Sunday, June 25, 2006

Is Ford running out of gas?

Goldman Sachs just made a big hire to run its newly created bankruptcy restructuring business. And one of Goldman’s big clients is Ford.

Is there a link between these two facts – e.g., is Ford soon likely to need Goldman’s burgeoning bankruptcy restructuring services? It could be shirtsleeves to shirtsleeves in five generations. As I pointed out three years ago in the
New York Times, companies are not required to report on where they stand with regard to terms of bank agreements which could help investors figure out the answer.

Ford stock has not been a good investment – it's tumbled 65% to $6.43 in the decade ending June 23, 2006 during which time the S&P 500 rose 90%. And its market share has tumbled from
24.8% in 1999 to 18.6% in 2005. With a $124 million loss in the last 12 months – a loss which would have been much bigger were it not for Ford’s vehicle finance profits -- and $12.54 worth of debt for every dollar of equity (compared to an industry average debt/equity ratio of 2.6), Ford has not escaped the notice of short sellers, who control 5.7% of its 1.83 billion share float, nor debt rating agencies, such as S&P, which rate its debt claims paying ability at junk levels.

I think the factors favoring a Ford bankruptcy outweigh the opposing ones. Here’s why:

Bankruptcy Pros

  • Near tripping covenants? I am appalled but not surprised that Ford does not report on the status of its compliance with bank covenants – terms of a contract between the company and its banks. This is important because if a borrower violates – or trips -- these covenants, the bank can demand immediate repayment of the loan and the company can file for bankruptcy if it can’t pay up. This comes to mind in considering that Ford carried a whopping $151 billion in debt (compared to a relative molehill of $21 billion in cash) as of March 2006 – up from $134 billion at the end of 2005. According to its financial statements, its contracts with lenders require it to maintain "certain debt-to-equity limitations, minimum net worth requirements and credit rating triggers." I have been unable to find details of the trigger levels -- e.g., Ford must maintain a debt/equity ratio below 14 – the violation of which would cause Ford’s banks to demand immediate repayment of its loans. However, the levels of the covenenant variables have deteriorated. For example, Ford’s debt/equity ratio has increased from 10.25 in March 2005 to 12.58 in March 2006; its credit rating from S&P tumbled from BB+ at the end of 2005 to BB- in January 2006 and its net worth has fallen from $15.7 billion in March 2005 to $12 billion in March 2006. Investors are in the dark as to how close Ford is to tripping its covenants;
  • Double digit bond yield. According to one former Wall Street banker, one way to tell whether the market thinks a company is about to file for bankruptcy is to look at its bond yield. Anything trading in the "high teens" is close to the edge. By that measure, Ford may have some breathing room, although at 10.6%, its bonds are yielding higher than ever in its history;
  • Negative free cash flow. Ford’s free cash flow – the cash available after capital expenditures – was a whopping negative $44.7 billion in the 12 months ending March 2006 – and in the most recent quarter its negative free cash flow was $2 billion. If Ford can’t generate positive cash flow, it becomes harder to pay back its debt;
  • Higher interest rates. According to Goldman Sachs analyst, Gary Lapidus, higher interest rates squeeze finance arm, Ford Motor Credit's profits. With the Fed raising rates and its credit rating declining, so is the spread between Ford's borrowing costs -- which are rising -- and the rate at which it can lend out money -- which is being slammed by competitive pricing and its own 0% financing gambit to regain lost market share;
  • Losing US market share. Ford’s North American operations, which lost $1.6 billion in 2005 and $1.2 billion in the first quarter, are losing market share. During the first quarter its US share fell to 17.6% from 18.2% the year before. This is a concern to ratings agencies and the lower the ratings, the higher Ford’s borrowing costs and the closer it comes to tripping a financial covenant; and
  • Insider selling. There are many reasons why an executive would sell shares of his or her company, not one of which is that the executive believes that the shares will rise in value. This maxim comes to mind in noting that there have been no insider purchases of Ford stock in the last six months – but 173,224 shares sold. While this does not pertain to Ford’s imminent bankruptcy, it does suggest a lack of confidence in the future of the stock by those who should know best.

Bankruptcy Cons

  • Newer models. Ford expects that by 2008 the average age of its fleet will be 3.2 years compared with 4.4 years today – including the Fairlane line which will be a more fuel efficient minivan line;
  • Small cars. Ford expects that by 2008 it will introduce three small cars selling for under $20,000; and
  • Ad campaign. Ford’s advertising campaign linked to American Idol is likely to generate goodwill.

The factors keeping Ford from bankruptcy appear to be a thin gruel. If my analysis is correct, Goldman’s James H. M. Sprayregen could soon be knee deep in axle grease as he helps Henry Ford’s great-great grandson take Ford out of bankruptcy.