Tuesday, June 9, 2009


The Chrysler Balance Sheet Estimate

The Supreme Court really ought to hear this case, on a number of legal issues (not factual). (1) Is the agreement of 90% of the creditors valid if they are under threat by the government? (2) Is a price fair if it exceeds the liquidation value but is a giveaway to the buyer because it is much less than he would have been willing to pay?

If the Supreme Court does not hear this kind of case, these important issues may never be brought up. It is no excuse that the Court is being rushed. These cases are urgent by their very nature, and we are going to see a lot of them, because we are in a recession with government bailouts. And they are cases of great public importance, where there should be lots of input from scholars.

I found the balance sheet estimate, finally, for the Chrysler deal. I've added them to this post as a picture file. This is absolutely central to understanding the legal case and public policy, yet it took a lot of digging and is buried in page 12 of Exhibit E of the undated, unpaginated, 196-page "Declaration of Robert Manzo". No journalist or lawyer shows signs of having read it, either. I think they just looked at a shorter declaration of his where he doesn't go into detail on the numbers.

What's important is the value that NewCo, the new Chrysler company, would take out of the firm in exchange for the $2 billion dollar price it is paying. For the legal case, what matters is the loss of value to the senior creditors, the ones with secured claims. NewCo will take away both assets and liabilities, but since the senior creditors have first claims to the assets, all that matters for them is the value of the assets removed, not the liabilities removed.

The simple answer is that the going-concern value of the New Chrysler assets is $28.5 billion according to the dealmakers' estimate, so $2 billion looks like a lousy price. That could be wrong, though, as I'll explain below.

I will use the estimates for July 1, 2009, the date the new entity would be formed. The assets are quite different for then compared to December 31, 2008, presumably because in the meantime Chrysler is paying suppliers and workers and such. A separate question is whether the senior creditors have been gravely harmed by delay--- it looks to me as if they would have gotten more than $2 billion dollars if Chrysler had been liquidated on December 31, 2008.

Anyway, let's look at what the value of the NewCo assets are on July 1, 2009. The accounting number for "Total Assets" is $28.5 billion (which excludes any assets Fiat brings to the new company, assets that the senior credits couldn't get anyway). The market value could be either higher or lower. If just Fiat were buying the assets, we'd expect the market value to be higher; if just the government and union were buying, it might be lower since they might accept a money-losing deal.

If the assets are really worth $28.5 billion, then the sale of them for $2 billion is a ripoff of the senior creditors. It could be justified only by the argument that the alternative is a liquidation that would yield less than $2 billion.

Let's look closer at the assets, though, to think about the value for either liquidation or going concern. The Manzo report doesn't have details, so we'll have to some guessing. Current assets are the most accurately measured in accounts. They are $7.2 billion. Even if the inventory, valued at $4.3 billion, really could only be sold at 50% off the price of each car, current assets are still $5 billion. On the other hand, there are $5.9 billion in current liabilities-- accounts payable and such. Maybe in order to get the current assets, the senior creditors would have to pay the current liabilities-- I don't know enough about the situation, which is special in bankruptcy. Suppose they do. Then we're at a value of -$.9 billion going to NewCo.

Operating Leases and Gold Key Lease Assets are presumably contracts which the accounts accurately value (that is, they already a have an adjustment for expected bad debts). They're worth $3.9 billion. So we're up to +$3 billion going to NewCo.

Deferred Tax Assets, Intangibles, and Prepaid Pension are probably worth $0, so let's forget about them, and about "Other Long-Term Assets". Combined, those are listed at $4.6 billion, but we'll call them $0. So we're still at $3 billion going to NewCo.

Note that all these items so far presumably would retain their valeu in liquidation. In that case, the liquidation value so far is $3 billion, so even under the Court's legal reasoning, the sale price is too low.

The big item is Property, Plant, and Equipment, at $14.2 billion. These things are usually valued at cost, so the accounts might well be overvaluing them. Also, their value would be very different for liquidation than if they were run as a going concern.

In liquidation, a 90% loss seems a reasonable assumption. Then they are worth $1.4 billion, and the liquidation value is $4.4 billion.

As a going concern, PPE could be worth even more than cost-- as they are in any company that is making a profit as a going concern. To be conservative, suppose they're worth half of cost--- just $7.1 billion. That brings the value of assets as a going concern up to $10.1 billion.

Something important that I can't figure out quickly is whether if Chrysler is to be a going concern it must keep other liabilities such as its pensions. (Also, is Gold Key Lease Debt intimately linked to Gold Key Lease assets?--- are those creditors senior creditors?)

Some other things to think about: (1) What is the value of this deal to Fiat, the government, and the UAW? Does their interest tell us something about whether the balance sheet estimates are too low or too high? (2) What assets are intimately connected with liabilities? (3) What is the impact of the deal on the senior creditors? (4) Why are some assets being left behind in the Old Chrysler? (5) What would the government have paid if necessary to save the deal?

Update: June 11. A comment at HLS Forum: I'm an economist thinking of writing an academic article on an issue in this case: whether the $2 billion price should have been allowed by the judge.

This seems to me crucial. The judge answered "yes" under the reasoning that any price above the liquidation value of about $1 billion was reasonable. He didn't cite any judicial opinions for that reasoning. Was this a case of first impression for that point?

If we accept his reasoning, then whether the other creditors were pressured by the government is irrelevant, since the price they agreed to was reasonable.

I don't accept it. I don't think the Indiana Pensioners were all that clear about it, but here is what their position ought to have been:

1. The legal rule ought to be that a fair price in a 363 sale is a price that a Collateral Trustee acting faithfully to maximize creditor value would get.

2. In a 363 sale, that price is never the liquidation value. If there is a competitive market, it is that market price. If there is just one potential buyer, it is the result of haggling between a Faithful CT and that buyer.

3. The result of such haggling would ordinarily be somewhere about halfway between the liquidation value and the maximum amount the buyer would be willing to pay.

4. In the Chrysler sale, such a price might be as high as $13 billion, halfway between the $1 billion liquidation value and the $25 billion book value of the assets.

5. Since $2B is a lot less than $13B, the Collateral Trustee was not Faithful.

6. The Collateral Trustee not being Faithful is good evidence that the 90%+ agreement by creditors was pressured.

The "fair price" point would seem to be important to lots of bankruptcy cases.

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