Thursday, June 4, 2009
The fate of GM
Magic Act: Conjuring Up a Profit at GM Like a magician who artfully controls his audience's attention, the government's General Motors investment is all about financial diversion. Here's the fancy trick: It won't be very hard for a revamped GM to succeed at making a buck. Its debts will be cut from about $73 billion to about $17 billion. Its labor costs will be reduced by as much as $2 billion a year. On Wednesday, GM got even more help. GMAC, which funds dealers and car buyers, began issuing $3.5 billion in three-year debt backed by the federal government. This should cost GMAC about 2.2% annually. Ford Motor Credit just priced a five-year bond. It's paying 8%. "New GM" will thus have a far easier road to turning a profit over the next 12 to 18 months. And you can bet that first profitable dollar will be cause for celebration in Washington and Detroit. But let's break the magician's credo and show how the trick works. Beneath the magician's table is a black box. It happens to be stuffed with about $65 billion in cash. That's taxpayer money. Some $20 billion of it was given to GM over the past few months, and another $30 billion is being used for the company's reorganization. About $15 billion of it goes to support GMAC, which the Obama administration says is essential to keeping GM alive. Like any lender, the government would be expected to demand this money be repaid. But that's not really happening here. Save for $8 billion in debt and another $2.1 billion in preferred stock, the money is being converted into an illiquid 60% stake in GM. Why didn't the government take more debt and less equity in GM? It worried that GM couldn't bear the interest expense. Explained another way: The new GM may "succeed" at getting to profitability, but only as much as taxpayers have absorbed tens of billions of losses in upfront equity. GM's Fritz HendersonIn President Obama's view, this is all part of the path to helping "this iconic company rise again and move toward profitability." Measuring it as an investment, it appears nearly impossible that taxpayers will get their $65 billion in equity back. The government's 60% stake backs into an implied GM market capitalization of about $70 billion. It will support another $26 billion in debt and preferred stock owed to the U.S. Treasury and the UAW. GM's best market cap was $60 billion in 1999, when it was cranking out high-margin SUVs. Even with huge amounts of debt and other liabilities, GM produced record annual revenue of $176 billion. Also, its pretax, preinterest profit margins were a stellar 12.6%. With the bankruptcy plan, GM will have shed four brands, its majority-ownership stake in GMAC and most of its European operations. Roughly speaking, this might put its annual revenue at about $100 billion. Assuming GM can return to Ebitda margins of 10% (they're currently negative) would mean GM's earnings power will have been cut by over half compared with a decade ago. What is that revenue stream worth? Through most of this decade, one of the world's best car companies, Toyota Motor, has been valued at about eight times its cash flow to enterprise value. Say an outside investor is willing to value GM's cash flows at six times. Roughly speaking, that makes GM's equity worth $33 billion, meaning taxpayers' stake would be worth only $20 billion, less than half their original $42 billion equity investment. And that doesn't include the uncertain fate of the $15 billion given to GMAC. Still, one day in 2010 or 2011, GM will declare itself profitable. The government's bailout plan will be hailed. But it will be an illusion created by taxpayers' black box of billions.