- By Praveen Chawla
Garrett Motion Inc. (GTXMQ) is a Tier 1 supplier to the automotive industry. The company primarily develops highly engineered turbochargers for both diesel and gasoline vehicles. Together with its main competitor, BorgWarner Inc (BWA), the company dominates the market for turbochargers.
The company was spun off of Honeywell International Inc. (NYSE:HON) in September 2018. As part of the spinoff, Honeywell loaded Garrett down with debt, which it used to extract a $1.4 billion payment (which is a scummy but typical private equity strategy). More importantly, however, it cleverly forced it to assume a chunk of its asbestos liability. As the balance sheet shows, Garrett has negative equity: assets of $2.066 billion versus liabilities of $4.169 billion.
On Sept. 20th, Garrett Motion filed for Chapter 11 bankruptcy protection while also proposing a $2.1 billion sale of the business to private equity firm KPS Capital Partners. KPS will be its stalking horse to acquire the company's assets following its filing on Sunday in the U.S. Bankruptcy Court in Manhattan.
"Although the fundamentals of our business are strong... the financial strains of the heavy debt load and liabilities we inherited in the spinoff from Honeywell - all exacerbated by COVID-19 - have created a significant long-term burden on our business," CEO Olivier Rabiller said.
On Dec. 2, 2019, Garrett filed a lawsuit against its former parent company. Its allegations included: 1) top Honeywell executives devised the spinoff to offload its asbestos liabilities, 2) Honeywell did not negotiate the one-sided Indemnification Agreement with Garrett, 3) the Indemnification Agreement violates New York law, 4) onerous and unlawful covenants in the Agreement affects Garrett Motion's key corporate decisions for 30 years and 5) Honeywell breached the Agreement it wrote for itself.
In the complaint, Garrett Motion also alleged that it did not have proper legal representation since Honeywell retained the same lawyers for both parties, thus creating a conflict of interest. Garrett says that the Indemnification Agreement illegally requires it to indemnify Honeywell for punitive damages. Additionally, it says the agreement hobbles the company's ability to refinance debt and engage in corporate transactions such as a mergers and acquisitions deal. Since Garrett also has no right to prepay Honeywell for the liabilities, the latter is essentially in control for 30 years. To top matters off, Garrett also noted that Honeywell failed to provide information regarding the asbestos liabilities despite repeated requests for more than a year.
Overall, this appears to be an elaborate plan concocted by Honeywell to get rid of a cyclical and declining business, while at the same time extracting maximum profits and ridding itself of asbestos liabilities. However, it may be that the company just got a bit greedy.
Garrett, on the other hand, is desperate to rid itself of Honeywell's asbestos burden. The business itself looks to be highly cash generative. In spite of the huge debt load, the company earned net income of $217 million on a trailing 12-month basis until June. Management appears to have coordinated with bondholders and KPS to file bankruptcy to offset the Honeywell liability.
Shareholders are clearly the only ones at risk of getting fully wiped out. However, since the Chapter 11 filing, Garrett has been delisted from the New York Stock Exchange and now trades on the over-the-counter exchange. Shares have appeared to rebound, which means the market is expecting a substantial recovery for equity holders. Of course, the stock is still extremely speculative.
The drama should play out over the next several quarters in the courtroom and on the negotiating table. Bloomberg reported that Oaktree has offered to buy Garrett's assets and is seeking Honeywell's support given it owns the subordinate asbestos liabilities, which are senior to equity holders.
For the equity holders, this could be a multi-bagger or a complete wipeout. They are likely to launch their own lawsuits (via class-action lawyers) and Honeywell could also be targeted for illegal conveyance of asbestos liabilities. So there is a lot of smoke and fog on the battlefield, so investing now is only for the most risk-tolerant and intrepid of traders. Lawyers and bankruptcy specialists will be examining the documents to determine potential outcomes. It will be interesting to see which gurus jump into the fray in the coming weeks.
Disclosure: The author has no positions in Garrett Motion.
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This article first appeared on GuruFocus.