Trade Around Delphi Is Getting Hairy

Hedge funds struggle to gauge the company's solvency prospects.
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Speculators continued their frenzied dance around

Delphi

(DPH)

Wednesday following the auto-parts maker's reported bid for $6 billion in aid from former parent

General Motors

(GM) - Get Report

.

About 16 million shares of Delphi traded by late afternoon, nearly thrice the daily average. The stock was down about 4% to $2.65 as traders -- many of them hedge funds -- struggle for insight into the company's battle to remain solvent.

Delphi bonds also firmed.

A GM spokesman would not confirm the aid request, first reported by

Bloomberg

, but did say the two sides were in talks. Delphi also acknowledged the negotiations without being more specific.

The question for GM boils down to a cost analysis: Is Delphi more expensive in or out of bankruptcy?

"It is a tossup," says Brian Johnson, an auto analyst at Bernstein & Co. "It's going to be huge volume on Oct. 17." That's the date a new and tougher bankruptcy law becomes effective.

"There is a bullish spread now," says Johnson, noting that there is more upside in the stock than in the bonds because bonds can only move up to par. "If there is a deal, the stock could go up to $4-$6," he says.

"The market has not made up its mind one way or another," says a hedge fund executive who declined to be identified because his firm -- like almost every major hedge fund -- is involved in the trade.

The executive says that the greatest opportunity for gains is in the equity, followed by the short-term bonds. Longer-term bonds have less upside. For this reason, "people are long the stock and short the bond," he says.

Johnson sees one promsing bond: the Delphi Trust bond. Trading at a deep $27 discount due to its illiquidity, the paper could move up substantially if a deal happens, he says.

So will it?

For some, the answer is yes, because Delphi going bankrupt would end up costing more than $6 billion to GM. "Things will work out for Delphi given that there is a pretty good case for avoiding bankruptcy," says the hedge fund executive. "GM could justify helping Delphi because it could get really hurt if it doesn't."

The $6 billion aid request is the first time that a real figure has been thrown out in the market for people to comment on or react to, he says. "But it is a misleading one," he adds.

If Delphi filed for bankruptcy, GM is liable for pension costs and may also have to pick up some health care claims. And then there is the "incalculable cost of disrupting business," he says, because Delphi is GM's main auto-parts supplier. The company could lose market share and see costs rise by as much as 3% -- $500 million a year -- from losing its supplier, he says.

Others are less sanguine.

"We expect continued pressure on

Delphi equity," says Johnson, adding that fears are likely to spike Friday should Delphi not repay a bank loan. "No party

Delphi, GM or the union appears to be optimistic."

For Johnson, $6 billion in aid is a stretch. He estimates that GM support is unlikely to top $3 billion, saying GM could decide not to pay for full health care, limiting coverage to Delphi employees who have already retired. The union knows that and should prefer a deal to a Chapter 11 filing, he says. That leaves the company's fate with its union, Johnson reasons. But Delphi, "a company with $2.6 billion in cash on its balance sheet and that is not really burning a lot of operating cash, could withstand a long period of uncertainty well until next year," says the hedge fund executive.

Calls to a UAW spokesman and to a Delphi spokeswoman were not returned.