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28th September 2007

Global Insight analyst Aaron Bragman yesterday summarised what is known so far about the tentative agreement between General Motors and the United Auto Workers and suggested it appeared to show GM victorious in achieving cost savings that could make its U.S. operations competitive with its transplant competitors.

The new contract, like the old one, is a four-year deal that expires in 2011. Responsibility for the US$50 billion in retiree healthcare liabilities will now rest with the UAW, in the form of a Voluntary Employee Benefits Association (VEBA). Reports indicate that GM will fund the VEBA at US$0.70 on the dollar, requiring a payout to the fund of nearly US$35 billion. How that amount will be funded has not been detailed, but a combination of cash, stock, and bonds is expected. The UAW maintains that the VEBA will be sufficiently funded to guarantee retiree benefits for the next 80 years.

(The National Legal and Policy Center (NLPC) yesterday objected to the agreement to transfer more than $50 billion health care in liabilities to a fund controlled by the union. Dr. Carl Horowitz, director of the Organized Labor Accountability Project and editor of Union Corruption Update, said, "This is a great deal for GM. They get to shed billions in obligations made to former workers. It is a great deal for the UAW. Gettelfinger and his cronies get to control billions in health care dollars. It is a lousy deal for retirees and future retirees who may lose some or all of their benefits.”

Horowitz continued, "Union-controlled health and benefit plans lack transparency. That is why they so often get looted by corrupt union officials. The UAW is not clean. As we have documented, many unions have been plagued by a number of benefit scandals in recent years.")

There will be no wage increases for the duration of the contract, nor will there be any cost-of-living adjustments. In return, workers will instead receive a US$3,000 lump-sum payment this year as a signing bonus, plus lump-sum payments equal to roughly 3% of annual pay the second year of the contract, 4% the third year, and 3% the final year. In exchange for giving up the cost-of-living increases, medical co-pays will be locked in at their current levels.

GM has reportedly won the ability to implement a two-tier wage system, allowing the company to pay new non-manufacturing recruits (maintenance, janitorial staff, etc.) a lower wage than the current employees receive. The current average UAW wage is US$27.81 per hour; the new recruit wage has not yet been made public.

Nearly 4,100 temporary workers will be changed to permanent status, but paid at the new lower rate. A new round of buyouts will be coming with the hopes of clearing the ranks of senior workers in order to make room for new employees.

The controversial system that allowed laid-off workers to still keep collecting pay and benefits despite being idled has been changed, but not eliminated. The ranks of those on the jobs bank list has been drastically reduced thanks to buyouts earlier this year, and the bank has now been changed to expand its geographical requirement from 50 miles to a new, as-yet undisclosed distance.

Outlook and Implications

Global Insight’s Aaron Bragman writes: “While GM has stated that significant new investment will be committed to North American manufacturing, no specific details are yet available as to where that investment may be placed.

But it does follow that since GM has gotten what appears to be a landmark deal that has achieved significant concessions from the UAW, that a dramatic change in U.S. manufacturing cost structure has enabled it to once again consider U.S. production in a competitive light. GM's efforts in internationalising its operations and coordinating production sources for global platforms has paid off in this regard; unlike previous years, threats of moving production offshore should U.S. manufacturing costs remain uncompetitive were quite valid this time around.

“The contract should help address the cost gap between the Asian transplant automakers operating in the United States and the Detroit Three, but even if it does not eliminate the gap entirely, the reduction in costs is significant enough to have a major impact on the health of the automaker.

“The biggest win for GM: the VEBA. By eliminating US$50 billion in liabilities and US$3.3 billion annually in payments, GM will dramatically improve its cash flow, its balance sheet, its earnings-per-share, and a host of other metrics. But beyond that, the ancillary effects will help GM even more. Gone will be the approximate average US$1,200 out of every car that GM pays for retiree healthcare; that money now goes into GM's coffers to fund development, research, new models, and eventually, dividend payments. Reports are that GM was able to secure the VEBA deal at US$0.70 on the dollar, which is on the high side of most estimates, and more than the reported US$0.63-$0.67 that GM was reportedly offering. As such, GM will have to come up with US$36 billion or to fund the VEBA, an amount that will likely consist of financing, cash, and securities.

“The credit market has been very tight lately as a result of the sub-prime mortgage market meltdown earlier this year, as Cerberus Capital Management discovered when it went to try and sell its debt in order to purchase Chrysler. But most financial analysts have said that they do not foresee a difficult time ahead for GM in securing financing for the VEBA funding, since the US$36 billion one-time payout creates a much healthier company than an amorphous US$50 billion liability that is almost certain to increase. Beyond the elimination of the liability, GM's credit rating could also improve, leading to lower borrowing rates and enabling the company to fund everything less expensively than before.

The big question now, and one that is likely to be answered today, is who will be next: Chrysler or Ford? Ford publicly hoped that it would actually be the UAW's primary negotiation target. The UAW has stated that it is planning on following the pattern bargaining tradition, and will be taking the contract as it stands to the other two automakers. Whether or not the other two automakers will accept it as-is or attempt to renegotiate all or part of the contract remains to be seen, but with the initial details of the contract frankly looking very favourable to the automakers, it could be accepted with few changes at Ford.

Ford currently has roughly US$31 billion in total retiree liability, while Chrysler reportedly had approximately US$19 billion. Ford's biggest challenge is likely to be how to fund the VEBA; the company is already mortgaged to the hilt just to fund its operations while it attempts to effect a turnaround plan that is moving slower than most observers are comfortable with. However, just like at GM, Wall Street is likely to look favourably on a deal to eliminate uncertain liabilities, and may provide some expeditious funding for the venture.

While Ford may be eager to seal a new deal with the union with minimal changes from the GM contract, Chrysler may be a different story. The shift in ownership to private equity fund Cerberus Capital Management has put Chrysler's stance on things like the VEBA deal in an uncertain light. With the company's new focus on cash flow and not balance sheet health, eliminating those liabilities to benefit long-term owners in return for a significant cash flow in the short term may not be in Chrysler's game plan.”