Too big to fail?

With the US automakers in dire straits at the moment, I’ve read a lot of commentary that says General Motors, Ford and Chrysler are “too big to fail” and the government HAS to bail them out. In Old Mutual, South Africa has its own business that in theory is “too big to fail”, but one that I am going to stick my neck out and say can and will fail.

Do I think the US carmakers will be bailed out? Yes I do.
Do I think it will solve their problem? Not a sausage.

Let’s be realistic – the operating environments for these car manufacturers is not going to change over 2009. The reality is that even if they cut some costs, shut down some lines etc, the US tax payer is going to have to acknowledge that when they cross that fat black line of bailouts, they’re going to be tied into paying at least another year of bailouts to make for an orderly exit.

Lets pick an arbitrary figure of US$15bn per quarter to keep these 3 firms afloat – that is 60 BILLION dollars a year just to keep 3 businesses afloat. With the GM and Ford Credit arms being so stretched, I see this house of cards collapsing and THAT will be the shock to the system that leads me to my next assertion – the straw that breaks the back of Old Mutual.

Old Mutual is a funny business. Very successful in the Nordic regions and South Africa, management instead has decided that its real future lies in places like China and the US. So far the expansion plans have been littered with very expensive failures, that the company has been able to gloss over with the impressive gains in the equity markets.

Over the last few 12 months the company has plummeted from R23 odd a share to around R8.50 a share. Ouch. In the meantime they paid over the top for an acquisition in China and they’ve been pissing into the wind with something like US$400m in capital to deal with problems in their Bermuda book and the US life operations.

The company has said that shareholders shouldn’t worry because it has US0.8bn in capital reserves but this figure does exclude money they need to still release for their Chinese acquisition and a final dividend which now looks increasingly under threat.

But something occurred to me the other day – Old Mutual’s capital problem is two-fold. They may have the capital – but where does that capital sit? In London or in SA? The answer is that a big chunk of that capital in fact sits in South Africa (one of the few places where they are making good money).

Foreign exchange regulations are going to be very tough to move that capital off shore should their international ops take much more strain. At the end of the day, if they sell off Mutual & Federal, the capital will remain in South Africa, as would a big chunk of an asset such as Nedbank.

I personally don’t think Old Mutual’s (international operations) can survive the shocks to the system that another (sudden) 15% decline in equity markets could produce. But more importantly it’s the operating environment that has me the most worried.

A mistake I think is being made, in that we’re not giving enough credit to the ‘suddenness’ of events.

Six months ago, we didn’t ‘expect’ to be discussion trillion dollar bailouts and the failure of some of the world biggest companies.

People are going to lose their jobs and it is not going to be a gradual dip spread out over next year, where systems can adjust. People are losing their jobs NOW, businesses are closing down NOW, governments are retrenching people NOW.

Consumers are stretched beyond breaking point – there is no savings base of any kind behind them – their cash is gone and the only way they can keep going is to source credit. When that tap is turned off they cut expenses – insurance, medical aid, pension fund contributions (which they will cash out irrespective of tax consequences – when you need money you need money).

Conclusion
While Old Mutual’s South African operations will probably survive, I suspect that the risk of failure in its international businesses must be extremely high at the moment. SA will probably be cushioned by a pretty strong business model (despite the grief they are given) and the cash flow from the sale of Mutual & Federal, even if they walk away with far less than the business should be worth….