The General Motors (GM) Bankruptcy Trade - How to Profit Without Shorting the Stock
Bear with me, finance post ahead:
As most of you know, GM filed for Chapter 11 bankruptcy this morning, listing $172.8 billion of liabilities and only $82.3 billion of assets - a $90.5 billion shortfall. Even assuming that GM can liquidate their assets (they won’t) at book value (they can’t), that means that before common equity holders see a penny, $90.5 billion of debt will have to be forgiven - 52% of the total outstanding amount.
Additionally, it appears the ownership structure for the “new GM” has already been set: Under the proposed restructuring, about 60 percent of the new GM would be owned by the United States, about 12 percent by the governments of Canada and Ontario, 17.5 percent by a union health trust, and 10 percent by the company’s current bondholders. Do you see any allotment for existing equity holders?
Further, the precedent established by the Chrysler bankruptcy is that equity holders are completely wiped out - Cerberus took a 100% write down on its investment in Chrysler.
Accordingly, I (and many others, based on what I have read) believe that GM common stock is headed to $0.
If you agree, here’s how to play it:
GM December 2009 $1 puts (GM XV) are trading at $0.71 per contract. This means that if the equity goes to $0 before mid-December 2009, your profit is $0.29 per contract, or about 40% on your original investment.
Risks to the position include:
- Bankruptcy process not resolved by options expiration in December 2009 - I believe this is unlikely, for two reasons. First, the Whitehouse Fact Sheet on the GM bankruptcy outlines a 60-90 day process, which takes us only through August 2009. Even if bureaucracy bogs down the process an additional 90 days, December 2009 still gives us plenty of time. Second, the precedent set by Chrysler’s quick bankruptcy process indicates a desire for expediency by the government.
- Risk of additional government involvement to drastically cram down bondholders - I believe this is also unlikely. Most bondholder negotiations take place pre-bankruptcy filing, and this is no exception. It appears that bondholders have already come to an agreement with the Whitehouse to swap their debt for equity in “new GM”.
So that’s my basic thesis. Anyone that’s still with me - thoughts?
