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Under the Hood With GM


The bottom line is that no deal is going to alter the negative cash flow dynamics of the GM auto business.

General Motors' (GM) stock price has risen 13% in the last few days in anticipation of successful negotiations with the UAW over healthcare obligations. Let's really look at its impact.

UAW is willing in principle to execute a healthcare deal with the big U.S. auto companies whereby those companies pre-fund a separate healthcare plan for all past and future workers. Some of the important details of the deal that need to be negotiated include how much initial pre-funding is supplied by the companies, the amount supplied by any OEM parts suppliers, assumptions about future healthcare inflation, the timing of future funding, the assumptions about return on plan assets, discount rates, and actuarial assumptions about plan participants. All those details are incredibly important and could swing the funding requirements by billions of dollars.

The "Street" is assuming that something like $35 to $38 bln will be contributed to the fund from GM (amounting to 70 cents on the dollar for GM's current assumed liabilities for healthcare.). Dana Corp., which was bankrupt at the time it agreed to a similar funding structure, did 71 cents on the dollar and Goodyear Tire (GT) agreed to 83 cents on the dollar (after a 45 day strike). GM seems to be offering 65-67 cents on the dollar and says it's its line in the sand.

Questions become then where it comes up with $35-38 bln to fund the deal (issue stock and dilute equity or borrow more). The Street believes that it would need $5-10 bln of additional cash to fund this plan. For reference, 75% (75 cents on the dollar) of funding from GM would cost them $40.5 bln, so the bigger portion of the healthcare benefits it funds the more it will have to borrow in capital markets. Post almost any deal above 55 cents on the dollar of funding from GM (which UAW would never agree to), GM still won't be cash flow positive in its auto business.

Against its competition, GM's fully loaded wages per worker are $73.25 per hour (wages of $39.70 and benefits of $33.55), a full $21 more than Toyota (TM). Any healthcare deal struck would remove around $8 per hour of this cost, still leaving $13 of difference between GM and Toyota for example (although Toyota, even at dollar cost parity to GM, would still have significant benefits over GM because it uses temporary workers and has fewer skilled workers as a percent of its overall workforce, making it far more flexible to adopt to changes in industry dynamics).

On net, it would appear that some sort of deal is probable near 65-75% funding. Such a funding of healthcare benefits cuts the competitive cost gap with Toyota by 38%, but still leaves GM with a huge competitive disadvantage operationally in its auto business. The actual details of the deal beyond the percent of funding are at least as, if not more, important to determining the actual capital structure changes GM would need to take as well as the operational cost benefits it might get (the UAW would need to concede $11 more per hour to just get GM back to Toyota's cost per hour level).

But the bottom line is that no deal is going to alter the negative cash flow dynamics of the GM auto business. I believe that the stock has run up ahead of any deal announcement (today, Sept 14, has been considered one 'deadline') in the hopes that the UAW would accept very low funding (good for GM) and that the UAW would make all sorts of other concessions on benefits and wages. I believe that it isn't going to do both. And even after all that, GM still won't sell enough cars to be cash flow positive even if sales remain at their current levels. If we are going into a slower consumption cycle, which I firmly believe, the numbers get much worse very quickly.

The net benefit to GM's EPS is $0.47 per share next year if it completes a healthcare pre-funding at 75% of its current liability. The Street has the company producing 16.2 mln cars next year. If the actual auto sales are 5% lower than that, EPS gets lowered by $0.30 per share (2/3rds of the healthcare EPS benefit goes away). If car sales are 10% lower than 16.2mm, then EPS gets hit by $2.03 per share: more than four times the healthcare benefit is wiped out. (All this is to say nothing about the cash flow which is still negative in all healthcare scenarios).

The above illustrates that GM is far more levered to the auto sales business than any EPS benefit it may or may not get from a healthcare deal with the UAW.
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