GM: Nationalize Us.

I'd joked a couple years ago on this blog about General Motors being a non-profit, because it didn't make any profits. Now, GM wants to become a genuinely nationalized firm.

Debt and Equity Reorganization

GM said that it will ask the government to take more than 50 percent of its common stock in exchange for canceling half the government loans to the company as of June 1. The swap would cancel about $10 billion in government debt. In addition, GM is offering stock to the United Auto Workers for at least 50 percent of the $20 billion the company must pay into a union run trust that will take over retiree health care expenses starting next year.

If both are successful, the government and UAW health care trust would own 89 percent of GM stock, with the government holding more than a 50 percent stake . . .

[GM] will offer 225 shares of common stock for every $1,000 in notes held by bondholders as part of a debt-for-equity swap. Henderson said the objective is to reduce GM's $27 billion of outstanding public debt by about $24 billion. The company estimates that after the exchange, bondholders would own 10 percent of the company.
That would leave current common stockholders with only 1 percent . . . The plans, if successful, would reduce GM's debt by $44 billion from the present figure of about $62.4 billion. . . . GM's plan depends on 90 percent of bondholders exchanging their debt. . . . [GM expects] to file for bankruptcy protection somewhere around June 1, but such a filing would be unlikely very long before the deadline. Bondholders have until May 26 to accept the exchange offer.

To recap:

U.S. Government: >50%
UAW: a little less than 39%
Bondholders: 10%
Old Stockholders: 1%

The U.S. is owed $15.4 billion in old loans and GM needs $11.6 billion in new loans; the government would give up $10 billion of loans on June 1. The U.A.W. would give up $10 billion of the $20 billion owed to retirees for health care. Bondholders would give up $27 billion in debt.

Some analysts are skeptical that the bondholders will take the deal, based upon GM's market capitalization of $1.3 billion for 100% of the stock. But, the current stock value appears inflated. If GM files for bankruptcy, GM stock is worth nothing, even if it reorganizes. If GM reorganizes out of bankruptcy, GM stock is diluted by 99%. GM needs a 100% chance of avoiding bankruptcy and seeing its market capitalization recover to about $130 billion for the current stock price to make sense. Given that this has far from a 100% chance of happening, people buying GM stock now are really betting that GM's market capitalization will grow to several times $130 billion in the event that bankruptcy is avoided and it does recover.

On a static, point in time, accounting basis, GM stock has negative value. The company has lost market share, is losing money, has liabilities in excess of its assets, and has had negative financial accounting equity for a long time.

Bondholders will be bargaining in the shadow of bankruptcy, more than the publicly traded stock price. GM bonds now have junk ratings and are at grave risk of default. A debt-equity swap of some sort could be forced upon bondholders in a Chapter 11 bankruptcy, and a liquidation of the company would likely come out even worse for bondholders. The only real question is whether a non-bankruptcy reorganization affords them a better or worse deal, in light of the terms of the deal and the business impact of a bankruptcy filing.

Bondholders might get a better deal relative to the UAW in a bankruptcy (the bondholders would get a bit more stock than the UAW would, instead of less than a third as much stock), but only if the bankruptcy doesn't reduce value more than an out of court negotiation does.

Bondholders are being offered a raw deal, (1) because they bring no new value to a reorganization and won't continue to extend credit to GM, (2) because the bondholders who remain, either bought far more conservative investments than they have which they are uncomfortable holding or bought them cheap as speculators. The speculators are happy so long as they get back more than they paid from queasy prior bondholders. The long time bondholders want certainty.

In contrast, the UAW's cooperation in the medium to long term is needed to make the business survive as a going concern (and its current contract concessions also involve unstated liability concessions), as is the government's.

Business Plan Reorganization

The plan would also "cut 21,000 U.S. factory jobs by next year and phase out the storied Pontiac brand." Furthermore:

Besides the U.S. job cuts, General Motors Canada said it plans to slash its hourly work force to from 10,300 currently to 4,400 by 2014 . . . .

The company also said it plans to reduce its dealership ranks by 42 percent from 2008 to 2010, cutting them from 6,246 to 3,605. . . . the company w[ill] be making offers to the dealers in the coming weeks. . . . a big chunk of the dealership reduction—about 450—would come with the elimination or sale of Saturn, Hummer and Saab. GM would then look to end relationships with dealers that do only a small volume of business with GM, and then move on to other dealers . . . the new plan lowers GM's break-even point in North America to an annual U.S. sales volume of 10 million vehicles. . . .

The company said it would phase out its storied Pontiac brand no later than next year, and the futures of Hummer, Saturn and Saab will be resolved by the end of this year by either selling them or phasing them out. . . . talks continue with potential parties to buy a stake in Opel and are expected to continue through the end of May. . . .One of the conditions to get aid from Germany is to have a private investor take a stake in Opel[.]

Why Pontiac?

The new GM will focus on four core brands: Chevrolet, Buick, GMC and Cadillac.

The fate of three other troubled lines -- Saturn, Saab and Hummer -- will be decided at a later date, GM said. They are likely to be sold off or shut down, while Pontiac will be shuttered.

Pontiac's problem was not sales, GM Chief Executive Fritz Henderson indicated during a conference call Monday. In 2008, Pontiac was the company's third-best selling brand behind Chevrolet and GMC and sold twice as many vehicles as Buick, a brand that will apparently survive the changes at GM.

The problem for Pontiac has been profitability. GM doesn't generally break out profits by brand, but Buick and GMC, which are sold in dealerships alongside Pontiacs, are more profitable, Henderson said.

"We didn't have a strategy that we were satisfied with that would allow us to win with the Pontiac brand," he said.

2008 GM Vehicle Sales

Chevrolet 1,801,131
GMC 376,996
Pontiac 267,348
Saturn 188,004
Cadillac 161,159
Buick 137,197
Hummer 27,485
Saab 21,368
Total 2,980,688

Presumably Saturn, Hummer and Saab were also unprofitable.

One of the travesties of modern financial accounting is that even such basic managerial accounting information as brand profitability in a company like General Motors that has just eight brands, isn't widely available.

The notion that relatively distinctive brands like Pontiac, Saturn, Hummer and Saab are unprofitable, while indistinct brand Buick, with lower sales than Pontiac and Saturn is not, is mysterious. What precisely does Buick offer to the GM lineup?

Without seeing the numbers, it is hard to know.

It may be that Pontiac, Saturn, Hummer and Saab have more models of their own, and hence higher design costs, while Buick may simply involve rebranding of Chrysler vehicles and hence involve lower design costs.

GM had been pushing an effort to consolidate Pontiac, Buick and GMC at the same dealerships (presumably under the theory that they were mid-priced vehicles). GMC and Buick may have appealed to similar middle aged customers, creating cross-sale opportunities, while Pontiac's younger target market may have not fit in well there and hence, sold poorly.

It could also have something to do with alternatives in the market. Saturn is aimed at the kind of customers who prefer imports, but prospective Saturn buyers may like actual imports better. Pontiac is aiming at a muscle car market that Chrysler and Ford may be doing a better job of serving. Indeed, Chrysler's entire lineup seems oriented towards the muscle car niche. Hummer's low fuel efficiency may make it a victim of a declining market segment that competes with well established Jeep. Saab was never a big part of the American market.

A Buick, in contrast, may appeal to people who like Chevrolet, but would prefer something more upscale, but can't afford a Cadillac. Most foreign car companies brands don't offer a mid-market brand (although Hyundai's Genesis discount luxury concept has propelled it to the healthiest recent sales in the U.S.). Mercury and the Chrysler brands aren't as fierce competitors.

Also apparently, "Buick took first in JD Power and Associates reliability study," which boosts its attraction with the Consumer Reports reading public and boosting GM's image, Buick has some sunk cost already designed new vehicles coming out, and Buick is very popular in China.

Still, if I had been asked to guess which brand would follow Oldsmobile into oblivion a couple of years ago, I would have guessed Buick, rather than either Pontiac or Saturn, because they offer something different, which is what a brand is supposed to do.

Analysis

So, GM's vision is a company with fewer brands, fewer dealers, and fewer employees, selling fewer cars, and owned mostly by the federal government (with a controlling interest) and the UAW as a trustee for retired employees, which can break even if it sells just a few more cars, and can be profitable if its Chevy Volt concept takes off or the automobile market seriously recovers.

Presumably, the U.S. government would sell its stake in the company at some point, once the business had turned around, either to the public, or the union. Large publicly owned companies aren't entirely foreign to the U.S. There are several in the financial sector (some old, some from the bailout), and there are also Amtrak and the Tennessee Valley Authority. It would also give the President the kind of authority over the company needed to prevent misuse of government investments. But, it also creates a great incentive for the government to create an uneven playing field in the regulatory sector.