Some Thoughts on the Chrysler Restructuring Plan

The Chrysler web page for their restructuring plan they presented to the Feds is here.  The summary pdf my comments are based on is here.  Thoughts:

  1. It is criminal that this is going to Congress, not a bankruptcy judge.  This is a conspiracy of management (looking to hold onto their jobs and equity), equity holders, and employees to usurp value from the senior debt holders, who would normally be first in line in a bankruptcy.
  2. There is no WAY I, as a private investor, would put one additional dime into Chrysler based on this plan.  All the Same-Old-Incremental-Sh*t, with no explanation of what they are going to do differently.   Somehow they are going to cut half their models and lay off tens of thousands of employees but hold fast on market share, somehow reversing years of steady decline.  No explanation of how.
  3. In section one, they blame it all on the credit markets.  Specifically, the lack of ability of the Chrysler finance arm to lend to customers.  But I showed the other day that consumer lending is still strong by banks.  What they are really saying here, but they are smart enough not to utter the actual words, is that their sales depended on a finance arm that was willing to lend at below-market rates to people with bad credit scores, and the lack of this hidden subsidy is what is making it hard to sell their cars.  Credit exists -- what no longer exists is zero-percent-interest-to-anyone-who-walks-in-the-door-no-questions-asked financing.   Instead of figuring out how to make cars that don't require hidden subsidies to get off the lot, they are trying to get the government to fund their hidden subsidies.
  4. The present value calculation is a joke.  I could spend 3-4 business school classes discussing problems with it, so I won't now.  But one element that stuck out at me was that they come up with a terminal value in the calculation as a multiple of EBITDA  (Earnings before Interest, Taxes, Depreciation, and Amortization).  Really?  EBITDA is a common metric, but it is beyond meaningless when looking at a company going bankrupt under the weight of interest costs and capital spending.  Besides, they have the gall to assume that net cash flow (excluding financing activities) will be positive for the combined years 2009-2010.  Im-freaking-possible.  Remember, if any private investor in the country believed these numbers, Chrysler wouldn't have to be begging at Congress's door.  Congress is their last chance to find a sucker who will give them more money.
  5. OK, I can't totally leave aside the NPV calculations yet.  They have a table of NPV's at different rates of return  (which is meaningless because their cash flow assumptions can't be believed).  The rates of return are 5%, 10%, 15%, and 20%.  This is ridiculous, though many may not recognize it.   20% is a low rate for the discounting of about any large equity investment, but it is absurdly, ridiculously low for a high-risk investment in a company that has been burning cash for decades and is facing its second near bankrupcy in 30 years.  Any savvy investor in the world would smell a dead fish here, but Congress won't because Chrysler is waiving electric cars at them
  6. And speaking of electric cars, any intelligent restructuring plan would recognize that electric cars, even if they are successful in the marketplace, are not going to be anything but a cash drain for years.  This kind of thing has to be put on hold while the company gets back on its feet.  But instead, since this is a political and not a business document, Chrysler is practically leading with it.  In fact, the sections "4:  Commitment to Energy Security and Environmental Sustainability", "5:  Compliance with Fuel Economy Regulations," and "6:  Compliance with Emissions Regulations" all come in priority order ahead of "7: Achieving a Competitive Product Mix and Cost Structure."  In fact, this section about costs and competitive products comes dead last in the plan.  LOL, a "business" plan, indeed.
  7. I thought it was funny that on the cover of the report, they have all kinds of happy politician-grabbing stats about how many red-blooded Americans they employ and how much of their production is made in the good old USA.  But their entire restructuring plank #3, which is labeled "strategic alliances," seems to boil down to a bunch of outsourcing to foreign partners.  Which is fine with me, but probably would freak out the Dems they are selling it to should they figure it out.

In the new corporate state, this is what business plans will look like.  Because were aren't selling returns and wise investment of capital, we are selling the care and feeding of political constituencies and pressure groups.

Postscript: OK, I realize I criticized the plan without suggesting what should be in it.  Here is what I would demand as an investor:  An achnowlegement and discussion of the reasons for past market share slide, and targeted actions to reverse these trends.  As Chrysler has said they have been working on this problem for 30+ years, the proposed solutions will need to sound radical, not incremental.  Further, they need to stop complaining that below-market rate consumer financing does not exist, and explain how they are going to sell cars at a price that covers their costs as well as a return for shareholders.

  • http://space4commerce.blogspot.com Brian Dunbar

    My assumption is that the guys that run Chrysler are reasonably bright and know their business.

    ... explain how they are going to sell cars at a price that covers their costs as well as a return for shareholders.

    Assuming this is a goal the people running Chrysler would like to achieve .. I think it is possible that this is an impossible task for that organization.

  • ben

    And speaking of electric cars, any intelligent restructuring plan would recognize that electric cars, even if they are successful in the marketplace, are not going to be anything but a cash drain for years. This kind of thing has to be put on hold while the company gets back on its feet. But instead, since this is a political and not a business document, Chrysler is practically leading with it. In fact, the sections “4: Commitment to Energy Security and Environmental Sustainability”, “5: Compliance with Fuel Economy Regulations,” and “6: Compliance with Emissions Regulations” all come in priority order ahead of “7: Achieving a Competitive Product Mix and Cost Structure.” In fact, this section about costs and competitive products comes dead last in the plan. LOL, a “business” plan, indeed.

    I love this paragraph. This is why I read Coyote Blog.

  • Bill

    Largely spot-on analysis; I share your reaction. We shouldn't expect anything better. These execs are supplicating before politicians, not market-based sources of funding. How many members of Congress or their staffers can understand any sort of rudimentary valuation model, let alone the subtleties in a methodologically correct valuation?

    I'll take your valuation criticism a step further. They're apparently valuing free cash flows, not the free cash flow (solely) to common equity. Therefore, the correct cost of capital is probably the WACC, not the cost of equity.

    And anyway the first lesson of valuation in an introductory MBA corp finance course is that you don't conduct scenario analyses by varying the cost of capital. You do it by varying the cash flows (which, you note, are laughable to begin with) and examining the NPV according to the intrinsic cost of capital. (I realize there are subtleties according to whether the leverage ratio is fixed or varying with time.)

    The cost of capital is a function of the cost of debt, the cost of equity, the marignal tax rate and the amount of leverage in the capital structure. Both the COE and the COD are at a first order level functions of the underlying assets and industry. Increasing leverage makes the debt riskier and the equity less risky. That's what the WACC calculation comprises.

    Arbitrarily sticking a high cost of equity on a DCF valuation is not the proper way to do the job; it's as meaningless as cranking out ludicrous cash flows. That's the greatest criticism of the Chrysler summary valuation chart.

    Calculate the cost of capital and then vary the cash flows according to the value drivers. It's not that Chrysler's equity has a cost of capital of 40%. It's that it has a cost of perhaps 9 or 10% at most (?) but that the cash flows are extraordinarily anemic and subject to great negative volatility.

  • Rich

    This plan states the company is cutting costs. Yet this past week while I was on vacation in Jamaica at Sandals White House an all inclusive resort (minimum daily rate of $500 a day) MOPAR held a convention for over 100 people for 4 days. Add in air fare how much money was wasted on this event? Is this a good use of bailout money? I don't think so. This company continues its wasteful ways at taxpayers expense!

  • Link

    Accurate math and realistic financial planning are the last things on their minds. Chrysler's nominal owner Cerberus only cares about how GMAC comes out of this. The real owners of Chrysler and GM are the debtholders and the UAW, but they can't or won't sort out their relative positions until they can see how much they can get from Obama & Co.

    No one in their right mind would consider investing in a Big Three automaker these days. The idea that you could create company-specific projections of returns when the industry is down to 10 million of new car sales ... and may be stuck there for an indeterminate time ... is laughable.

  • K

    The Big Three have a sad history over the last few decades. Where is the evidence that Chrysler management and owners can run a car company successfully even before this recession or depression or, as I call it, a disaster in progress.

    Every party with money sunk in Chrysler is unwilling to invest any more. That clearly tells us to let them go. It is the US that taxpayers should be concerned about. And there is no benefit for the US in bailing Chrysler out or prolonging the agony.

    Much the same can be said of GM and Ford. Neither is healthy except by comparison to Chrysler.

    I don't like the government choosing the winners among private companies. Yet that is exactly what Washington and states seem determined to do. If it must be so then at least provide the help to the least hapless.

  • ErikTheRed

    Well, considering who's going to be signing the check wouldn't you expect their plan to be a bit (oh yes, wait... wait... wait for it...) Dodgy?