June 7, 2007 - $1 Billion is not enough!

6/7/2007

The fact remains that, in the end, you cannot give away risk.

At the end of 2006 Goodyear Tire & Rubber reached an agreement with the Steel Worker’s Union that essentially allows Goodyear to fund a trust with $1 billion for future healthcare benefits. Considering that up until this time Goodyear had set aside nothing for healthcare benefits, that might sound like a good deal for the workers. Considering that the healthcare liability for current and future union retirees was over $1.3 billion, it might not sound like a good deal at all.

Who are the winners in the deal? The company wins because it has traded a growing, unfunded, and even unknowable liability for a one-time fixed payment. This relieves Goodyear of future increases in cost in an area that seems to have no upper limits. The union wins because, even though it does not have direct control over the trust, it does have direct control over the election of board members to the trust and negotiates what other contributions Goodyear might make to the trust. In an economy in which private sector union employment has plummeted in recent decades, this also gives the unions a way to stay relevant. Shareholders of Goodyear win because the deal removes a cloud of uncertainty from the company’s financial future.

Who are the losers? Current and future retirees are on the short end of this stick, along with union employees. According to the terms of the deal, there will be no changes in benefits throughout the current contract, which expires in December 2009, but after that all bets are off. Starting with the new period in January 2010, the union states that the committee overseeing the trust will have to administer the assets (meaning the funds available and the liabilities to be paid) in the best interest of all participants. This means that because there are not enough assets to pay the benefits at current levels (which is already true), there must by definition be a cutback in what is offered. The employees of Goodyear lose because several types of ongoing contributions from Goodyear have been determined- Cost Of Living Adjustments, Profit Sharing, and even future raises are on the table. So essentially employees will be contributing more to the plan, even if not directly.

This approach – trading a huge liability for a smaller payment now – is being studied by most employers in the auto industry. The next great test will be when Cerberus negotiates with the unions of Chrysler concerning the takeover from Daimler. For the deal to be successful, Cerberus will have to win concessions from the unions that match in principle what happened at Goodyear. When that occurs, the unions at GM and Ford will follow. This will rearrange the puzzle pieces concerning the viability of these companies going forward, and potentially will have a tremendous impact on their enterprise values.