, and helped lead the company down the path on which it has ended up today. Is innovation and competitiveness Henderson’s first priority? Normally, one would think so as the CEO is responsible to the shareholders; but when those shareholders are represented by labor union officials and members of the US House and Senate, one can only imagine what the shareholder agenda might include.
We’ll have to wait to hear what the UAW and Congress have to say, but one thing is certain if this proposed restructuring is successful. Those who have invested the most, current bond and equity stake holders, will have the least to say and those who have profited the most, hourly workers and the UAW, bolstered by elected officials long beholding to both, will be heard loud and clear.
Signature Update is offered by Richard Haskell, Managing Director of Signature Wealth Management and CEO of Signature Management, LLC
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