21st July 2009
An update on GM's bankruptcy
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Welcome back.
Last week the new GM emerged from Chapter 11 bankruptcy, starting a new life as a new company. The Chapter 11 and Section 363 process went ahead as expected. The old GM was split into two parts. The first part is a new GM that will take over all of the profitable parts of the old GM. The dregs remain in a company rebranded as the Motors Liquidation Company, which will be gradually wound down over the years to come.
Motor Liquidation Company (MLC) is the legal successor of the old GM. This means that all securities issued by the old GM (including the bonds that I suggested that we monitor) are now MLC securities, and not part of the new GM.
As stated in the restructuring plan, the new GM will be owned by the US government (60.8%), the Canadian Government (11.7%), VEBA or Voluntary Employees Benefit Association (17.5%) and 10% by MLC.
This is the first development. MLC holds the 10% (and the extra 15% in warrants) that are destined to pay the claims of the unsecured bondholders, or in simpler terms, to the holders of the bonds. On the MLC website (www.motorsliquidation.com) however, it clearly says that none of the securities issued by MLC (the old GM) are or will become securities of the new GM.
To be honest with you, this announcement puzzled me. When I read the announcement related to the original Chapter 11, it was quite clear that 10% of the new GM would be set aside for holders of the unsecured bonds. It is also quite common for companies in Chapter 11 to satisfy part of the bondholders' claims with shares in the new company that emerges from the bankruptcy procedure.
After looking further into the matter I found that so far nothing has been decided for the unsecured creditors (the bonds). The focus of the Chapter 11 process was to get the new GM to reemerge as a viable company as quickly as possible, and then to sort the remaining mess later.
There's a lot of speculation surrounding the old GM equity (ticker US: MTLQQ) and the false hope that it might provide a backdoor entry into the new GM. So before we go any further let me be clear: do not, I repeat, do NOT buy the old GM equity (US: MTLQQ) as it is worthless, and will not be converted into stock in the new GM.
The company has made it clear that there will be no funds to pay the bondholders in full. So that means that shareholders will get a big fat 0. Please do read the warning issued by the SEC/Finra.
Bonds are the only instruments that will eventually receive some payment from the liquidation of MLC, and the amount bondholders will receive is still unknown. Now I still believe that it's quite likely that the bondholders will receive shares and warrants in the new GM, but it's still too early to say.
What happens next?
The next date to put in the calendar is July 27th, when the official committee of unsecured creditors will meet and might release some new information.
Next we will have to wait for the restructuring plan, or the liquidation plan (Chapter 7) that will outline the proposals for the payment of the unsecured creditors (bondholders). This might take a while perhaps a few months. Once it is released, we should be able to assess the recovery ratio of the defaulted bonds. The plan should spell out what the bondholders will receive, whether it's cash, or cash and stock plus warrants in the new GM.
The 10% stake in the new GM that is now owned by MLC could eventually be distributed to the bondholders, but the timing and the way in which it will be done is still unknown.
As for the new GM, an Initial Public Offering (IPO) is planned for next year. Here it is unclear which stock will be sold to investors; whether the government will reduce its stake or new stock will be issued and the proceeds used to pay down the loan received from the US government. This matters because if new stock is issued then the shares and warrants belonging to MLC will be diluted.
Meanwhile the restructuring will continue apace. The latest figure for the North American car market shows 9.69m vehicles were sold on an annualized basis. Hopefully some improvement in the underlying profitability and viability of the new GM will begin to emerge, especially as the new GM is planning an advertising blitz at the end of the month once the cash for bangers government scheme starts in the US.
The small matter of the warrants
For simplicity reasons, I excluded the warrants from my calculation , but depending on the terms these could provide extra recovery potential. I reckon they are the best way (in terms of risk / reward profile) to play any turnaround story in the new GM.
So far little is known. The only things we're sure of are that VEBA will have 2.5% of the new GM in warrants, and the bondholders will be awarded warrants over an extra 15% of the new GM. This is on top of the allocation of shares in the new GM. This also means that the total number of shares could be increased by an extra 17.5%, therefore diluting the stake held by the US and Canadian governments.
Again I tried to look to see if I could find more information on this little matter, but I was only able to find an article on Bloomberg suggesting that 50% of the warrants (7.5% of the equity in circulation) could have a strike price that corresponds to a market cap of $15bn for the new GM and the remaining 50% could be issued with a strike price corresponding to $30bn market cap.
If this is correct then it would mean that the first warrants would be in the money and could be worth at least an extra 3% in the recovery value. I'll spare you the back of the envelope calculations, but I still assume a recovery ratio of 10% on $22bn of unsecured debt giving a market cap for the new GM of $22bn (as in the previous newsletter). The second warrant (the one with strike at $30bn) however would be far more interesting and could be the one to buy to play a GM turnaround it would be like buying an out-of-the-money option (if you're not familiar with options, you can read a basic primer here).
Much of the value of these warrants would also depend on the time horizon for the conversion. As you can imagine, a warrant expiring in 2015 would be far more valuable than one expiring in 2013.
The bonds
The prices of bonds of the old GM (or as it is now known, MLC) have fallen a touch and are trading at around 10% of face value. That's a price which I previously suggested as an entry point. But given the uncertainty surrounding the MLC website statement, I'd advise you to wait a little longer.
This is a long-term trade and we have plenty of time to get in. It might even be worth waiting for the new GM's IPO, or the allocation of the warrants, and getting a long position then.
In the near future, the price of the bonds could move according to how well the new GM is moving. But I would expect these movements to be small. They could also move on the back of some significant newsflow relating to the liquidation of MLC.
Conclusion
All in all, the situation is still far from clear. That's why I am suggesting that you wait a little longer before buying the bonds while the situation develops and more elements become clear. This is true, even if the prices of the bonds have fallen.
The warrants would be the best way to play this trade, but unfortunately we don't know much about them yet.
One last warning to remember: unless you are a scripophilist (a collector of stocks and bonds certificates) DO NOT BUY old GM shares (US: MTLQQ) because they are worthless! And even if you do collect stock and bonds wait a couple of years and buy them on eBay that s how I got my MCI Worldcom certificate for $2.50 plus postage!
Some other interesting companies to watch
I would also like to draw your attention to a few more companies that have hit trouble this week. Apart from Allied Carpets, which went into administration last week and is too small to be of any concern to us, a couple of companies have announced that they are renegotiating the covenants on their debts.
This means that the companies involved are finding it difficult to deal with the amount of debt they have outstanding. It's generally seen as a precursor to trouble that could lead to a rights issue or a debt-for-equity swap, and in some cases, to bankruptcy.
These are Arcelor Mittal (FP: MT) and Cemex (US: CX) . Both are re-negotiating the covenants on their existing credit facilities and debts; both are leaders in their particular slow-growth cash cow businesses (steel and cement); both have made large acquisitions in the past few years financed by debt; and both have been hit hard by the recession.
So far no action should be taken. Just monitor the situation and wait for further developments. Both companies have debt issued in euro (EUR) and sterling (GBP) as a result of their respective purchases of Arcelor and RMC Concrete and could present us with opportunities in the future.
The second point I'd like to note is on Yell (LSE: YELL) , another troubled company with a lot of debt. I've read an interesting report suggesting that the number of pages in its central London directory was down 44% year on year. I think this company should be avoided altogether. I don't think it has a bright future, as you'll use the internet more and more to look for services you might need, rather than browsing through a paper directory. So don't touch it.
As usual, I welcome questions, suggestions, criticism, ideas, you can get in touch with me at my usual e-mail: eventstrader@f-s-p.co.uk.
Riccardo Marzi
Events Trader
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