Peugeot, Its Record High Default Probability, And A Brief Primer On Corporate Viability Under Socialism
With central bankers dominating the airwaves, and the only thing that matters is who prints where and how much, most can be forgiven to have missed one of the more important micro developments in the past few weeks: namely the case study of emblematic French automaker Peugeot, which just happens to be Europe's second largest, and its Credit Default Swaps, which have doubled in the past 4 months, to a record high spread of 813 bps, which means the probability of default for the company has nearly doubled from 29% to 52% in a few short months. Yet what is it about Peugeot that is interesting - well the fact that the biggest spike in its default risk has taken place in the last few days, which have seen a nearly 100 basis point spike. The catalyst: "French President Francois Hollande, elected in May after pledging to block a “parade of firings,” said July 14 he would lean on Peugeot to rework the plan intended to stem losses and trim production capacity. The government will report the findings of a review later this month, as well as measures to prop up the French auto sector." The problem is that this type of state intervention into corporate viability and profitability is precisely what precipitates wholesale bankruptcy. And this is precisely what the bond market has reacted to. Because while Hollande is doing all he can to pander to populism, and to recreate America's epic failure involving GM, the reality is that by enforcing what he thinks is "right" and "fair" dooms not only Peugeot and its 200,000 employees, but millions of upstream and downstream workers.
Bloomberg has a brief background on the story:
Europe’s second-largest carmaker announced plans to close a French factory and eliminate a total of 14,000 jobs. Peugeot is burning through 200 million euros ($244 million) of cash each month and Moody’s Investors Service placed its Ba1 rating, already junk, on review July 13 for a possible downgrade. Peugeot’s manufacturing and sales organizations had financial assets and undrawn credit facilities of 9.6 billion euros as of December 31, the last date for which they provided full data.
Peugeot’s cash reserves allow it to “survive for one to two years,” said Xavier Caroen, a Zurich-based Kepler Capital Markets analyst who has a “hold” rating on the company. “We hope the French government lets them cut production and shut some sites in France, or they won’t have any earnings in the future,” Caroen said.
In other words, all else equal, the company will, in its current format, go out of business in "one to two years" as it simply can not grow into its balance sheet, and because its expenses far outstrip its revenues. So what does the company do? The logical - it fires, or specifically it announces its intentions to fire, 14,000, or about 7% of its labor force: an act which in itself very well may be insufficient, but at least it will extend the viability of the firm courtesy of a modestly reduced cash burn.
Not so fast, says president Hollande.
Instead, according to the socialist, the company is wrong, and he is right, in that its top line can support its overhead. How? Nobody knows, but according to the French president, 1-2 years of cash viability is not a concern (and by that time who knows: maybe someone else will be president anyway). So instead what will happen is Peugeot will not fire anyone, and the market, convinced that the company is a goner will send its cost of debt into the stratosphere making refinancing, or loan extension, impossible. And who can blame the market: without a gun to its head, who wants to literally burn money?
So as the company gets locked up into a terminal toxic spiral of ever increasing debt costs, and ever declining cash flows, what happens? Well, in two years the company filed for bankruptcy, and instead of 14,000 people being fired today, in the process extending the viability of the company for at least a few years, the company will without any doubt, file for bankruptcy by 2014 at the latest, costing the jobs of not only the firm's employees as it gets acquired by some Chinese auto consortium merely for its trademarks (and certainly not for its unions), at pennies on the dollar, but also millions of jobs of upstream vendors as well and downstream distributors, retailers, mechanics, and all other related jobs.
So here is today's lesson in corporate viability under socialism:
- Lose 14,000 jobs today, while preserving the enterprise and its 186,000 remaining jobs, but losing some popularity in the process
- Or be hailed a hero of the people and for the people, preserving 14,000 jobs for 2 years, and watch as your entire auto industry disintegrates in two years.
This is a question we would pose not only in France, but every other place that is experiencing creeping socialism. Which incidentally is every country in the "developed" world.