Although GM has been written up on a few other occasions such as February 15, 2013 by Dogstar, January 6, 2012 by stanley 339, and February 17, 2011 by Ragnar0307, with all due respect, I wasn't satisfied with the depth of the explanation of (1) optimizing the trade, (2) accounting for the liabilities, (3) how the balance sheet was restructured, (4) investigation of the fixed cost restructuring, (5) investigation of the impact of restructuring on pricing power, (7) competitors valuations, and so forth. I apologize if the price has shifted since I wrote this idea, but I would bet that there will be opportunities to acquire at the price shown in this document based on the forced seller’s activity. Enough introduction, on to the show.
A large forced seller and an underappreciated permanent restructuring has created an excellent long-term investment opportunity. Using the complicated capital structure to our advantage, an investor can earn a 90% return based on elimination of a valuation discount, not to mention several potential upsides.
90% Return Potential
There are several securities: Series A Preferred shares, Series B Preferred shares, Series A warrants, Series B warrants, VEBA warrants, common shares and options.. But there’s two in particular that are interesting.
The Series B warrants allow owners to convert each warrant into a common share of New GM for $18.33 per warrant until July 10, 2019. Trading at $12.03 per warrant, the Series B warrants break even at a common share price of $30.36 or 8% higher than the current share price of $28. If the share price increases to $41 per share, Series B warrants will generate a gain of 90% vs. 45% on common shares. However, if the share price decreases to $26 per share, the Series B warrants will generate a loss of 40% vs. a loss of 10% on common shares. The warrants sell at a premium of $2.36 per share or 8% and expire in 2019, providing leverage for an annual cost of only 1.4% per year.
Another interesting option would be long-term January 2015 LEAPS, which break even at $34 per share and would generate a return of over 190% at $41 per share.
General Motors Company (“New GM”) has been written up a great deal over the past year. Despite the coverage among news organizations, financial publications, and investment researchers, it remains undervalued owing to (1) major selling shareholder overhang, (2) underappreciated restructuring, and (3) discounted valuation relative to competitors.
1. Major Shareholders
In December 2012, the Treasury owned 500 million shares or 27% of New GM. The Treasury announced its intent to fully exit its investment in New GM within 12-15 months as part of winding down the TARP. On December 19, 2012, New GM purchased and cancelled 200 million shares from Treasury or approximately 11% of its shares outstanding. The Treasury sold approximately 5.5 million shares in January 2013 and another 17.5 million shares in February 2013. The Treasury will liquidated its remaining stake of 280 million shares, or 15% of the fully diluted shares, by March 2014.
As of March 2013, New GM has total diluted shares outstanding of 1.805 billion, comprised of 1.366 billion common shares, 100 million Preferred Series B shares which convert into 152 million common shares in December 2013, 136 million Series A warrants which convert into common shares, 136 million Series B warrants which convert into common shares, and 15 million restricted stock units.
The fact that the Treasury is liquidating 20% of the float of New GM creates an opportunity for new shareholders. First, it injects uncertainty, which makes potential investors fearful. Second, it provides an opportunity for meaningful appreciation once the overhang associated with the liquidation ends by March 2014.
2. Underappreciated Restructuring
Despite the fact that New GM has been so extensively written up, there aren’t public documents that clearly explain the legacy obligations, bankruptcy and restructuring and their respective impact on enterprise value. The enterprise value of New GM as of March 2013 is $43bn, after the effect of adjustments related to its U.S. pension deficit, non-U.S. pension deficit, Series B Preferred shares and Series A Preferred Shares, and includes the effect of eliminating legacy obligations such as retiree healthcare and other obligations such as asbestos, environmental claims, legacy warranties and union litigation.
$43bn = $5bn automotive debt - $13bn cash + $51bn of fully diluted market capitalization
$51bn fully diluted market capitalization = 1.8bn shares x $28 per share
For perspective, GM’s retiree healthcare deficit was more than $47bn in 2006. Today, the enterprise value of New GM is less than Old GM’s historic union healthcare liability.
Eliminated its legacy obligations. A few of the changes to New GM’s senior capital structure:
- GM Automotive Debt. Old GM had $41bn of parent company debt outstanding as of December 31, 2008 yielding between 6.75% and 9.45%. New GM effectively traded all of this debt for 10% of New GM’s common equity. Interest expenses have been reduced by $2bn annually, which flows directly to shareholders. Of course, this level of cram down was unusual, and left a bad impression on investors, but none of this matters to New GM owners.
- Series A Preferred shares. New GM issued 360 million Series A Preferred shares to the US Treasury, Canada Treasury, and VEBA as part of the bankruptcy, later repurchasing 84 million shares from US Treasury. The Series A Preferred shares are callable beginning on December 31, 2014 at $25 per share. These shares have a 9% rate and annual distributions of $621 million per year. A simpler way of thinking about the Series A Preferred shares is to assume that they have already been repurchased for $4.8bn and deduct 2013 and 2014 dividends from New GM’s cash.
- Series B Preferred shares. New GM issued 100 million Series B Preferred shares to the VEBA in November and December 2010 which convert automatically into common shares at a pre-defined conversion band on December 1, 2013. These shares have a 4.75% rate and annual distributions of $238 million per year. Assuming the GM share price stays below $32 per share, Series B Preferred shares will convert into 152 million common shares, resulting in a fully diluted share count of 1.8 million shares. A simpler way of thinking about the Series B Preferred shares is to assume that they have already been converted into common shares and deduct 2013 dividends from New GM’s cash.
The major hangup for New GM investors is the pension and post-retiree benefit obligations. Let’s start with the easy stuff – the legacy obligation which was terminated as part of the bankruptcy and restructuring:
- OPEB Obligations. Old GM had $47bn of retiree healthcare obligations outstanding for over one million of GM’s union employees, retirees and dependents as of December 2006. All three Detroit automakers and the UAW struck a landmark agreement in 2007, and GM was able to move all responsibility for union hourly retiree healthcare to a Voluntary Employee Benefit Association (VEBA) in exchange for $24bn of cash, $1.6bn of additional payments over 20 years, $4.4bn convertible note, and benefit payments of $5.4bn through 2010. This is the $30bn OPEB obligation on Old GM’s balance sheet as of December 2008. This deal was monumental for GM. GM spent over $100bn on OPEB in the fifteen years ending 2008.
However, during the financial crisis and bankruptcy, the Auto Task Force, GM and the UAW reached an even better agreement. In the new agreement, the VEBA was funded with 10% of New GM common equity (160 million shares), $2.5bn of notes (retired in October 2010), $6.5bn of Preferred Series A shares, and 46M warrants at a strike of $42.31 (exercisable until December 31, 2015). Again, New GM is free of the hourly retiree healthcare obligation, and it only cost New GM $14bn. Healthcare expenses have been reduced by $4-5bn annually since 2006, or $3bn annually since 2008.
Now for the major hangup for New GM investors – the pension and post-retiree benefit obligations. Let’s review the remaining legacy obligations which are the major deterrent for potentialinvestors:
- U.S. hourly pension deficit. New GM has GAAP-based U.S. hourly pension plan assets of $68bn and liabilities of $82bn, representing a shortfall of $14bn or 17%. These amounts are after GM transferred its salaried pension obligations at the end of 2012. Analysts tend to focus on this GAAP deficit, because as recently as 2011, GM was required to keep its pension deficit below 20%, and GM anticipated contributing approximately $2bn into its pension plan in 2015 and $1bn in 2016. Further, closing the salary pension plan required a premium of 110% of PBO, and some analysts use this as a benchmark for the cost of closing the hourly pension plan – requiring $22bn rather than its deficit of $14bn. Finally, some estimate that GM would have to fund 120% of its deficit – implying required additional cash contribution of $30bn to close out the U.S. pension deficit.
- However, the GAAP and hypothetical termination calculations are overly near-term focused. In July 2012, the U.S. government enacted legislation known as “MAP-21” which allows pension plan sponsors such as GM to adjust the interest rates used to calculate its pension liabilities and therefore its current funding ratio and required contributions. GM can now use a band of +/- 15% in 2013, +/-20% in 2014, +/-25% in 2015 and +/-30% in 2016 of 25-year average corporate rates rather than simply using 24-month average corporate rates. GM will have no federal requirement to contribute capital to its hourly retiree pension plan through 2017 based on GM’s calculations, and so New GM has flexibility with respect to its pension plan.
- MAP-21 does not impact GM’s GAAP accounting for its pension deficit. Misperceptions about the pension deficit will persist through 2017. However, thinking beyond 2017, GM has four levers with which to deal with the U.S. hourly pension deficit.
- First, GM can contribute cash to the plan incrementally using operating cash flow.
- Second, GM can generate asset returns. In 2012, GM earned very healthy 11% returns, but it’s uncertain what happens in the future. GM’s U.S. retiree pension asset allocation as of December 31, 2012 is 19% equity, 60% debt and 21% alternatives, as compared to 38% equity, 43% debt and 20% alternatives as of December 31, 2006. The plan is heavily weighted to secured obligations today.
- Third, and most importantly, GM can wait and maximize the discount rate assumption which is used for calculating GAAP pension deficit. The U.S. pension benefit obligation (PBO) discount rate assumption is 3.6% as of December 31, 2012, as compared to 5.9% as of December 31, 2006. Each 25 basis point decrease in discount rate results in $2.2bn change in PBO. A return to 5.9% discount rate by 2017 (or after) would result in a $20bn reduction in PBO, eliminating the GAAP shortfall.
- Fourth, GM can continue to manage down its U.S. hourly pension plan. Over the past decade, GM has gone through several rounds of voluntary hourly pension buy-outs; in 2011, New GM negotiated no increases to the Tier I employee pension plan for the first time since 1953, and also negotiated that Tier II employees will receive a defined contribution pension plan rather than a defined benefit (pension) plan. As a result of these actions, GM expects annual pension benefit payments to decline from $6.5bn in 2013 to $5.5bn by 2018 (and declining further).
- All this is what the CFO Daniel Amman meant when he said : “We obviously would rather get some tailwind from asset returns and discount rate to bring the plan more closely to fully funded before we start dropping large amounts of cash into the plan. So we want to preserve flexibility. We have the flexibility to play this out for a little longer, and that's what we're doing.”
- Non-U.S. pension deficit. New GM has non-U.S. pension plan assets of $16bn and liabilities of $29bn, representing a shortfall of $14bn or 47%. The annual benefit payment is $1.5bn in 2012, increasing to $1.6bn in 2022. The largest plans are in Canada, Germany and the UK. While the U.S. historically required funding pension plans on a ratio of 80% assets to funding target, not all countries have required pension funding levels. An example, Germany-based Volkswagen has domestic projected benefit obligations of $30bn against assets of $9bn or a deficit of $21bn. Further, it is likely that pension obligations do not pierce through to New GM, and New GM is shielded from these deficits. Further, it’s likely that each of GM’s foreign subsidiaries are funded with cash from New GM on a secured basis, and these unsecured pension obligations are junior to New GM’s capital. It is appropriate to exclude the Non-U.S. pension deficit from enterprise value because these obligations do not have mandatory contributions or reach up into New GM.
- U.S. and Non-U.S. Retiree OPEB. New GM calculates its retiree healthcare obligation on an actuarial basis using the discount rate of AA rated bonds matched to spot rates along a discount curve. As yields fall, the actuarial value of this liability increases. Hence, it’s important to look not just at the actuarial value, but also the cash outlay. New GM’s retiree healthcare costs will be approximately $484 million in 2013, $438 million in 2014, and $433 million in 2015, declining to under $420 million by 2018, all of which will flow through automotive cost of goods sold, and which is a very manageable annual amount that has no cash calls but nonetheless is valued for GAAP purposes at a 5.5% effective yield
- Also, the salaried OPEB liability was dramatically reduced during the financial crisis. By January 1, 2009, New GM eliminated health care, dental, vision, and other coverage for U.S. salaried retirees, spouses and dependents over the age of 65 (who were transferred to Medicare), capped its salaried retiree healthcare claims for pre-65 yearold employees at 2006 levels, reduced post-retirement life insurance, and eliminated post-retirement health insurance. New GM traded these benefits for a $3,600 per year annual pension benefit.
- So the only healthcare obligation that remains is expenses related to healthcare benefits accrued before 2006 for retired employees under the age of 65 and the $3,600 per year annual pension benefit. In fact, New GM ranks last of Toyota, Honda, and Nissan in post-retirement healthcare coverage. Given that New GM’s obligations are capped, declining, and included in cost of goods sold, this presentation excludes this liability from the calculation of enterprise value.
That’s the entirety of the capital structure. Net cash of ($7)bn, market capitalization of $51bn, and enterprise value of $43bn. However, is New GM worth more than $43bn?
EBITDA improved by $22bn, and New GM generated $14bn of EBITDA in 2012. New GM also received $1.4bn of dividends from its Chinese JVs, invested $8bn in capital expenditures, and improved overall free cash by $23bn, generating $7bn of cash flow in 2012.
Interest expense have been reduced from over $2bn to nearly zero. Taxes are going to be approximately $1bn. While New GM has $7bn of U.S. federal and state net operating loss carry forwards, New GM will pay taxes on international profits representing approximately 10% of pretax profits in 2013. Preferred dividends are excluded because they have been backed out of the enterprise value. The run rate for 2012 suggests free cash flows of $6.3bn to New GM.
Valuing a business that generates $14bn of EBITDA, $7bn of free cash and $6bn of free cash flow for only $43bn seems overly conservative. Perhaps the market doesn’t believe the viability of the restructuring. How has New GM been able to create $22bn of new EBITDA in the period from 2008 to 2012? New GM is divided into four regions: North America, Europe, Rest of World, and China JV’s. New GM also has a Finance and a Corporate group. Let’s review each.
GM North America: Permanent Restructuring
The major source of improvement in New GM is its North American operations. GM’s North American division generated EBITDA $11bn in 2012, as compared to ($8)bn in 2008, a massive $19bn of the $22bn EBITDA improvement! Why has GM North America been able to generate $19bn of EBITDA in the period from 2008 to 2012? Major cost reductions and price increases enabled by bankruptcy. Let’s look at the permanent cost reductions achieved through the bankruptcy and restructuring.
- Manufacturing Footprint Reduction. New GM reduced its capacity from 47 powertrain, stamping and assembly plants to 32 powertrain, stamping and assembly plants. Few recall that the reason the UAW had its 74,000 workers strike GM in 2007 was not retiree healthcare, but rather the amount that GM had committed to invest and produce at its U.S. plants in the future. The number of U.S. plants had already been reduced from 59 in 2000 to 47 in 2008. The decision to close a plant is a hard fought bargaining item. What would have taken years of protracted negotiation was completed in a year because of the bankruptcy process.
- For reference, closing assembly sites allows New GM to cover fixed costs with lower sales volumes. Formerly, analysts were concerned about overcapacity at GM’s plants – i.e. GM would be forced to overproduce in order to cover fixed costs, overstuffing the channel and leading to incentives and fleet sales. Today, analysts are concerned about New GM not having enough capacity. New GM is operating at 100% two-shift capacity utilization at truck plants and will increase production to 120% two-shift capacity utilization in 2013. Additionally, New GM plans to make 80% of these plants "flexible" by 2014, whereas only 60% and 26% were flexible in 2008 and 2006, respectively. Flexible plants allows New GM to build multiple nameplates within facilities, which enables New GM to move production to countries/regions/plants based on market demand, union considerations, cost structure all their favor.
- There are added benefits of being able to focus operations on just 32 plants. New GM can distribute its best employees to its strong plants. New GM has left the legacy obligations (environmental, shutdown) with the bankruptcy estate. New GM can focus its capital investments for tooling at fewer plants. Finally, New GM has less salaries, contractors, maintenance, taxes and other overhead. Let’s say that the average hard savings is $50 million per year per plant x 15 fewer plants or about $0.75bn savings.
- Dealership Rationalization. A bit of history, formerly, overcapacity was prevalent and dealerships competed with one another. GM has been trying to rationalize its dealership network since at least 1970. GM had reduced its dealership count from 12,000 in 1970, to 6,900 in 2006 and 6,300 in 2008. Closing dealers is tough. The annual rate was about 200-400 deals per year. Insiders have described each closure as “its own little soap opera”. Retail dealership outlets are independently owned and capitalized. Each closure requires negotiations involving equipment, specialty tools, parts, cars, real estate, long-term contracts, finance, warranties, and settlements. In addition, laws are different in each state and dealerships have a great deal of protection.
- However, New GM was able to reject dealership contracts In the bankruptcy process, and used the bankruptcy to force the closure of 1,800 smaller, unprofitable, or non-critical dealerships or nearly 30% of its remaining dealerships in a few months. The largest immediate benefit of consolidating local dealerships is the reduction in intra-brand competition. Fewer dealerships in a given market, less excess inventory, better pricing power, better commissions, better salespeople (than competing brands), less reliance on used cars/service/parts, more investment in marketing and facilities, more customer loyalty. Today, showrooms from the 1970s are being replaced with nicer and cleaner showrooms.
- For New GM, a rationalized dealership network means improved profitability and attractiveness across the network, massive investment and redesign of dealer showrooms, better brand identity and pricing for new products, and less rebates and incentives. New GM expects to save $2.2bn in incentives – although this number is tough to quantify. Let’s say that the annual hard cost savings of the “big bang” are $0.4bn, comprised of $200 million on local advertising, $125 million otherwise spent on individual dealer closures, and $90 million on overhead staff, IT expenses and training for dealerships.
- Brand Rationalization. Prior to restructuring, GM generated 90% of its contribution margin from four brands – Chevrolet, GMC, Buick and Cadillac. In fact, the Saturn, Saab, and Hummer brands generated average contribution margin losses of $1.1bn per year from 2003 to 2007. Still, GM couldn’t afford to shut down the brands. First, it couldn’t take volume out of its vast production network. Turnaround specialist Jerome York was hesitant to lose Saturn and Pontiac for this reason. Second, it had an unwilling dealer network. Third, GM would have incurred large cash and accounting charges. It cost GM between $0.9bn and $1.5bn to close down Oldsmobile in 2004. Only the bankruptcy could have enabled New GM to eliminate its Hummer, Saturn and Pontiac brands.
- Let’s take Bob Lutz’s public views on the brand rationalization. Lutz said that he had suggested selling or closing Saab in his first year at GM. He said that Saturn had a world-class product lineup, but that it would take too long for the public to recognize it. Hummer became a poster brand for planetary destruction and therefore a liability. Pontiac became the symbol for GM's management failure, because no other brand suffered as much from rapid changes in the brand strategy and product plan. Clearly, in his insiders opinion, the four jettisoned brands brought down the brand value of New GM as a whole. Additionally, GM had to support eight different brands with design, engineering and advertising resources despite having just 20% market share. Annual savings on just a contribution margin basis for these four brands are $1.1bn relative to 2008.
- Nameplate Rationalization. Enabled by its brand rationalization and footprint reduction, New GM is rationalization its 48 nameplates in 2008 to 36 nameplates by 2014. For comparison, Honda has only 15 nameplates. Having fewer nameplates allows New GM to focus design, engineering and advertising resources. In addition, each model requires significant capital spending on tooling and equipment. For instance, at just the Fairfax Assembly Plant in Kansas City, Kansas, GM invested $140 million in 2010 to produce the revised Chevrolet Malibu, $160 million in 2007 to produce the Buick Lacrosse, $210 million in 2007 to produce the new Chevrolet Malibu, $651 million in 2006 to produce the new Saturn Aura, $722 million in 2004 to produce the new Chevrolet Malibu. It’s possible that New GM saves $200 million per model x 12 models or $2.4bn of capital expenditures every refresh cycle.
- Salaried Headcount Reductions. New GM cut 10,000 global salaried FTEs between 2008 and 2009 as part of its restructuring plan, including 3,000 U.S. employees. GM’s U.S. salaried employee base had already been reduced from 49,000 in 2000 to 36,000 in 2006 to 30,000 in 2008. New GM reduced U.S. salaried overhead by at least $0.4bn relative to 2008.
- UAW Concessions. The general consensus among public commentators (particularly during the 2012 Presidential debates) was that GM’s union came away from the bankruptcy with a sweetheart deal. Yes, union pensions were preserved ahead of secured lenders. However, there were major concessions in the 2009 negotiation.
- New Rounds of Voluntary Hourly Attrition. New GM was able to negotiate an hourly employee buyout offer for 16,000 FTEs to reach its target of 46,000 hourly workers by 2012. This is unattractive to the union for obvious (membership) reasons. Already, the U.S. hourly workforce had been reduced from 74,000 in 2006 to 62,000 in 2008. Savings are about 16,000 x $100,000 per FTE or $1.6bn compared to 2008. No question there is still some work here. As of 2010, 39% of GM’s hourly employees are retirement eligible, as compared to 17% at Ford/Chrysler. Assuming that New GM can reach 17% retirement eligible, there are 46,000 hourly workers x (38%-18%) x $30 per hour savings x 2080 hours per year = $0.6bn of additional savings.
- JOBS Program Eliminated Immediately. Prior to the bankruptcy, GM was required to provide full income and benefit protection in lieu of layoffs to union workers for an indefinite period of time. This meant that when plants closed or production slowed, GM continued bearing the full cost of union employees who were not working. Analysts estimated that there were up to 5,000 FTEs in the JOBS program in 2005. Annual ongoing savings are 5,000 FTE x $100,000 per FTE or $0.500bn compared to 2008.
- Legal Service Eliminated by December 2013. A bit of prehistory here, prior to bankruptcy GM was responsible for providing legal services to all UAW employees for all personal matters, except for things like investments made for rental properties or for suing GM. I’m not going to estimate the cost of this one.
- Tier II Wages Made Permanent. Certainly the most contentious concession. GM had a single pay tier for U.S. union workers until 2007, when GM obtained the right to create a second tier (“Tier II”) for newly hired “non-core” (material movement, kitting and sequencing) positions during GM’s 2007 restructuring. After 2007, GM continued to negotiate to apply Tier II wages to entry level “core” (vehicle assembly, engine assembly, maintenance and quality) positions as well. Then during the financial crisis, the U.S. government required GM and UAW to close the competitive gap with other domestic auto suppliers. New GM was able to expand the use of Tier II wages to all entry-level positions. The Tier II wage rates is approximately 50% of Tier I wage rate, with higher medical cost share, and defined 401k contribution plan. The estimated Tier II all-in cost per hour is approximately $26 per hour as compared to $60 per hour for Tier I workers excluding OPEB. The basic agreement between the UAW and New GM is that New GM has an effective cap on the percentage of Tier II employees of between 20-25% in a given plant with the percentage up to 40% in certain negotiated cases where New GM is manufacturing small cars. After the 25% rate is reached, GM will transition Tier II workers with 3-years of experience to become Tier I workers as Tier I workers retire so that the percentage remains at 25%. The most important piece of the 2011 labor negotiation, even beyond making JOBS and Legal Services eliminations permanent, was that Tier II wages were made permanent. Although savings will be higher as senior workers are bought out and Tier II workers are transitioned into Tier I workers at lower than historical wage rates, let’s estimate cost savings of $34 per hour ($60 per hour less $24 per hour ) x 25% of GM’s 46,000 employees, or $0.8bn per year.
- Other Concessions. Here’s a few more concessions achieved in the 2009 labor negotiation. Again, these items were impossible even as late as December 2, 2008, when Old GM submitted its first restructuring plan. The Auto Task Force actually required GM and the union to come back on February 17, 2009 with a new plan with accelerated concessions. Annual cost savings are $0.4bn.
- Reduction in Skilled Trades classifications to three (Electrical, Mechanical, Tool and Die), which means that the lines of demarcation within the plant are removed and skilled job classifications such as construction, painting, carpentry, building maintenance, electrical, welding, pipefitter, and crane repairs are consolidated and reduced – that is, workers can now be placed on jobs such as painting or fixing light fixtures when required, rather than wait for specific skilled trades positions to do the work.
- Reduction in assembly job classifications and outsourcing of cleanup jobs (i.e. janitorial work).
- Ability to move to alternative work schedules such as 4/10, which is easier for New GM to manage, and a negotiating item despite the fact that most workers like it.
- Overtime (time and half pay) working more than 40 hours in a week rather than for working more than 8 hours in a day. Total savings approximately 10% reduction in OT x $30 per hour x 2080 hours x 46,000 FTE = $300 million.
- Elimination of unused vacation pay and employees now have to use or forfeit vacation/vacation pay within the year awarded (employees could formerly game this and save up vacation). Additionally, New GM can use temporary and flex workers to fill in for vacationing employees.
- Base wages frozen for four years (through 2013) and elimination of COLA raises for most employees which results in an effective $0.73 per hour raise as compared to more than $2 per hour raise for COLA historically. Total savings approximately $5 per hour x 2080 hours x 46,000 employees = $500 million.
- Profit Share plan, which is a negotiated item, as it aligns employee incentives with New GM much better than COLA. Profit sharing is paid in a band based on North America EBIT and capped at $12,000 upon $12bn of EBIT (2012 EBIT was $7bn). Total new costs $6,000 x 46,000 FTE = ($300 million)
- Signing bonus of $3,000 which is $3,000 x 46,000 FTE = ($100 million)
- Elimination of two extra days of holiday pay, elimination of eye and dental coverage.
- Employees now have to call in 30-minutes ahead of time for sick time as opposed to after the fact, and employees only receive six unexcused absences from work rather than infinite before they are terminated, although realistically things still will go to arbitration.
- Pay checks are deposited electronically rather than mailed to employees’ residences which saves GM cost and paperwork.
- Most importantly, binding arbitration until September 2015, enabling New GM to obtain a reasonable contract in 2011 without a strike. Of course, a key aspect of the 2015 negotiations will be percentage cap on Tier II workers.
In summary, New GM has been massively restructured – capacity, distribution channel, brands, overhead, and union agreement. These fixed cost reductions are sustainable and permanent. Moreover, as we will see, these cost reductions allow New GM to improve its top line. Although North American sales volume declined from 3.6 million units to 3.0 million units from 2008 to 2012, North America revenues actually improved from $83bn to $89bn! That’s because although the loss of sales volume impacted sales by $16bn, the increase in product pricing improved sales by $22bn. This price increase may surprise some people unfamiliar with New GM. Let’s walk through why:
- Termination of Negative Feedback Loop. Historically, GM had to operate at high volumes across many different plants to cover massive fixed cost obligations. This excess capacity limited GM’s ability to control production, inventory, incentives and sales prices. GM would unveil a new product, the product would not be accepted by the retail market at GM’s target volumes, so GM would have to sell the product into the fleet (rental car) market near cost to make up for volume, and those fleet cars would tarnish the image of the car and also lower the average used price. As the average resale price declined, the new car’s first day depreciation rose, and demand by retail buyers declined, forcing GM to use incentives to increase retail sales and fleet sales once again. This negative feedback loop could continue through each new product cycle. For example, GM used to fleet 70% of its Pontiac Grand Prixe in the early 2000s. Today, New GM can control production, inventory, incentives and sales prices to a degree which was impossible before the restructuring.
- Improvement in Vehicle Quality. One measurement of quality is the annual J.D. Power Vehicle Dependability Study, which measures mechanical and design problems experienced during the past 12 months by original owners of three-year-old vehicles. A few datapoints:
- In 2006 which measures vehicles introduced in 2003, the industry average score was 227. Toyota scored 179 or 21% better than average. Volkswagen scored 299 or 32% worse than average. Chevrolet scored 241 or 6% worse than average and GMC scored 239 or 5% worse than average.
- In 2013 which measures vehicles introduced in 2010, the industry average score was 126. Toyota scored 112 or 11% better than average. Volkswagen scored 174 or 38% worse than average. Chevrolet scored 125 or 1% better than average and GMC scored 134 or 6% worse than average.
- Between 2006 and 2013, industry average quality improved by 45%. Toyota improved by 37%. VW improved by 37%, falling behind. Chevrolet improved quality by 48%, improving to better than average. GMC improved by 44%, reaching the average.
- Average Transaction Prices Up. Average GM transaction prices were $23,000 in 2006 and $30,000 in 2012. A few data points: 2011 Buick Lacrosse average transaction price is $7,000 more than the 2009 Buick Lacrosse and its 36-month residual value increased from 31% to 49%. 2011 Chevrolet Cruze average transaction price is $4,200 more than the 2010 Chevrolet Cobalt and its 36-month residual value is up from 31% to 45%. 2011 Chevrolet Equinox average transaction price is $3,800 more than the 2009 Chevrolet Equinox and its 36-month residual value is up from 41% to 48%.
- Reduced Usage of Incentives. Although there’s a lot of noise in overall metrics, the average amount of incentives across GM has declined. GM offered an average of $5,500 in 2005 $3,300 in 2006 $3,700 in February 2011 $3,100 in February 2012, and $3,200 in February 2013 – and all this while average prices have increased. Let’s look at a few data points:
- In 2006, the average incentive for GMC pickup trucks was $6,400 per truck. In 2008, GM again instituted Employee Pricing incentives of up to $6,000 per truck. In 2013, the largest incentive is $3,000 for GMC’s 2013 trucks – and in a year in which New GM is moving product to make room for 2014 truck models.
- In 2005, the Chevy Tahoe MSRP was around $48,000. GM offered an employee pricing discount of $7,500, and other rebates of $3,000, for total discounts of $10,500 or discounts equal to 20% of MSRP. In 2013, the Chevy Tahoe MSRP is around $47,000. GM offers $1,500 of incentives as of March 2013, or discounts equal to 3% of MSRP. Discounts have improved by 17% full points of incentive relative to 2005. New GM is no longer focused solely on market share.
- The GMC Sierra 1500 sold with $4,112 of incentives in 2006 and $3,644 in 2007. The 2013 GMC Sierra 1500 are sold with $0 incentives on standard models and $2,500-$3,000 on certain larger models.
- Faster Portfolio Refresh. GM is refreshing its portfolio at twice the historical rate -- 39% of the portfolio by 2013 and 80% of the portfolio by 2015. New vehicles include an all new pickup truck and SUV lineup in 2014 and 2015.
The restructuring actions enabled approximately $9bn of permanent hard cost savings and $6bn of price improvements. New GM is finally competitive in North America.
GM Europe: Complicated, Messy
GM Europe is comprised of GM’s three brands: Vauxhall, Opel, and Chevrolet. The brands are sold in that order of premium, middle and value. However, the pricing doesn’t always follow the strategy, and occasionally Opel is sold for less than Chevrolet. In summary, it’s a complicated and messy business.
- Germany is the largest car market in Europe. Opel’s headquarters and most of its assembly facilities are located in Germany. Opel has a #3 position in Germany with 7% of the market. For reference, Volkswagen/Audi has the largest share with 30% of the German market.
- Russia is the second largest market in Europe. Chevrolet is GM’s global brand and has a #1 market share in Russia out of the foreign automakers – one of New GM’s jewels. Russia has 271 cars per 1000 people as compared to 787 cars per 1000 people in the U.S. Volkswagen anticipates that annual Russian car sales will grow 31% between 2008 and 2018.
- UK is the third largest market in Europe. Vauxhall has its roots in UK and assembly facilities in UK. So Vauxhall has a #2 position in the UK with 11% of the market. For reference, Ford and Volkswagen have #1 and #3 market shares in the UK.
- Beyond that, there are 27 EU-member states and EFTA members. Each country in Europe has its own specific car preferences. Vauxhall/Opel/Chevrolet competes in each.
New GM is changing business practices, cutting its overhead costs, negotiating with German unions to reduce costs, closing a German facility, fixing its dealership network and unveiling new cars – in addition to restructuring actions taken prior to 2008. However, staring at a map of Europe’s assembly facilities, New GM’s facilities are located in high cost countries Germany and UK. For comparison, Volkswagen’s facilities are located primarily in Czech, Poland, Slovakia, Hungary and Bosnia. This puts New GM at a competitive disadvantage, particularly in a market with overcapacity, lower priced cars, and declining demand.
GM Europe has declined from $0.9bn EBITDA in 2008 to ($0.7)bn EBITDA in 2012, or a decline of ($1.6)bn. The loss of sales volume impacted sales by $6bn, and the loss of pricing has impacted sales by $6bn, resulting a net top line reduction of ($12)bn from 2008 to 2012. Somehow GM Europe took out $10bn of costs (including variable and fixed), but that’s still not nearly enough. Free cash flow was a negative ($1.8)bn in 2012. Not much positive, except that New GM is getting pummeled by analysts, and New GM VP & CFO of GM Europe said that GM will be breakeven EBIT (cash flow neutral) by 2015. That sounds like an upside case.
GM Rest of World: Underappreciated
New GM has vital operations, collectively referred to as “Rest of World” herein, which are comprised of design and engineering offices, plants, and dealer networks in South America (where Brazil and Argentina are major markets) and International Operations (where South Korea, Australia, India, and Middle East are major markets). New GM sold 1.8 million units in its Rest of World region in 2012, which is more than New GM sold in Europe in the same period. Only one region, Brazil with 35%, accounts for more than 10% of Rest of World sales.
New GM is in the top three of auto companies in the Rest of World region, alongside Toyota and Volkswagen. Sales will grow based on demographic-driven demand alone, even without changing market share. For instance, while the U.S. has 800 cars per 1000 people, India has 18 cars, South Korea has 363 cars, Argentina has 314 cars, Columbia has 71 cars, Egypt has 45 cars, Venezuela has 147 cars, and Indonesia has 15 cars. Volkswagen expects South American annual car sales to grow by 62%, Indian annual car sales to grow 129%, and other worldwide annual car sales to grow by 33% between 2008 and 2018.
From 2008 to 2012, New GM generated increased sales volume of $4bn, increased pricing of $4bn, and net top line improvement of $7bn. Costs increased by $5bn across the regions. Rest of World EBITDA was $3.6bn in 2012, more than doubling since 2008. Rest of World Free cash flow was $1.4bn, which represents an improvement of $1.4bn since 2008.
Breaking these amounts down, GM South America generated $0.8bn of EBITDA (a decline of $0.6bn from 2008) and $0.3bn of free cash flow. South America results have declined as a result of tougher South American competition – in particular cost and pricing pressures in Brazil. GM International Operations EBITDA increased by $2.6bn since 2008.
New GM owns approximately 50% of three different China-based joint ventures. These joint ventures sold 2.8 million cars in 2012. For comparison, GM North American sold 3.0 million cars in the same year. New GM reports the value of these joint venture interests on its balance sheet. In 2008, the joint ventures were valued at $1bn. In 2009, New GM began using “Fresh Start Reporting” wherein GM began valuing these business based on a DCF calculation with long-term WACC, growth-rate, and market share assumptions. In 2009, New GM reported the value of the joint venture interests as $7bn. These interests remain valued at $7bn in 2012.
Another datapoint on the value of New GM’s joint venture interests in China is the value implied by recent transactions involving these joint ventures. In September 2012, New GM purchased 1% of Shanghai General Motors Co., Ltd. (SGM; GM now owns 50%) for $119m or a valuation of $6bn. In November 2010, GM purchased 10% of SAIC-GM-Wuling Automobile Co., Ltd. (SGMW; GM now owns 84%) for $52 million, valuing SGMW at $500 million.
It goes without saying that the demographics in China are amazing. Today, there are only 85 cars per 1000 people in China, as compared to 797 cars per 1000 people in the U.S. Some analysts think that vehicle sales in China will reach 30 million per year in the next decade – more than U.S. and Europe annual volumes combined. New GM is positioned well for Chinese growth. New GM is the #2 auto manufacturer in China by market share with 2.8 million units in 2012, behind only Volkswagen Group China with nearly 3.0 million in the same period. In addition, GM has electrical vehicle technology, which may be required to compete in the near future. Of course, the Chinese government could outlaw new car purchases due to pollution or traffic, and competition remains very fierce.
GM’s Chinese JVs are required to distribute 100% of the previous year’s net income. The distribution occurs in the second quarter of the following year. In 2006 and 2008, GM China did not pay dividends. In 2010, New GM received distributions of $0.7bn relating to 2009. In 2011, New GM received distributions of $1.2bn relating to 2010. In 2012, New GM received distributions of $1.4bn relating to 2011. Indications are that 2012 was a record year for Chinese auto sales, and New GM should receive a similar or greater amount in 2013.
GM Financial and Corporate
GM generated most of its EBITDA through its finance arm in 2006. However, GM sold half of its finance arm to Cerberus in 2005 and then lost the remainder in bankruptcy. New GM did not have a financing division in 2009. Therefore New GM acquired AmeriCredit Financial Services Inc., which provides auto loans to dealerships in the U.S. and Canada, for $3.5bn in July 2010, rebranding it GM Financial. GM Financial generated $100 million EBITDA in 2010, $700 million EBITDA in 2011, and $1bn of EBITDA in 2012.
In November 2012, GM Financial then entered into definitive agreements to acquire GMAC’s international leasing operations in Latin America, Europe and China for $4.2bn to provide a captive finance unit in all markets. The transaction for GMAC International Leasing will close in mid-2013 and would add over $0.5bn of EBITDA to GM’s results on a pro forma basis.
GM Corporate includes various non-operational issues such as interest, income taxes, premium for purchasing stock from UST, non-cash debt charges, impairments, as well as central corporate charges.
New GM is fixed. North America is restructured, Europe is being stabilized, Rest of World operations are strong, China is strong, and GM Finance is growing. Now New GM is competitive. So how is New GM valued against its competitors – specifically Toyota, VW, Honda, Daimler, BMW and Ford. Based on 2012 results, New GM is given a lower EBITDA, free cash flow and EBIT multiple than all companies except for BMW.
More interesting, New GM trades at a significant discount to Ford in terms of multiple of EBITDA (3x vs. 4x), free cash flow (7x vs. 11x), and EBIT (5x vs. 7x). Assuming that the market removes the discount placed on New GM’s relative to Ford, New GM’s share price would be $35 per share (EBITDA), $45 per share (free cash flow), $41 per share (EBIT). Potential catalysts for this to occur include alleviation of concern about the forced seller and greater understanding about New GM.
Appendix: Common Misperceptions
For those readers still interested in the story, here’s clarifications to a few misconceptions about New GM:
1. Rapidly losing North America market share
GM’s market share in North America declined from 23.8% to 16.9% from 2006 to 2012, or a total of 6.9% points of decline. In the U.S., which makes up over 85% of New GM’s North American sales, GM’s market share declined from 24.2% to 17.9% from 2006 to 2012, or a total of 8.5% points of decline. However, there’s a better way to look market share than total sales volumes. We need to adjust sales volume to include only New GM brands (Chevrolet, GMC, Buick, and Cadillac) and exclude brands that were jettisoned in the bankruptcy (Saturn, Pontiac, Hummer, Saab). After these adjustments, the sales volume of New GM brands actually improved from 2.5 million units to 2.6 million units from 2008 to 2012, while market share declined from 19.5% to 17.9% or only 1.6% points. The majority of the loss of market share is related to four jettisoned brands.
For context, from 2006 to 2012, Toyota’s U.S. market share declined from 15.5% to 14.4%, or a total of 1.1% points. New GM’s brands lost only 0.5% more market share than Toyota, despite all the bankruptcy. Who has been taking share from both Toyota and GM? Volkswagen grabbed 2.3%, Nissan grabbed 1.7%, Honda grabbed 0.6%, and other brands (Koreans such as Kia, Hyundai) grabbed 6.4%. The fear of a massive 8.5% decline in GM’s U.S. market share is overblown. Now, it remains to be seen if New GM can gain market share now that its costs are competitive.
2. U.S. auto market has bounced back
U.S. auto sales were 14.5 million units in 2012, an improvement from 2011, but still a historically low year. From 2001 to 2007, average annual U.S. vehicle sales volume was 17.1 million units per year. Annual vehicle sales of less than 16 million was unthinkable. It’s possible that U.S. annual sales volumes rise to 17 million vehicles, or an increase of nearly 20%. Assuming market share remains constant, New GM would sell 470,000 additional vehicles priced at $29,500 per vehicle or $14bn additional U.S. sales. If each new car earns a 30% EBITDA margin, this would be $4bn of additional EBITDA.
3. U.S. pickup truck market has bounced back
Total U.S. Housing starts averaged 1.3 million per year from 2002 to 2012, or 67% higher than the 770,000 starts in 2012. Total U.S. pickup sales averaged 2.2 million per year from 2002 to 2012, or 20% higher than 1.8 million units in 2012. U.S. housing starts and pickup sales were 97% correlated from 2002 to 2012. As total U.S. housing starts improve, total U.S. pickup sales will improve.
New GM has a 35% share of the U.S. pickup truck market, selling 645,000 pickups in 2012. Returning to the 2002 to 2012 average, New GM could sell 121,000 additional pickup trucks. Also, New GM is finally releasing its next generation of pickup trucks in May 2013, which had been delayed due to the bankruptcy. With an improvement in U.S. housing starts to 1.3 million per year, and assuming that New GM at least keeps its market share, pickup trucks sell at a 50% premium MSRP to New GM’s North American average, and pickup trucks sell at 50% EBITDA margins, New GM would generate $2.7bn additional EBITDA.
4. New GM is not competitive with other U.S. auto manufacturers
There’s a misconception that New GM wages are not competitive with foreign plants in the U.S. It’s true that in 2006, New GM’s all-in average hourly wage for its 74,000 hourly workers was $78 per hour in 2006 including OPEB. However, the competitive gap with foreign automakers in the U.S. was meaningfully closed during the restructuring.
After the effect of the Tier II changes, hourly voluntary buyouts, and the VEBA, New GM wages have moved towards parity with Toyota. Today New GM’s all-in average hourly wage for its 46,000 hourly workers is approximately $56 per hour. This compares with $55 per hour at Toyota and $47 per hour at Nissan. Center for Automotive Research estimates that average blended labor rates in 2015 will be $60 per hour at GM, $56 per hour at Toyota, and $49 per hour at Nissan.
4. New GM is a relic of Detroit, Michigan
New GM is truly a global auto manufacturer with a worldwide network of designers and engineers. Major design offices are located in South Korea, Australia, Brazil, and Germany, in addition to Warren, Michigan. The design for the Chevrolet Camaro was created by a South Korean. The design and development for the Chevrolet SS was created in Australia. The design and development for the new Chevy Cruze is being created in Germany. Today, New GM is coming out with cars such as the Chevrolet Corvette Stingray, Cadillac ATS, Cadillac XTS, Chevrolet Cruze, Camaro Camaro, and a GMC truck lineup. Many don’t realize that it takes at least five years for automobiles to go from concept to dealership floor. New GM has been designing and engineering these vehicles from 2008 to 2013. The lead engineers and designers behind these vehicles were not lost during the bankruptcy. There’s plenty of public information on the design studios, and intelligence suggests that morale is higher than any time in the past decade.
In addition, perhaps the largest remaining long-term cost lever that New GM has at its disposal is to finally use “global architectures” for its vehicles. This means that New GM will use the same design solutions for groups of vehicles and make them scalable based on the size of the vehicle – i.e with the new Alpha global architecture to be introduced around 2016, New GM will be able to build the ATS, CTS, Camaro and SS on the same lines at plants around the world. New GM can spend less resources designing for multiple architectures, invest less capital in tooling, produce cars in lower numbers at optimal plants, and capture volume purchasing discounts.
5. Buick and Cadillac are Dead
Clearly, New GM has the most expertise in full size pickups, full size sports utilities, Camaros, and Corvettes. However, New GM hasn’t been able to focus on four core brands and so few vehicles in decades. It’s a major change in business model. According to Bob Lutz in public interviews, in terms of financial resources, Chevrolet will gets the bulk of the resources, Cadillac will receive the second most resources and will emerge as a global brand, Buick will receive the third most resources and share costs with Chinese JVs; GMC will receive the least to fund a distinctive brand as its architectures are shared with Chevrolet.
Buick will be an exciting component of New GM going forward. New GM sold only about 150,000 Buicks in the U.S. in 2012, but historically sold over 200,000 per year. Intelligence suggests that New GM is going to be focused on reviving the Buick brand in the next few years. In addition, New GM is going to focus on the Cadillac brand. Cadillac sold 150,000 vehicles with 5 models (only 2 new) in the U.S. in 2012, compared to BMW with 280,000 vehicles and 10 models, Mercedes with 300,000 vehicles and 13 models, Audi with 140,000 vehicles and 11 models and Lexus with 240,000 vehicles and 9 models. Cadillac may be able to increase its luxury sales when it refreshes the remainder of its lineup, and New GM will focus on turning Cadillac into an international luxury car brand.
6. Automotive is a Cyclical, Low-Margin, Capital Intensive, Competitive Industry.
Just kidding. Automotive is really tough. However, New GM is finally competitive again.
7. New GM Valuation has Baked in All The Upsides.
Adding up the above, there is potential for incremental $8bn of EBITDA, clearly showing that New GM has of opportunities for enhanced profitability.
Disclosure and disclaimer: All information is taken from publicly available 10-Ks, 10-Qs, earnings and sales call transcripts, www.autoline.com, www.goodcarbadcar.com, www.gmauthority.com, and other public sources of information. You should assume that I own a personal investment in the securities discussed. For example warrants, common shares, options of GM. Because the information in this post is based on my personal opinion and experience, it should not be considered professional financial investment advice. All information and data is for informational purposes only. I make no representations as to the accuracy, completeness, suitability, or validity, of any information. I will not be liable for any errors, omissions, or any losses, injuries, or damages arising from its display or use. All information is provided AS IS with no warranties, and confers no rights.
I do not hold a position of employment, directorship, or consultancy with the issuer.
Neither I nor others I advise hold a material investment in the issuer's securities.
1. Forced seller. Treasury is liquidating 20% of the float of New GM creates an opportunity for new shareholders. First, it injects uncertainty, which makes potential investors fearful. Second, it provides an opportunity for meaningful appreciation once the overhang associated with the liquidation ends by March 2014.
2. Better understanding of New GM. This was one of the most complex bankruptcies ever, so the market is still confused about:
A. Just how significant it was for New GM to eliminate its legacy healthcare, debt and other obligations. Old GM’s 2006 retiree healthcare deficit of more than $47bn is greater than the enterprise value of New GM.
B. Just how to think about the remaining pension, OPEB, and complex capital structure.
C. The fact that New GM is finally competitive in North America. New GM generated $14bn of EBITDA in 2012, and improved by $22bn between 2008 and 2012. Of the $22bn EBITDA improvement, $19bn is related to North American cost reductions and price increases enabled by the highly unusual restructuring and bankruptcy. My figures are approximately $9bn of permanent hard cost savings and $6bn of price improvements in GM North America. You have to actually do some digging to fully understand these cost reductions and pricing improvements.
3. Elimination of valuation discount. New GM receives a significant valuation discount to Ford in terms of multiple of EBITDA (3x vs. 4x), free cash flow (7x vs. 11x), and EBIT (5x vs. 7x). Assuming that the market removes the discount placed on New GM’s relative to Ford, New GM’s share price would be $35 per share (EBITDA), $45 per share (free cash flow), $41 per share (EBIT).
4. Longer-term and speculative in nature but totalling $8bn of EBITDA based on my meatball math: (1) automotive recovery +$4bn, (2) housing recovery +$2.7bn, (3), europe restructured and fixed +$0.8bn, (4) rest of world growth based on demographics $0.4bn, (5) Ally international transaction +$0.5bn, (6) China growth +$0.3bn.