Other Editorials

By Any Other Name

Wednesday, February 21, 2007

Ford's Non Bankruptcy

A few weeks ago, I wrote about a Wall Street analyst's report about how GM was already in bankruptcy given the state if its balance sheet, sales decline and losses. [Detroit in Review -- 2006] This week, it's Ford's turn. I've already mentioned that Ford was in technical bankruptcy because it had mortgaged all its assets in exchange for loans that exceeded its market value.

Things are a bit clearer thanks to two articles in the Wall Street Journal last week. The first article (7 February 2007) explained "How Troubled Firms Skip Bankruptcy Court". Recent reforms in the bankruptcy laws coupled with the willingness of private equity firms and hedge funds to lend where traditional banks have shied away give big corporations in big trouble more options.

Don't shed a tear for bankruptcy attorneys. While Chapter 11 bankruptcy filings are down, the demand for out-of-court restructuring work is so good that some attorneys have to turn away business. And as usual, the private equity firms, hedge funds and Wall Street banks make heaps of fees on both sides of the transaction.

These days, at least 20% of new bankruptcy cases are "pre-negotiated". That means an outside lender is lined up and management actions are taken in anticipation of filing bankruptcy so the process with the court can be more streamlined. One creditor gets screwed while another steps in with fresh money and lots of clean assets for pennies on the dollar. "Money is so cheap, it's hard to get into financial trouble." I loved that quote from a UCLA law professor. I'm glad that's how the attorneys and lenders look at things. I wish money was "cheap" for me!

But the article specifically noted that General Motors and Ford Motor Co. have spent the past two years in a "massive out-of-court restructuring of their North American operations." So I guess that Wall Street is happy with the way things are going or both GM and Ford would have been forced into Chapter 11 bankruptcy. Apparently these "informal" methods give management more flexibility. No one has to answer to a federal bankruptcy court judge and much of the machinations, back room deals and fees go undisclosed or buried in massive restructuring charges.

But why is Wall Street determined to keep both GM and Ford alive given that neither company is worth anything near their market capitalization? While no answer is given, it seems obvious that Wall Street will keep these two companies alive as long as there are low hanging assets ripe for stealing for pennies on the dollar and for the substantial fees still to be made on both sides of every transaction. Private deals are preferred to "public disclosure" of terms and fees and compensation paid. Gee, I wonder why?

The second article was hidden on the last page of the Money and Investing section of the WSJ this past Monday (12 February 2007). The breakingviews.com | Financial Insights column stated: "For Ford, It Doesn't Add Up." The numbers cited are pretty simple, so let's go through the thought process. Ford was trading for about $8.80 per share when the column was written.

They added up all Ford's liabilities, including unfunded pension and healthcare costs and debt and gave Ford the benefit of the doubt that it could reduce its health bill in union negotiations by 25%. The total: $58 billion.

Then they tallied up Ford's assets, excluding the car business but including Ford's one-third interest in Mazda, cash in the bank and cash at Ford Motor Credit. The book value of all Ford's non-car business assets is around $52 billion.

If you just looked at those two figures, Ford would have a negative net worth of $-6 billion. But we haven't factored in the value of the car business. Ford's balance sheet shows stockholders equity or net worth of a positive $6 billion. The difference is $12 billion of which $6 billion is sucked up by liabilities. So isn't the car business worth at least the $6 billion? Well, not so fast.

In the next three years, Ford expects to spend $17 billion of its cash. So if you subtract the $17 billion in cash from total assets you only have $35 billion in assets left. The negative equity rises to $-23 billion.

At the current market price of $8.80/share, Ford is valued by Wall Street at $16.5 billion. But when you add on the negative $23 billion, you would have to conclude that the car businesses at Ford (including all foreign subsidiaries, Jaguar, Aston Martin, Range Rover and Volvo) is worth $39.5 billion.

Basic accounting tells us: Assets minus liabilities = net worth. We can do simple algebra to figure out the implied market value of Ford's car businesses: Where X is the value of Ford's car business: (X + $35 billion) - $58 billion = $16.5 billion. Simplify: X - $23 billion = $16.5 billion. Solve by adding $23 billion to each side and X = $39.5 billion.

But is Ford's car business worth nearly $40 billion? Probably not! The basic formula to value a business is 10 times pretax income. Ford's sales in 2006 were $132 billion. Wall Street would like Ford to earn a return of 4% in pretax profits. Four percent of $132 billion is $5.28 billion. Subtract taxes and multiply by ten and Ford would be worth around $40 billion. Sounds good, right? Again, not so fast.

Goldman Sachs (Wall Street's imperial vampires) estimates that Ford's sales will decline 2.5% annually for the next three years. Given Ford's continued reliance on large trucks and SUVs, the likelihood of increasing gas prices and increased competition from Toyota, Honda and Nissan, things aren't looking so rosy for Ford. It took Nissan six years to complete its turnaround. Nissan wasn't encumbered by Ford's unfunded employee benefits and Nissan had a slew of popular new vehicles in the pipeline.

The article suggests that a more realistic goal for Ford would be to return a pretax margin of 2%. If Ford can maintain that rate, it would avoid Chapter 11 bankruptcy; but given the declining sales it means that Ford's stock price should be around zero.

Again, the math is pretty simple. If Ford earned a return of 4% and the profits were taxed, it would be worth about $40 billion. If you take half (a 2% return) value would be $20 billion. So let's go back to that algebra problem, except this time we know that X = $20 billion, so we will solve for Y, which would be the value of Ford's stock. (X + $35billion) - $58 billion = Y. Y = $-3 billion. Given that Ford would have a negative or zero stock value. It's hard to explain Wall Street continuing to give Ford a market cap of $16.5 billion.

But of course, the vultures of Wall Street -- the investment bankers, hedge funds, private equity players, consultants, attorneys and accounts -- must see some huge profits yet to be made on Ford. And they will get these assets at bargain prices.

Ford is already selling some of its parts businesses to private equity buyers as well as other public companies. The brokers on both sides are the same vultures, as usual. As Ford needs cash, more assets will be sold at steeper discounts. Someone is making lots of money on Ford's non-bankruptcy bankruptcy. It just isn't the small investors or employees. I hope Ford makes it back to health before it's been sucked dry!