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May 28, 2009

SPECIAL REPORT: GM Bondholders on Clash Course with the Federal Government

SPECIAL REPORT: GM Bondholders on Clash Course with the Federal Government

GM bondholders have rejected the latest offer from the ailing automaker to forgive $27 billion in unsecured debt in exchange for a 10% equity stake in the company. Common Sense Capitalism stands with the GM bondholders in their fight for a true equity valuation in bankruptcy court. The bankruptcy decision could be one of the most important in corporate finance for decades to come.


To put it plainly, GM bondholders are getting screwed by the government. GM bondholders are being asked to agree to 10% equity for $27 billion of debt while the UAW is receiving 20% equity for $20 billion in debt and the federal government is receiving 70% equity for around $20 billion in debt and $50 in extended credit from the Treasury. Simply put, GM is giving 10% equity to an entity that is owed over 40% of the current debt being negotiated.


In the history of Chapter 11 bankruptcy, bondholders have usually been the first in line to claim the benefits of liquidated assets. The bondholder sacrifices more than employees as they give a company money that they cannot call back (unless bonds are callable) and must accept interest payments on until the bond matures or the company pays the bond off early. The bondholder sacrifices the most, yet they have the least control over their money. Shareholders offer their money, but can also redeem it whenever they want. Employees don’t pay anything, but are paid by the company, so I don’t understand why they would even be in the same class in a bankruptcy proceeding. From the SEC website (

“During bankruptcy, bondholders will stop receiving interest and principal payments, and stockholders will stop receiving dividends. If you are a bondholder, you may receive new stock in exchange for your bonds, new bonds, or a combination of stock and bonds. If you are a stockholder, the trustee may ask you to send back your old stock in exchange for new shares in the reorganized company. The new shares may be fewer in number and may be worth less than your old shares. The reorganization plan will spell out your rights as an investor, and what you can expect to receive, if anything, from the company.
The bankruptcy court may determine that stockholders don't get anything because the debtor is insolvent. (A debtor's solvency is determined by the difference between the value of its assets and its liabilities.) If the company's liabilities are greater than its assets, your stock may be worthless.”


Screwing the bondholders would represent a dangerous new precedent and likely spell doom for General Motors to ever be a privately held company. If GM bondholders are forced to accept the 10% equity offer, do you think they will lend money to GM in the form of bonds in the future? Would you sell bonds to General Motors? Would a bank lend money to General Motors? Considering the risks of the government sweeping in, bailing out the automaker, and wiping out all relevant investors, the answer is no.

This is why the Treasury is offering $50 billion in additional credit to GM, because nobody else is going to lend them the money. So, who is GM going to turn to for all future loans and financing in a world where the bondholders have been screwed? You guessed it, the federal government. Even if GM found buyers for bonds, the prices of those bonds would be so low (and the interest so high) that it would not be an attractive method of financing for such a large company.


I believe the new GM should be comprised of a 40% stake by the bondholders, a 30% stake by the UAW, and a 30% stake by the government. Furthermore, the proceeds from the assets being liquidated by GM during bankruptcy (Pontiac, Hummer, Saturn, Saab) should go towards paying off the government’s loan and reducing its stake in the company.

GM should also eliminate roughly 50% of its U.S. based employment. In the new economy, demand for new cars is so low that it does not make sense to employ all these people and produce all these cars that nobody will buy. Sorry President Obama, one of your biggest political support centers needs to be easily cut in half.

Additionally, GM should look into moving its production to the southern United States, thus further reducing costs. Another cost reducer would be to consolidate the existing models that GM is retaining. Maybe Buick will only be sold in China (where Buick is the #1 selling car) and only in the form of a car. Maybe we should only have one or two Chevy SUVs instead of five.
Had these ideas been implemented three or four years ago, when the market was already weak, GM would have easily saved $10 billion in costs, if not more. That would put a sizable debt in what it has needed from the government. The bottom line is that if we have to do the wrong thing (bail out GM), let’s at least put a sizable effort into wanting private investment to return to the company.


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