Kill 'bad GM' so 'good GM' can live?

A proposal to split the automaker in two could save brands such as Cadillac and Chevrolet while letting a bankruptcy court liquidate Hummer, Saturn and other assets. [via msn]

General Motors (GM, news, msgs) executives and Treasury Department officials have made it abundantly clear that they want to keep the auto giant out of Chapter 11. But behind the scenes, GM and its advisers have been war-gaming various bankruptcy options as a last-ditch way to save the company.

One scenario being taken seriously goes like this: The automaker is split in two –- a "good GM" consisting of the brands and operations deemed most viable, and a "bad GM" made up of the brands slated for the junk heap, a big chunk of debt and underperforming operations.

The bad GM likely would be liquidated, say several people familiar with the automaker's thinking, and the good GM would emerge fairly quickly from bankruptcy as a going concern.

If GM ends up in bankruptcy court and chooses that strategy, it could solve some big issues.

So far, bondholders have shown little willingness to compromise -- at least not as much as GM would like. Under the plan, the automaker would convert much of its $60 billion debt into equity, and creditors would take stock in the "good" company and receive proceeds from the liquidated "bad" company.

With the threat of contracts being torn up in bankruptcy, the United Auto Workers might accept scaled-back staffing and benefits.

The two-company strategy also offers significant political and marketing advantages. The government, which would likely finance the company while in bankruptcy, could credibly tell taxpayers that the good GM had an excellent chance of prospering. And the move would tell consumers that it's safe to buy GM vehicles.

What would the good GM look like? Much like the company that executives described to Treasury officials in a restructuring plan filed in February. The good GM would keep Cadillac and Chevrolet. Ditto for GMC trucks, which are profitable in economically sound markets, and Buick, which continues to pack brand muscle in China.

GM would load up the bad company with Hummer, Saturn and any factories or operations it needs to ditch. Unless GM were to find a buyer, it would unload those assets in bankruptcy court, where they would be liquidated.

Dealers would have a tough time suing to be made whole while Hummer and Saturn are in Chapter 11. GM could even put its Canadian operations into bankruptcy. GM does good business there, but its pension plan is seriously underfunded. (Such a move would be less likely if the Canadian government provides GM the financing it has requested.)

Even with federal backing, a Chapter 11 filing would be risky, though. Creditors could hold up proceedings for a long time. As GM struggles to extricate itself, consumers could balk at buying its cars.

"Bankruptcy is like war," says Michael L. Cook, a bankruptcy attorney at Schulte Roth & Zabel. "You think you know about it until you go through it."

GM and the feds seem to agree.

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So why is GM war-gaming bankruptcy? Partly over concerns that the auto market could worsen. What's more, even if the union and bondholders were to give the automaker what it wants, GM would still need to borrow $22.5 billion to $30 billion from the Treasury to survive.

Add $8.4 billion in Energy Department loans to help GM make more fuel-efficient vehicles, and the automaker could end up with a debt load of more than the $60 billion it already has.

If the Treasury decides it doesn't want taxpayers paying GM's creditors, a creative bankruptcy might be the only way out.

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