THE HOTTEST INITIAL PUBLIC OFFERING of 2010 could be General Motors. That's right. GM.
The auto maker, long synonymous with bloat and mismanagement, has undergone an impressive turnaround since it emerged from a brief stay in bankruptcy last year. GM still is no Honda or BMW, but it's probably in its best shape since its heyday in the 1960s. It operated at a narrow loss in the third quarter, and fourth-quarter results, due later this month, could show an operating profit.
Wall Street is excited because a competitive GM could be very profitable if the auto market turns up next year. Some of the good news: GM's U.S. market share is up, its costs are down, its vehicle incentives and inventories have declined, while its resale values have risen.
GM may go public in the second half of this year, and its stock-market value could top $50 billion, more than Ford's $40 billion or Daimler's $43 billion. A tarnished Toyota still is tops in the industry with a $127 billion market value.
JPMorgan credit analyst Eric Selle wrote in a client presentation last week that a public GM could have a market value of $63 billion. That could be aggressive, but $50 billion is a real possibility. After its near-death experience, GM finally has an excellent balance sheet, with $42 billion in cash at the end of the third quarter, against $29 billion in debt and preferred stock. This admittedly reflects Uncle Sam's largess in pumping $50 billion into GM in late 2008 and 2009, plus obligations the auto maker shed through its restructuring.
After seeking bankruptcy protection in June, GM emerged in July as a private company shorn of much of its debt and with four equity owners: The federal government turned most of a $50 billion loan into a 60.8% stake. The Canadian government received an 11.7% stake for putting $9 billion into GM, which has several assembly plants north of the border. The United Auto Workers union got a 17.5% interest for forgoing a $20 billion health-care claim against GM. The holders of $27 billion of GM's public debt, as well as other creditors, got a 10% equity stake, plus warrants for an additional 15% of the company.
[GM chart]
A $50 billion equity value for GM would be good news for U.S. taxpayers; Washington could recoup a big chunk of its $50 billion investment. The Treasury's 60% holding would be worth $26 billion. In addition, Uncle Sam holds $9 billion of GM debt and preferred shares. CEO Ed Whitacre has said that GM will repay the debt by June. The UAW is in the best position because it may get back 80% of its $20 billion in health-care claims via the GM equity stake, plus $9 billion of debt and preferred stock. Even if the debt rallies, bondholders will fare the worst, reflecting the politically motivated restructuring of GM by the Obama administration that favored the union over bondholders despite their similar legal claims. The union is also apt to do better than taxpayers, based on its sweet deal.
A 2010 IPO isn't a sure thing. Whitacre has been noncommittal about a date, but has said he'd like to see an IPO as soon as possible. The Obama administration is eager to begin exiting its investment in what some pundits call Government Motors. GM executives declined to speak to Barron's.
Investors can play GM via some $27 billion (face value) of debt of the old GM, which trades around 30 cents on the dollar and is due to be exchanged for a mix of stock and warrants in the new GM. These are no longer conventional bonds that pay interest and principal; they simply will give holders equity in the company.
The original bondholders have been hammered -- the debt traded at 95 cents on the dollar as recently as 2007 -- but prices have tripled from about 10 cents since before the bankruptcy filing as Wall Street has warmed to the company's story.
THE DEBT CARRIES OBVIOUS RISK, given the uncertain recovery value. Many institutional investors avoid such complex distress-debt situations. There are many other ways to play a revival in global auto markets that are much simpler than buying General Motors debt, including shares of Ford (ticker: F), Daimler (DAI), BMW (BMW.Germany) and Toyota (TM), whose stock is down 12% this year amid concern about the financial and sales impact of its highly publicized recalls. Ford, near 12, trades for 12 times projected 2010 profits. Daimler, whose shares are off 22% this year, to 42, offers a diversified international play on cars and trucks, including its marquee Mercedes-Benz franchise.
GM bond bulls, including analysts at JPMorgan and Morgan Stanley, have argued that the debt could rise to 40 cents on the dollar if the company's recovery plays out and equity investors gravitate toward the debt ahead of an IPO. Probably the best plays are GM's old convertible debt, including the 6.25% and 5.25% issues formerly listed under the tickers GPM and GBM. They trade for about $6.50 -- 26% of their $25 face value. These are less expensive than many other GM debt securities, like the 8[frac38]s of 2033, trading near 30 cents on the dollar.
Retail investors can buy GM debt, although some brokerages have rules that make it tough to do so because the issuer has gone through a bankruptcy. Information on GM debt prices can be found at www.investinginbonds.com, a Website that tracks over-the-counter bonds.
Investors probably should avoid GM's old equity, now trading around 55 cents a share under the name Motors Liquidation (MTLQQ). On its Website, Motors Liquidation expresses its "strong belief that there will be no value for the common stockholders in the bankruptcy liquidation process, even under the most optimistic of scenarios."
The bankruptcy filing, rather than ruining the company by scaring away car buyers, was a huge benefit because it let GM do things that critics said it should have done decades ago -- including closing about 40% of its U.S. dealerships, getting rid of most of its debt, culling its brands, reducing its workforce and rationalizing elements of its UAW relationship.
Car buyers are back in GM showrooms, thanks to some hot models -- Toyota's troubles also might be helping. The American company's domestic market share hit 21% in January, up from 19% a year earlier, in part aided by sales to rental-car companies.
GM's winners include the new Chevrolet Camaro, which is besting Ford's Mustang and selling for around $35,000 without any financial incentives. Sales of Cadillac's new $40,000 SRX sport-utility vehicle were up 200% in January relative to January 2009, and it's now No.2 in a competitive category behind only the Lexus RX 350. GM is the market leader in crossover vehicles with the Chevy Equinox and GMC Terrain. Even once-dowdy Buick has a strong seller in the sleek new LaCrosse, which is holding its own against entry-level Lexus and Acura sedans. GM also remains a leader in full-size pickups and SUVs.
The Camaro reflects GM's renewed focus on engineering. Its standard engine is the 304-horsepower direct-injection V-6 from the Cadillac CTS. Mated to a standard six-speed manual transmission, the car gets almost 30 miles a gallon in highway driving. The $40,000 CTS, meanwhile, rivals the $50,000-plus BMW 5 series and has been named one of Car & Driver's top 10 vehicles three years in a row.
Under the hard-nosed, pragmatic Whitacre, a former AT&T CEO, the company is trying to maximize profits by matching production to demand. This might seem elementary, but for GM it's a breakthrough. Before its bankruptcy, it often overproduced, leaving its dealers with unwanted cars that could be sold only with the help of incentives, which topped $5,000 per vehicle in late 2008. The aim back then was to keep plants running and unionized workers on factory lines, rather than drawing pay while idle in the company's infamous "Jobs Bank." The practice tarnished GM's brands and their resale values. GM's incentives in January were under $3,200. That was still $500 higher than the industry average, but the numbers are moving in the right direction.
GM Vice Chairman Bob Lutz recently told Crain's Automotive News that several GM models, such as the Terrain and even the large Chevrolet Tahoe SUV, are in short supply, adding the "scary thing" that if industry sales pick up, its market share might fall because "we can't supply" the vehicles. GM is running multiple shifts in certain plants rather than reopening some idle plants.
In the emerging markets, GM has a strong position, notably in China, where its joint ventures -- China doesn't let foreign auto outfits operate independently there -- control 15% of what has become the world's largest auto market. Buicks are a Chinese status symbol. And GM has more than 20% of the fast-growing Brazilian car market, plus good positions in India and Russia.
From July 10, when it emerged from bankruptcy, until Sept. 30, GM had an operating loss of $261 million, as North American losses of $651 million offset $390 million in international profits and other income. In contrast, Ford made $868 million, or 25 cents a share, in the fourth quarter. Yet GM has made great strides since 2008, when it lost $21 billion from operations.
Western Europe remains a problem for GM, which decided to keep its money-losing operations there after considering selling them. That unit's crown jewel, Opel, is a key small- and medium-car engineering source for its parent; the 2011 Buick Regal, available this spring, is derived from the Opel Insignia, named 2009 European Car of the Year by automotive journalists.
GM has done well in emerging markets, where it isn't burdened by onerous union contracts. And it finally has a competitive cost structure in its large North American operations, meaning that it should earn ample profits if depressed vehicle sales, now running at a seasonally adjusted annual rate of 11 million, move up toward 14 million units by 2011. In the first nine months of 2009, GM slashed $6 billion in costs relative to its comparable 2008 stretch. GM cut its U.S. workforce 18% in that span, with its executive ranks declining by a third.
GM has wound down production of Pontiac and Saturn and sold Sweden's Saab. The sale of Hummer to a Chinese company fell through last week; the SUV maker will be shut down. GM now has four domestic brands: Chevy, Cadillac, Buick and GMC. This has produced engineering and marketing savings and concentrated GM's focus: it now has half the brands it once had.
GM's fourth-quarter results, due in March, are likely to show that it had about $34 billion in cash on Dec. 31, versus $42 billion on Sept. 30, in part because of scheduled payments, including for some $2.5 billion of borrowings to the U.S. and Canadian governments. Net cash could total about $8 billion -- the $34 billion minus $26 billion of debt and preferred. The company did have a sizable pension deficit -- $25 billion at year-end 2008 -- but that probably narrowed a lot during the stock market's 2009 rally.
GM issued 500 million shares to its four equity holders last July. If in-the-money warrants are included, the share count is about 590 million. How much are they worth?
Most analysts value the company based on projected 2011 pretax cash flow, which depends on factors such as projected global sales. New York-based Evercore Partners, which made financial projections in conjunction with GM's proposed reorganization last year, has assumed a base level of $10 billion of 2011 cash flow, versus an estimated $6.4 billion this year. Put a multiple of four on that, and GM is worth $40 billion.
But that doesn't include the value of its net cash, Chinese joint ventures, a 17% share of General Motors Acceptance Corp. and a stake in a restructured Delphi, the former GM auto-parts maker that emerged from bankruptcy last year. Combined, the value of these four assets could easily top $10 billion. The Chinese joint ventures earned $200 million in the third quarter, while the GMAC stake could be worth $3 billion, based on the finance company's book value. (GMAC itself plans to go public.) Add it all up and GM could have an equity value of $50 billion, or $85 a share ($50 billion divided by the 590 million existing shares).
The stock's value, in turn, affects that of the $27 billion of publicly traded debt.
Bondholders are entitled to 50 million shares, plus 45 million seven-year warrants struck at $30 a share and another 45 million 10-year warrants with a strike price of $55. At $85, the bondholders' 50 million shares would be worth $4.25 billion, and the warrants might be worth an added $4 billion, depending on how their time value is assessed. It's unclear how soon after an IPO the bondholders would get their shares and warrants from GM.
The GM debt is now worth about $8 billion: $27 billion face amount times 0.30 (for 30 cents on the dollar). JPMorgan analysts argue that the debt is attractive because GM's 2011 cash flow could easily top $11 billion in a stronger car market, given the company's vastly improved cost structure.
Barron's hasn't always been right on GM -- most notably we recommended buying the stock about a year before the company went bankrupt -- but this time the auto maker's dawn seems real.
Bottom line: GM is on the mend, thanks in large part to the bankruptcy that its former leaders had warned would destroy it -- and thanks, most of all, to the generosity of Uncle Sam.
http://online.barrons.com/article/SB126722854236252683.html#articleTabs_panel_article%3D1
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