Back on September 17th, this blog suggested that the UAW fund its retiree “VEBA” – which stands for Voluntary Employee Retirement Association, and will henceforth be referred to on this blog just as VEBA – with GM stock. The idea was that it would give the union a say in the company’s future, so they wouldn’t just be suckers picking up the pieces when management screwed up.

Maybe someone was listening. 

The UAW could end up owning a very large part of GM’s stock. And, the UAW’s members now have a big stake in the company’s future.
 
Though the press reports that GM has agreed to pay $35 billion to the UAW to assume GM’s retiree health care expenses, that’s not true. Both sides got a better deal than that.
 
The way the VEBA has been structured is nifty. Company management and union leaders are entitled to feel smug. The strike seems to have been a message to UAW members, not to GM. The deal is based on a community of interests. 
 
Were GM paying $35 billion, it would be paying 70¢ on the dollar to shed its current retiree health care liabilities, at least a 5¢ above top dollar. (The up front price is less than the total exposure because the exposure is paid over time. It’s like looking at your mortgage through the other end of the telescope: at it’s end, the bank gets $750,000 in principal and interest for loaning you $250,000 to buy the house now. As they say, “time is money.“) 
 
Up front, GM agreed to pay the VEBA $24.1 billion this coming January. But the VEBA doesn’t start paying benefits from its own funds until 2010. In the meantime, GM kicks in another $5.4 billion to cover the gap.

Total, $29.5 billion. That’s 60¢ on the dollar.

Plus, the UAW being nervous about health care costs rising faster than expected, GM agreed to pay as much as $165 million in any one year and no more than $1.6 billion total over 20 years to cover deficits incurred by the VEBA. But: GM’s only pays if the VEBA loses money in a given year and, even then, GM’s exposure is capped for the year and for at the total. So, if the VEBA lost $300 million in two successive years, i.e., $600 million, GM would only pay $330 million. 

Should the VEBA put together twelve years of $300 million dollar losses, i.e., $3.6 billion, GM would be responsible for no more than $1.6 billion – and it could be even less if the losses weren’t even: if the VEBA loses $1 billion in year one and $300 billion in year two, GM’s exposure is 2 x $165 million = $330 million, even though its cap is $1.6 billion.
So, that $1.6 billion is a worst case scenario. GM could walk away for $29.5 billion. Incidentally, the difference between worst and best case scenarios is about 1/6th the cost of developing an entirely new vehicle platform.

Now, here’s where we were right:

GM also writes a “convertible note” to the VEBA for $4.7 billion. It is by adding this to the $31.1 billion figure that the press comes up with the big number of $35.8 billion.

But, that’s not a payment up front and it isn’t cash. So, it isn’t worth $4.7 billion. 

Use of a convertible note is truly clever – but, perhaps you should have expected no less. Both the union and the company are run by accountants and both were being advised by some of the top investment banking houses in the country.

A “convertible note” means that the holder of the note – the one to whom the money is owed – has two options. The holder can simply take the interest plus principal. That makes it basically a bond. Or, if the stock price of the company gets above a designated point, the holder can elect to convert the note into company stock, at a price which is significantly below the market value of that stock. That makes it an option.

A convertible note is, in essence, an investment play on the company’s stock with no risk of loss. If the stock tanks, you take the bond price. If the stock soars, you convert at the option price, sell the stock and reap the windfall profit of the difference.

Of course, there’s nothing that says you have to sell that stock. You could keep it, figuring it would go even higher. 
Should that happen, the UAW VEBA would be GM’s biggest shareholder.

So, who really, really wants you to buy GM?

What do you think?
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