Many investors spend their time analyzing General Motors' (GM) market share, new car lineup or the hundreds of other nitpicking little items discussed on opinion boards. They spend much time analyzing the ins and outs and every detail concerning new product launches and how those factors will make or break the company. Although this is time well spent, we believe there is an even bigger catalyst hiding in plain sight that many investors are ignorant of.
You may hate the company's bankruptcy, but that doesn't mean you can't take advantage of it. As a result of GM's 2009 bankruptcy, two preferred stock classes were created, Series A and Series B. Series A is held privately and cannot be redeemed until the end of 2014. The dividend on this security is a whopping 9% per year. To quote CEO Dan Akerson in the most recent quarterly conference call, "This is expensive paper." The dividend on Series B is a more respectable 4.75% and the shares are publicly held and trade on the open exchange.
To understand how this is a catalyst, we need a little background on the preferred shares. Series B has a specific formula to calculate the amount of shares to be released when converted to common and a mandatory date of December 1st, 2013. As of the end of 2012, there are 99,988,796 shares outstanding for Series B. The conversion ratio is a complicated formula based on the trading price of the common stock at the time of conversion. It appears the most dilutive conversion ratio is 1.5152 shares of common stock for each share of preferred. If this were to occur, the shares outstanding would be diluted by 151,503,023 shares and the outstanding total would be in the range of 1,517 million shares.
This is where it gets interesting. Due to accounting rules, the company is required to allocate a portion of undistributed earnings towards Series B holders along with dividends paid to both Series A and Series B holders. The effect is a drastic reduction in the net income available to common stockholders. This makes logical sense, right? This money is not available to common stockholders, so they should be excluded from net income and net income per share. According to the company's most recent 10-K for the year ending 2012, this difference between net income attributable to common stockholders and all stockholders was $1,329 million or $0.84 per share.
Where are we going with this you may ask? Let's pretend that the Series B convertible stock was redeemed last year and see what kind of effect it would have had on GAAP earnings. The company reported GAAP earnings attributable to all shareholders of $6,188 million. Since we will keep the Series A preferred for another two years the dividends payable to unit holders needs to be subtracted from the above figure. General Motors paid $621 million to Series A holders last year (remember the high 9% annual dividend rate) so the new GAAP earnings attributable to common shareholders would be lowered to $5,567 million. This is a simple calculation and ignores any tax adjustments we feel are negligible.
Year-end share count totaled 1,366 million and if we assume a maximum dilution at conversion of Series B shares as stated earlier, the total outstanding common shares will rise to 1,517 million. A per share figure on our earlier net income brings the GAAP earnings per share to $3.67. This new figure is 18% larger than stated GAAP earnings of $3.10 released in the most recent 10-K and could have a significant impact on the share price. At a recent GM stock price of around $27 per share, the earnings yield becomes a whopping 13%. This calculation doesn't even take into effect the numerous non-cash charges that actually lowered GAAP earnings. Maybe we could save that for a later post.
The conversion discussed above is mandatory. It makes no difference if GM increases its market share or sells more cars or gets a grip on European operation; it is going to happen and investors should take note. One by one, these remnants of bankruptcy will slowly but surely fall off and the byproduct will not only be a healthier company, but also a better investment.