My View: Time Is Running Out for the U.S. Auto Industry
By Dan Dooley, Principal and COO, MorrisAnderson
In Q3 2005, I wrote an article for the Boston Bar Association's Bankruptcy Law Section Newsletter that discussed the deep seeded problems of what used to be called the Big 3 automotive manufacturers and that I now call the Woe Is Me 3 (WIM3). At that time, I said that 1) a big-time Tier 1 supply consolidation was necessary, 2) there would be massive automotive plant shutdowns, and 3) General Motors and Ford were likely to file Chapter 11 bankruptcy by 2010.
Just over three years later, I was wrong about one thing—it's going to be GM and Chrysler filing Chapter 11, and it may be one year earlier, in 2009, unless a taxpayer bailout of $50 billion or more for the WIM3 is approved by Congress.
Let's quickly review what's been happening since then in the U.S. auto industry. The U.S. economy went into a swift and deep recession and is dragging the global economy down with it. Oil spiked to $150 per barrel and destroyed the market for the WIM3's only product strongholds in SUVs and light trucks.
Total per-hour compensation for the WIM3 has risen to $73.20, compared to Toyota's $48 and $28.48 for more typical manufacturing hourly employees. GM has been burning through about $3.1 million an hour, or $52,000 every minute, while Ford burned through $7.7 billion of cash reserves in Q3 2008 alone.
Chrysler, which was sold by Daimler to Cerberus and now must stand on its own financially, and Ford both installed executives from outside the auto industry as their CEOs. No doubt these individuals have met incredible resistance from within their own companies for that reason.
GM and Chrysler both have publicly acknowledged that they will run out of cash in early 2009. All three automakers announced what they termed "restructuring plans," but these proposals will take two to three years to produce any significant financial impact. Most Tier 1 suppliers to the automakers filed Chapter 11 in 2005 and 2006, and many successfully reorganized. However, many of these companies will soon become Chapter 22s.
GM's spun-off Tier 1 supplier, Delphi, can't get financing to exit Chapter 11. Delphi was GM's test case for negotiating with the United Auto Workers (UAW) union. It generally worked, accomplishing lower wage rates, at $13 per hour, for new hires; cutting 27,000 jobs; reducing salaried jobs by half, to 7,700; and achieving more reasonable work rules, plus the ability to outsource production to the Pacific Rim.
WIM3 dealers are failing all over the United States. At the dealer level, new car sales have dropped by 25 percent for the transplants and 70 percent for the WIM3. This grim news actually may be the one bright spot for the WIM3 because their dealer density is five times that of Toyota. At least two-thirds of WIM3 dealers need to be closed to give the survivors enough sales volume to operate profitably.
Other recent industry developments include:
- Suppliers are refusing cost-down demands and actually are successfully jamming forward price increases.
- No one is providing new lending against working capital assets tied to the WIM3, and accounts receivable (A/R) credit insurance can't be purchased. This means the financial community foresees impending WIM3 Chapter 11 filings.
- Suppliers are actually squeezing credit lines on the WIM3.
Starting in 2010, GM will be offloading its U.S. workers' and retiree healthcare issue to the UAW's managed trust, or at least so GM thought. Perhaps the UAW will be a likely bankruptcy candidate now as well.
More Pain Ahead
Although much has occurred in the last three years, the fundamental landscape hasn't changed at all. Assuming they receive it, the WIM3 will consume the $50 billion in taxpayer funding in a short 12 to 18 months and will be back to the inevitable Chapter 11 filings. In essence, a bailout would only prolong the agony without changing the end result one bit.
The WIM3 problems can only be addressed within Chapter 11 because of the absolute necessity to rework agreements and contracts with unions and dealer franchisees across numerous legal entities in numerous states and countries. This can only occur in a Chapter 11.
Until the WIM3 accept the inevitable, here's how I think this continuing automotive industry drama will play out. The WIM3 will shut down almost all of their plants for four weeks or longer in mid-December and then start to slow down supplier payments in January. They must do this to conserve cash.
The disruption in both sales and collections at the Tier 1 level will result in the immediate bankruptcy filings of 10 to 20 percent of the downstream WIM3 suppliers. This is simply my guess, but one thing is certain—the impact will be significant and nearly immediate because hundreds of these companies are already on the brink of insolvency.
What is key is that most of these bankruptcies will become liquidations, and secured lenders will not get full loan recoveries. The WIM3 have little excess cash to fund troubled suppliers, as they consistently have done in the past. Lenders will be reluctant to increase their risk by even one more dollar in upcoming auto supplier cases.
Without a steady supply of orders and cash from the WIM3s, most suppliers have little chance at a cash collateral order and must rely totally on debtor-in-possession (DIP) financing, which is almost nonexistent in today's credit markets. Without access to DIP funding from the WIM3 or lenders, these suppliers will be liquidated. Some will even be shut down in hard-stop Chapter 7s.
Extracting money from the WIM3 when an insolvent supplier has significant leverage will become a fine-tuned art form. Intermet, for example, which manufactures cast-metal components, has done a masterful job of exercising leverage on the automotive OEMs in its Chapter 22 case.
The WIM3 will start to experience unplanned plant stoppages, which will adversely affect a second wave of suppliers who will file bankruptcy. Again, many of these companies will be liquidated. WIM3 plant operations and cash positions will be further weakened by these supplier bankruptcies.
Hunkering Down
If my predictions are accurate and Chapter 11 for all of the WIM3 is inevitable, what should Tier 1 and Tier 2 suppliers do now to protect themselves? They should:
- Shut and consolidate plants as soon as possible. Today's weak domestic auto production volume levels will likely go even lower. The U.S. has not hit the bottom of this economic cycle yet.
- Tighten A/R collections by demanding electronic data interchange (EDI) payments be accelerated from 45 days to 10 days. Tier 1 and 2 suppliers should argue that their suppliers have tightened credit on them because of their WIM3 credit exposure, so immediate “fast payment” terms are necessary or they will not be able to buy materials to service their agreements. However, Tier 1 and 2 suppliers must be careful to avoid directly threatening to withhold shipments from the OEMs.
- Research all primary production tooling to ensure they have a detailed understanding of what is theirs and what belongs to the OEMs. There are many gray areas in this analysis. These suppliers should start building data to lay claim to production tooling that falls into the gray area. They should consider attachments, such as pans, sliders, brackets, clamps, and other structural fixtures used in production, and in some instances the machines used to produce the part assets not owned by the OEMs. They should protect this information as a form of intellectual property (IP), even invoking attorney-client privilege if at all possible.
- Discuss with insolvency counsel how to declare WIM3 contracts in breach and terminate them before the OEM files Chapter 11. Tier 1 and 2 suppliers that have favorable deals—and very few do—will find that the OEM will simply reject their contracts after filing Chapter 11 and renegotiate them in a bankruptcy. Those with unfavorable contracts will find that they are forced to perform under them in an OEM Chapter 11. In my view a supplier is in a much stronger position if it has terminated its contract before the OEM files.
- Safeguard production process IP. Frankly, a supplier should put this IP into a special purpose entity with no direct contractual relationship to the OEM, which should create more leverage in negotiating with the OEMs.
- Refuse to fund new program tooling immediately, even for awarded programs. Because of the clear and present danger of the OEM filing Chapter 11, Tier 1 and 2 suppliers should insist that they be paid now for all funds expended and that the program will advance only if the automaker pays the tool suppliers. Given their weak financial condition, OEMs are hardly in a position to take back new programs and try to re-award them to another supplier.
- End the practice of expediting parts and paying for additional shipping costs.
- Perform a physical inventory at the OEM customer's plant and request a bailment on consigned inventory and any equipment the Tier 1 and 2 suppliers own at an OEM's plants.
- Freeze all capital expenditures and downsize operations 20 percent beyond what they think they can bear. Tier 1 and 2 suppliers must hunker down as if they're going into war because they are.
Darwinian Process
I believe the WIM3 ultimately will be combined into one U.S. manufacturer, with Chrysler being absorbed into either GM or Ford very soon, although I think this consolidation will occur in two stages over two to three years. For what it's worth, I think Ford is the most likely domestic automaker to survive.
The numerous divisions of each WIM3—GM alone has eight—ultimately will be reduced to three or four. This would eliminate perhaps 80 to 90 percent of the unique component parts that currently are made.
The upcoming economic and social devastation that will occur during this shakeout in the automotive industry will be huge:
- Retirees will lose their healthcare benefits.
- The Pension Benefit Guaranty Corporation (PBGC) will cut pension benefit levels after it takes over the pension plans, and the defined benefit pension plan era will officially end.
- Current employment in the industry will be cut in half, and base hourly wage rates will be cut to $16 from $20.
- Salaried employees will lose their union benefit look-alike benefit packages.
- Suppliers, supplier plants, and dealerships all will be reduced to one-third of their current numbers.
For some time, industry observers have sounded the alarm about the viability of the U.S. automotive industry, and now time clearly is running out. Belatedly, perhaps, the WIM3 are now coming to realize that they are in a Darwinian game of "Survivor."
View the original 2005 Article.
More about Dan Dooley:
Dan Dooley, CTP, is a Principal and COO with MorrisAnderson. A turnaround and crisis manager with 20 years of experience in general management, operations, finance, and project management, he has served as CRO, CEO, COO, and CFO for companies in the manufacturing, distribution, and service sectors. Dooley holds a bachelor’s degree and an MBA from the Carlson School of Management at the University of Minnesota.
More about MorrisAnderson:
Now celebrating its 28th anniversary, Chicago-based MorrisAnderson has offices in New York, Atlanta, Milwaukee, Los Angeles, Cleveland and St. Louis. The firm's service offerings include performance improvement, financial advisory, investment banking, interim management, lender services, turnarounds, workouts, litigation support, valuation, information technology services, and insolvency services and wind-downs. MorrisAnderson emphasizes hands-on involvement for companies with $20 million to $200 million in annual sales. |
