by John D. Menke
In the 25 years since the article Could ESOP Save General Motors? was written by Louis and Patricia Kelso, very little has changed regarding the tenuous financial status of General Motors.
On the one hand, today’s corporate tax rate and today’s inflation rate are much lower than the 50% tax rate and the 12% inflation rate that prevailed in 1981. Given these facts, one would think that GM would be in much better shape today than it was in 1981.
On the other hand, today GM faces liabilities for unfunded health care benefits that are several times larger, as a percentage of its net worth, than they were in 1981. For example, GM’s current market capitalization is about $12 billion. Its unfunded health care liability, however, is $50 billion-more than four times the market value of the entire company.
As a result, GM has been forced to cut its dividend rate in half, and plans to terminate up to 30,000 employees, close a number of plants, and freeze pension plan and health care benefits.
But these actions, however necessary they may be, will only postpone the day of reckoning. Eventually GM’s cash flow will not be sufficient to meet its accrued health care liabilities, and it will be forced to declare bankruptcy in order to shed this liability. The resulting loss of financial benefits by hundreds of thousands of former GM employees will send shock waves throughout the economy that will result in a large drop in the overall stock market, which will further jeopardize the pension and retirement benefits of millions of employees across all industries.
Fortunately, there is a solution to this problem that can avoid the advent of these dire economic consequences. And interestingly enough, this solution is the exact same solution that Louis and Patricia Kelso offered in their 1981 article.
If GM is to avoid bankruptcy, it must find a way not only to reduce future pension and health and welfare benefits, but to also pay off its unfunded liability for past health care benefits.
The only way this can be accomplished is through an ESOP. Yes, an ESOP can still save GM, but GM must act fast before it’s too late.
How it would work is the same as outlined by Louis and Patricia Kelso in their l981 article. The only difference is that the proceeds of the financing would be used to pay unfunded health care benefits rather than to purchase tools and equipment.
GM currently employs approximately 325,000 employees, and its worldwide payroll expense is about $20 billion per annum.
The first step would be to negotiate with the UAW for an immediate 20% wage reduction that would continue for a period of 10 years. The trade off for the wage reduction would be stock ownership through an ESOP.
The wage reduction would generate $4 billion of new cash flow per annum, totaling $40 billion over ten years.
The traditional wage reduction trade off has been that employees receive $1 dollar of stock for every $2 dollars of wage reductions. Using this formula, the employees would give up $40 billion of wages in exchange for $20 billion of stock.
Assuming that a consortium of bank lenders would be willing to provide a ten-year loan at 7% interest, this $4 billion of incremental cash flow would support a loan of $28 billion. By using these funds to reduce its unfunded health care liabilities, GM’s market cap should increase by this amount. Adding $28 billion to GM’s current market cap of $12 billion would result in a new market cap of $40 billion.
Based on these numbers, the $20 billion of stock that the ESOP would acquire would result in the ESOP owning 50% of the outstanding stock.
Thus, the second step would be for GM to form a new ESOP. The ESOP would borrow $20 billion from a consortium of banks. GM would borrow an additional $8 billion directly rather than through the ESOP. The ESOP would use its proceeds to buy $20 billion of newly-issued GM stock. GM would use the $20 billion received from the ESOP, plus the $8 billion received in a direct loan, to fund $28 billion of unfunded health care benefits.
Granted, there are those who would say that owning stock in GM is a risky investment. However, consider the alternative. The alternative is that GM will quickly slide into bankruptcy, in which case the employees will be hammered with probably an even larger wage reduction with nothing whatsoever in exchange. Under the above-described proposal, the employees do take a risk, but they have the upside potential as well, which is something they would not have in bankruptcy proceedings.
Further, the ESOP would be managed by trustees representing both employees and union members, who would be obligated to manage the ESOP in the best interests of the participants. Thus, as and when the shares of GM stock have been paid for by the ESOP, the trustees would be free to diversify the investments of the ESOP by selling shares of GM stock in the market and investing in other more secure investments.
As a final note, it should be noted that the ESOP did, in fact, save Chrysler Corporation from bankruptcy, a fact that has been easily forgotten by the financial community. After teetering on the verge of bankruptcy for several years, Chrysler implemented a wage-reduction ESOP similar to that described above. Following that, Chrysler not only avoided bankruptcy, but went on to become the most profitable of the big three automotive companies.
By the same token, an ESOP can, in fact, save GM. It will take some hard negotiations with the unions and with the existing company lenders, but it can be done, and it must be done, not only for the sake of the existing and retired GM employees, but also for the sake of the economy and millions of employees in other companies who will also suffer as a result of GM’s bankruptcy.
— John D. Menke is the founder and president of Menke & Associates, Inc., an ESOP investment banking firm headquartered in San Francisco, California
