Chrysler: Reshuffle the Corporate Capital Structure?

by: Bo Peng
SeekingAlpha
May 03, 2009

I just caught up with the Chrysler story today. What I found out shocked me, for the implications could be mind boggling.

Here are some key facts I've gathered that are relevant to what I'm about to say. If you think I got any of them wrong, correction is appreciated.

Fiat will pay $2B for 20% of Chrysler, with options to go up to 35% but it's not yet clear what Fiat would pay to exercise them. UAW's retiree health trust, VEBA, will effectively exchange the $10B cash owed by Chrysler into a 55% equity ownership. 70% of senior debtholders (about $4.8B of $6.9B total) have agreed to a 32% recovery cash offer. The remaining senior debtholders have announced they will fight the sale to Fiat in court, hoping to get better recovery at the end of Chapter 11.

If they fail to stop the sale, they'd get 29% recovery. The US and Canadian government will provide another $8B financing on top of $4B earlier, get 10% equity, and offer subsidy to Chrysler in the form of honoring warranties as well as help to UAW in the form of guaranteeing part of their pension and health benefits, valued at least billions (Pension Benefit Guarantee Corp alone is worth $2B). The existing majority equity owner, Cerberus, gets nothing for their 80.1% stake.

The mind-boggling part comes from the discrepancy in how various priorities in the capital structure get screwed up and treated inconsistently.

Fiat's offer is the basis for valuation. It values the company at about $10B total -- in terms of technology transfer and market/network sharing, it's mutual so let's call it net 0 for simplicity.

Ceberus has already benefited hugely from various government help to GMCC and Chrysler Financial. At least they're better off than Daimler (DAI), which wrote down their 19.9% ownership of Chrysler down to 0 late last year. And there's a chance they may get a better deal with GM, or at least through GMCC and Chrysler Financial on continuing basis. And, of course, they were the management directly responsible for Chrysler's troubles in recent years. No tears there.

Assuming tax-payers get 30% recovery on present-value basis, consistent with the offer to senior debtholders, for their loan, they get 9% recovery of all of their investments (10% equity is $1B, for about $11B give or take). Tax-payers hold the bag. No surprise there.

Senior debtholders get about 30% recovery.

UAW gets 55% for $10B, which translates to 55% recovery. That's worth a Borat "NIIIIICE", no? Especially considering pension/benefit creditors are supposed to be junior to secured debtholders in the capital structure. It's widely opined that UAW got an unprecedentedly good deal out of this one.

There you have it. Senior debtholder is the new junior.

What does this tell future potential senior debt investors in US corporations? Lehman's case taught them that the bankruptcy reform of 2005 pushed them behind derivatives counterparties.

As a result, bonds of all US companies with substantial financial derivatives activity have all had their valuation cut down by 10~50%, arguably even more depending on the extend of derivatives exposure. Without explicit government backing, even Madoff wouldn't touch it.

Now the Chrylser case has taught them that they're further pushed behind junior creditors, or at least junior creditors in the form of strong labor unions. One can only assume bonds of US companies with a strong labor union presence will take a big beating. This is hardly labor friendly in the long run.

The government has already effectively underwritten consumer mortgages, insurance, derivatives, and bank debt. Are we now going to underwrite all labor union contracts? Then let's be honest and call ourselves commies.

It's even more perverse than this. Why would senior debtholders agree to such an arrangement? Are they stupid?

Of course not. The 70% senior debtholders, being JPMorgan (JPM), Citi (C), Morgan Stanley (MS), and Goldman Sachs (GS), surely have most of their bonds covered by CDS. If you're 100% hedged with CDS, you care little whether your debtor goes bankrupt or not, or how much the recovery is. In fact, if your debtor is already in trouble, you'd rather have the debt default soon so that you can collect 100% at CDS settlement and move on.

This is in stark contrast to the Old World of creditors being stuck throughout Chapter 11, thus incentivized to help the company recover. The beauty of the New World is that you get the say without putting your skin in the game.

Chapter 11 can hardly be called "protection" any more.

So who are the losers besides tax-payers and the hold-out senior debtholders who aren't hedged? CDS sellers who sold protection on Chrysler loans. But chances are that they're the big banks who're underwritten by tax-payers.

After the reshuffle of corporate capital structure, we can expect the cost of financing and credit protection for corporate America, especially those with strong labor unions, to surge. This will only deepen and prolong the credit crisis.