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GM's Road To Recovery Parts 1 through 3

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Part I

GM’s Road To Recovery, Part 1

Back In Black

Posted: May 21, 2010

All Articles are by David Kiley

This week General Motors reported $1.7 billion in earnings before taxes and interest charges for the first quarter, and a net profit of $865 million. Wall Street analysts and company insiders say the automaker’s surprising pool of black is a sign of regular profits to come and could lead to an initial public offering of stock as early as the end of this year.

GM’s first-quarter profit came on a 40% surge in revenues, a remarkable achievement considering the company has shuttered half its brands and is not deriving profits from a finance unit. The first quarter black ink follows a $3.4 billion fourth quarter loss that actually contained $3.1 billion in one-time charges, meaning that GM was within $300 million of breaking even last December. After nearly running out of money at the end of 2008, GM had positive cash flow of $1 billion in the first quarter. The North American operation, long the source of GM’s financial woes, earned $1.2 billion before interest and taxes.

GM still has a long way to go before taxpayers, who today own 61% of GM, are no longer shareholders. The last time GM turned an annual profit was 2004, when the auto industry at large sold almost 17 million vehicles in the United States. This year, most analysts expect sales of fewer than 12 million. But the first quarter profit is the first step toward convincing institutional investors, as well as individuals, that GM stock will be worth buying again when its ticker symbol returns to the stock exchange, and the company again takes up its place on the Standard & Poor’s 500 Index.

The other sign that GM’s recovery is going better than expected is the company’s move last month to pay back the remaining $5.8 billion in loans made to the automaker by the U.S. and Canadian governments. The mass of confusion and criticism surrounding those payments, however, has somewhat dulled their impact. GM paid back those loans from escrowed Troubled Asset Relief Program funds it now says it does not need for its survival. But lost among misleading headlines and partisan chatter over GM essentially paying back government loans with other government funds is that GM is able to give back any money at all, less than a year after emerging from Chapter 11.

“There is no doubt that GM is making real headway in every category of their business,” says Joseph Philippi of Auto Trends Consulting, Short Hills, NJ. “But getting out from government ownership is going to be complicated and it may take a while.”

How Else Has GM Improved Its Business?

GM’s debt has gone from $94.7 billion before bankruptcy to $17 billion. That’s less than half of Ford’s comparable debt. GM has cut its annual operating costs by $10.7 billion a year. GM’s market share has dropped from 21% a year ago to 18.7% through April, despite shedding four of its brands (Hummer, Pontiac, Saturn and Saab). The company has recast its board of directors with new members, as well as purging senior executives considered too hidebound by GM’s old culture.

Does GM Have Real Momentum In The Marketplace?

One of the things GM is trying to make people forget is the name “General Motors.” Former vice chairman Bob Lutz, who retired from GM last month, said that former management was convinced that GM would fall off a cliff if it filed for bankruptcy because no one would want to buy a new vehicle from a bankrupt automaker. In fact, surprising few consumers directly associate Chevrolet, Cadillac, Buick and GMC with GM. The latest generation of vehicles, like Buick LaCrosse, Cadillac CTS, Chevy Equinox, and Buick Enclave have been highly praised by the automotive press and Wall Street, and are generally viewed as comparable in quality to Asian and German vehicles, and better styled in many cases.

What Are The Biggest Challenges To GM’s Recovery?

The government’s auto task force said that GM’s sales and marketing, and its management of its brands, was one of the two biggest problems at the company. The other was its financial management. The company has had three marketing chiefs in less than a year. But it recently hired the chief marketing officer from Hyundai, whose reputation for aggressive and innovative moves helped transform Hyundai’s image from a cut-rate Korean brand to a legitimate rival to Honda and Nissan. GM has shuffled executive seats quite a bit since emerging from bankruptcy and that has to stop if investors are going to have confidence in management.

Part II:

GM’s Road To Recovery, Part 2

Tracking The Improving Fortunes of “Government Motors”

Posted: May 22, 2010

Tracking GM’s recovery and calculating how much it is still beholden to the taxpayer -- and for how long this is likely to continue -- is confusing. But here are the important numbers, dates and facts to keep in mind as GM lurches toward an initial public offering of stock, and determines whether Wall Street and Main Street view the automaker as a bankable brand again.

How Much “Bailout” Money Has GM Received?

President Bush approved a bailout plan on December 19, 2008, which would give loans of $17.4 billion to U.S. automakers GM and Chrysler. Bush initially provided $13.4 billion, with another $4 billion available in February 2009. Of that, GM got $9.4 billion and Chrysler $4 billion. GM did not take the second payout scheduled in February.

GM filed for Chapter 11 Bankruptcy on June 1, 2009. The Feds provided $49.5 billion in what is called “Debtor-In-Possession” financing. This was operating capital to allow GM to restructure its operations. Normally, banks provide this financing. But given the fragility of the financial system and the risk of GM not making it, no banks stepped up. The U.S. provided $6.7 billion in loans and took 61% of the company’s equity in exchange for $42.8 billion in cash. The Canadian government gave GM $1.4 billion in loans, and $8.1 billion cash in exchange for 12% of the company’s equity.

So the total General Motors received from the U.S. was $59 billion, including the $9.4 billion before the bankruptcy.

GMAC, GM’S finance company, was given $5 billion in December 2008 and $7.5 billion for working capital in May 2009. At the times of these payouts, GM owned 49% of the finance subsidiary. Today, the unit is out of GM’s hands, and is majority owned by the Feds. GM is not on the hook for the bailout money given to GMAC, now called Ally Financial. The finance company today continues to provide financing to GM and Chrysler dealers and car buyers. GM is now making overtures to reacquire the finance company so it can better control the underwriting of loans to its customers.

Who Actually Owns GM?

After the government’s 61% stake and Canada’s 12% stake come the United Auto Workers union and former GM bondholders. Canada owns 12% of GM, because of the $9.5 billion it kicked in to GM’s reorganization in order to protect thousands of Canadian jobs.

As part of the bankruptcy deal, the UAW’s Voluntary Employee Beneficiary Association Plan (VEBA), which pays healthcare benefits to GM retirees, agreed to forgive $20 billion GM owed the VEBA during GM’s bankruptcy proceedings. The union agreed to accept a 17.5% stake in the new GM, plus $6.5 billion in preferred shares and a $2.5 billion promissory note from the U.S. government. This was a crucial agreement in GM getting through bankruptcy, because GM was drowning in what had become a long-term $60 billion obligation to paying retiree healthcare costs. If the union hadn’t agreed, it could have driven GM into oblivion by striking its factories.

Holders of GM’ corporate bonds were owed $27.2 billion before the bankruptcy. Those bonds were backed by hard assets of GM, such as factories and real estate. In order to get to them to agree to the bankruptcy terms, bondholders received a 10% equity stake, plus so-called stock “warrants” that could eventually give them a 15% stake.

How And Why Did GM Pay Back Its Loans Last Month?

Clearly, GM was trying to write a new story for itself by giving back money it doesn’t think it will need. The idea was to announce that the loans that were part of the bailout were paid back, so as to change the national conversation from “Government Motors” to "GM Charging Back!”

Banks that received TARP (Troubled Asset Relief Program) money enjoyed a change of sentiment after paying back TARP money. And Ford has been benefiting from not having taken bailout money at all. So, GM took money from one government funded bucket of money it had from TARP -- a $13.4 billion escrow account -- and used it to pay back loans, on which it was paying 7% interest, to the government.

It was a wise business move since GM's sales and cash-flow are much better than anticipated. Where the company erred was in running a television commercial with chairman Ed Whitacre saying: “We have repaid our government loan, in full, with interest. Five years ahead of the original schedule." The swagger of the ad, critics contend, gave the misleading impression to consumers/voters that GM had paid the whole bailout back, even though that's not what the ad literally stated.

Fueling the outcry against GM was The Wall Street Journal, which printed a headline above an op-ed article by Whitacre stating: "The GM Bailout: Paid Back in Full." That headline, written by the newspaper and not GM, was incorrect and misleading. GM, nor Whitacre, ever said the bailout was paid back in full, just the loans. But it played to the public as if Whitacre was overreaching in how he described the loan repayment. The ad conveyed the wrong idea, too. It is perhaps not surprising that GM reassigned chief marketing executive Susan Docherty to its Asian operation after this ad debacle.

Did GM Pay Back The Loans So It Could Get Better Terms On New Loans That Will Be Coming From The Department of Energy?

GM has applied for a $10 billion loan from DOE to retool plants and develop greener vehicles. That loan carries an interest rate of 5%, assuming GM gets it. But it would have been politically dicey for DOE to award GM the loan (DOE is making similar loans to Ford and other automakers and parts makers as well) if it still had the outstanding bailout loans.

Why Will GM Issue Stock To The Public?

It wants to trade government and labor ownership for public ownership. There is a stigma to being owned by the government. Besides, the governments, the union and bondholders don’t want to own equity in GM. They want to get the money that is owed to them. In order to do that, a market or GM stock must be created so they have others to sell their stock to.

Part III:

GM’s Road To Recovery, Part 3

Would (Or Should) You Buy GM Stock Again?

Posted: May 23, 2010

It was just a year ago that shareholders of General Motors were getting ready to watch their stock certificates become worth more as toilet paper than investments. And bondholders, especially retirees who were counting on the income and never thought they’d have to worry about GM defaulting on a debt payment, were being told that they had bet wrong.

Now that GM has been stripped of onerous debt and brands that were suffocating its ability to grow profitably, the question that will face investors of every stripe, from big-time portfolio managers to retirees and even recent college grads looking make money in the market, when the “new GM” issues stock perhaps as early as this November or December is this: Would you buy GM?

A decade ago when the Internet bubble was inflating, Initial Public Offerings were the rage. Any new company with an “e” in front of its name came out of the shoot like a horse hopped up on steroids for the Kentucky Derby. Why not? According to Renaissance Capital, a firm that specializes in IPOs, investors could expect an average 64% return on the first day of trading when a new stock was issued in 1999 and 2000. Getting in on an IPO on the first day was like buying a winning lottery ticket.

It hasn’t been that way recently, however. Since 2006, the average return on an IPO stock after one year has been 3%, while the return after two years has been a 42% loss. And in that time, only 26% of the companies that went public have been profitable. “It’s a much different IPO market today than individual investors remember from a decade ago,” says Kathleen Smith, chairman of Renaissance Capital, which has been tracking IPO performance.

One of the factors ginning up enthusiasm among investors anticipating a GM IPO has been the enormous returns by investors who bought Ford shares in early 2009, or the shares of auto parts makers. From March 9, 2009 to May 7, 2009, Ford’s shares climbed 600%. Parts maker TRW Automotive’s shares climbed 1,800% during the same period. Other parts companies like American Axle and ArvinMeritor were penny stocks in March of last year, and have roared back with similar returns for those nervy enough to have bought the stocks off the lows. “You can’t look at that, though, because those gains came off artificially low, panic prices,” says Joseph Philippi of Auto Trends Consulting, Short Hills, NJ, who was a long-time Wall Street auto industry analyst before becoming a consultant.

A GM spokesperson says the company is not ready to discuss the timing of its IPO, and did not offer comment about speculation that it will come as early as the fourth quarter of this year.

Beforehand, GM will do what is called a “road show” in which GM and its advisors will make a series of presentations to portfolio managers who buy big chunks of stock, and who will examine GM’s finances and give GM their input on what price the stock should be offered at. GM will issue new shares to the public, probably equaling 20%-30% of the company, as is the case with most IPOs. But GM and the investment banks that syndicate the IPO to investors will determine the right number of shares that will be offered to the public.

The Federal Government, Canada, the UAW and bondholders, which own GM today, will have the private stock they hold today exchanged for public stock, but will be restricted for a period of time after the IPO from trading their stock. In truth, they wouldn’t want to sell right away anyway because the idea is to let the public stock trade high enough that they could cash out of their private equity position at break-even or at a profit.

Stock analysts following GM today say the company is worth about $68.6 billion. GM would have to raise a total of $80 billion from new investors in order for all four groups to break even. With 500 million shares outstanding held by the four groups, their break-even share price is about $137.00.

So, for example, while President Obama has said that he intends to unwind the government’s ownership stake in GM as soon as is practical, the taxpayers could potentially do better than break-even if the government holds shares longer and GM’s fortunes improve. On principle, though, the government is not looking to make a killing on GM stock. There is political pressure for Uncle Sam to sell its stake soon after the shares hit the break-even point.

So, How Good An Investment Will GM Make?

Until the automaker starts making its case to institutional investors and investment bank advisors, there are more questions than answers. And because Congress was, and is, so divided about whether the government should have bailed out GM, as well as Chrysler, some of the questions that will be raised will be political in nature. To that end, GM will surely wait until after this November’s mid-term elections are over before it gets into the details of an IPO.

Do We Know About What One Share Of GM Will Cost?

Not yet. Wall Street will look at how the market is valuing other automakers such as Ford, Nissan, Toyota, as well as major auto parts suppliers. Right now, many of those companies are trading at a share price that is around six to ten times earnings per share. So, if GM through the third quarter of this year is on track to earn, say, $3 billion, that would be $6 a share based on 500 million shares outstanding. Eight times that amount would be $48. Once the IPO occurs, and there are, say, 100 million new shares issued to the public, the value of the shares held by the U.S., Canada, UAW and the bondholders will be equal to the market price of the new shares.

Will GM Executives Get A Better Deal On GM Stock Than Average Investors?

Given the taxpayers’ skin in this game, this is sure to be a debating point among members of Congress and investors previously burned on GM stock and bonds before the bankruptcy. But Renaissance Capital’s Smith says that outside investors want to see management invested in the IPO and performance of the stock. “Management will get in on the IPO, which is what you want. And from a political standpoint, no one will complain until it goes up and insiders get wealthy.”

Will Wall Street Firms Only Give Their Big And Best Customers Access To The Shares At The Opening Price?

There will be some of that, for sure. But this IPO climate is not the same as it once was, so it’s unlikely that those investors will have much of an advantage over other investors. The Renaissance Capital IPO Fund, for example, last year gained about 50% in a year when stocks were coming off their historic lows in March. But, so far this year, the Fund is actually lagging the return of the S&P 500.

What Will The Portfolio Managers Be Looking For Before They Decide On Investing In The New GM?

First is fundamentals. They will scrutinize the financial results GM has been providing since it emerged from bankruptcy: profits, cashflow, earnings before interest, taxes, depreciation and amortization (EBITDA), which is what many investors look at as best indicator of profitability. They will look at net profit margin, which is how much the company is earning on every dollar of revenue, and compare GM’s with that of company’s like Nissan, Toyota and Ford. And they will evaluate whether they think GM’s product line is gaining momentum in the marketplace.

Will corporate governance factor into how GM’s IPO is received?

Absolutely. GM’s previous board of directors was considered ineffectual, and too close to management. Today’s board is completely new, made up of chairman Ed Whitacre, who was brought in by the White House auto industry task force; Stephen Girsky, vice chairman, who had advised the task force, plus 12 other experienced managers from companies like Coca-Cola, Northrop Grumman and Alcatel-Lucent. Girsky in particular is very influential, and carries the currency of having been one of GM’s sharpest and most strident critics while working as a Wall Street analyst covering the company.

What Are The Clearest Signs That GM’s Value Will Climb?

Auto Trends’ Phillippi points to a few factors: The best and most competitive designs he has seen coming out of GM relative to what Asians are selling. “GM’s designs are exciting to look at, and that’s new.” GM has a dominant position in China, the fastest growing market in the world, and it will top 2 million in sales this year in a market that will be around 16 million-plus. GM is still the leader overall in light trucks in North America. Toyota and Nissan haven’t been able to make a dent in that highly profitable category. As the economy roars back, and housing picks up again, the light truck market will still be dominated by Ford and GM, with GM having the bigger market share. Lastly, GM like Ford, is proving it can earn a profit when the industry is limping along at 11.5 million-12 million in sales. If forecasts of U.S. auto sales reaching 15 million again by 2015 prove accurate, GM will be in a position to earn huge profits from that additional sales volume.



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