Trading the GM Bankruptcy 37 comments
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In my last Seeking Alpha column, I mentioned as a very speculative investment GM exchange traded or “retail” notes that trade on the NYSE. Thus far, this has not been a good investment. I mentioned XGM in particular, then trading at $4.90, and now trading at $1.56, with this loss partially cushioned by two dividend payments totaling 90 cents.
Despite these losses, I decided to not only hold, but buy in a little more around these prices. I certainly have been proven wrong in thinking that the Obama administration would not let GM file for bankruptcy, and this talk was mostly bluffing to get the bondholders to agree to concessions, which was the strategy with GMAC.
Even under bankruptcy I still see value in the bonds, but again as only a very speculative part of one’s portfolio. This is not an investment for the kids’ college fund.
My thesis has two major assumptions. First is that in an eventual bankruptcy senior debt holders will come away with a substantial chunk of the equity of the new GM. Second is that this new GM will be profitable. In this article I will discuss the reasoning behind these assumptions, and try to figure out how much GM senior debt, now trading for about 6 cents on the dollar (around 1.5 for notes with a face value of 25) is actually worth.
The first issue is how much of the new GM senior note holders will end up with. The most recent offer, which almost certainly will not reach the 90% tender rate needed to be accepted, is for 10% of the company. I consider this the lower bound of what we'll end up with in bankruptcy. The higher bound I believe is around 30%, which is a conservative estimate of the percentage of GM’s $27 billion securitized debt, represents a percentage of all senior liabilities, and what we’d get if contract and bankruptcy law are scrupulously observed, since these instruments are pari passu with other senior liabilities.
So if the $27 billion in face value securitized debt will be converted into 10% to 30% of the new GM, the next question to value these notes is how much the new GM will be worth.
Normally I'd start by looking at the balance sheet, but it is an opaque and dishonest mess. Like the banks I have often written about, their accounting is untrustworthy.
Instead I look at (1) GM's solid financial performance during happier times earlier this decade and what it might be shorn of its legacy liabilities after it emerges from bankruptcy (2) the market capitalization of other automakers.
In FYs 2002, 2003, and 2004 GM earned an average of $2.77 billion per year, or $3.58 billion per year “excluding Hughes Electronics and special items.” Those days of cheap gas, cheap credit, and free-spending consumers buying HUMMERS with HELOCS are long past, and I do not expect them to return. But what’s notable is that GM made this money despite the bloated dealer network, high labor costs, legacy healthcare and pension costs, worldwide over-capacity and all the other factors dragging it into bankruptcy today. What's also important is that Americans still love their full size trucks and truck-based SUVs, and these markets are protected in the US by a 25% tariff. Only Toyota (TM) has full size light truck operations in the US to avoid this tall trade barrier.
How much might GM make when the U.S. economy recovers, but with cheaper labor, no unprofitable dealers, Chrysler essentially gone, Ford (F) much smaller than before, and its huge securitized senior debt converted into equity? Well, in 2007 GM paid in cash $3.751 billion in post-retirement benefits and contributed $937 million to its pensions. Its 2007 AR estimated that in 2010 it would be paying about $6.5 billion in interest on its debt. That debt will soon be wiped away, and so will those interest payments, which amount to over twice GM’s profits in the earlier part of the decade. Without these liabilities in its salad years in the first half of this decade, GM would have made well in excess of $7 billion a year.
Perhaps you can see where I am headed here. Allowing for a few years of inflation, with its legacy debt done, with its legacy contractual liabilities (the three big ones being its unprofitable franchise agreements, union contracts, and retiree obligations) all resolved in bankruptcy, and with the backing of the U.S. and Canadian governments as major shareholders and providers of cheap financing, in two years I see GM with a clean balance sheet easily and making $5+ billion a year in profits. At a P/E of 10, that would value the company at $50+ billion. If bondholders end up with 10% of that, that’s $5 billion, suggesting that GM’s $27 billion face value bonds eventually will be worth at least $5 billion, or about 18.5 cents on the dollar. Or if GM bondholders manage to get 30% of the reconstructed GM, that’s 55.6 cents on the dollar. Given they now trade around 6 cents on the dollar, this suggests that an optimistic but reasonable medium-term forecast is a three-fold gain, with a 9-fold gain not completely outside the realm of possibility.
Buried beneath the layers of debt and legacy liabilities lies a company that still has a very strong market share of not only the U.S. market, but also many other world markets, including Brazil, China, Mexico, Canada, Australia. I know there are quite a few dollar bears here who predict the collapse of the U.S. currency. I don’t share this view, but I do agree with the consensus that it has long been overvalued against the major Asian currencies. If the dollar does drift downward, GM bondholders (soon to be stockholders) will benefit as Asian imports become less competitive in the U.S. market, and profits earned in foreign currencies in GM’s overseas operations will be worth more in U.S. dollars.
Another way to see if my $50 billion estimate is reasonable is to look at the market capitalizations of other automakers.
| Toyota | $119 billion |
| Volkswagen | $89 |
| Honda | $52 |
| Daimler | $36 |
| BMW | $21 |
| Ford | $15 |
| Renault | $11 |
| Fiat | $10 |
Given that all of these companies have legacy liability issues of their own, and except for Toyota all of them are smaller than GM, I don’t think my $50 billion market cap estimate for a new and healthy GM is at all unreasonable.
Disclosure: Long BGM and GRM
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In the future I also see the Chinese as developing as major competitors to GM.
And lots of people on Seeking Alpha don't see the economy recovering much--and people won't be buying many new cars unless they see this recovery.
So I think following the OP's suggestion is too risky.
In ten years when Oliver Stone does the movie, people will continue to argue about it. I think it just shows how inept the journalists and lawmakers are. I agree to hold the $25 bonds and wait for the inevitable "extension of the tender period" which has already been hinted at by the CFO on TV. For six cents on the dollar the feds could offer cash for the lot and save the day, but no, they have something else in mind. This worked thrice for me in the past: UIS and PCR and F
I can't comment your article, I haven't any knowledge to do that, but please let me say : I worked 40 years with my wife and two years ago we put all our money in a simple long term investment (GM bonds) because we are retired. Now we are forced to become stock players with a little part of our money and absolutly no experience for that.
What must we say? THANK YOU AMERICA !!!
On May 24 03:23 PM 405388 wrote:
> Greg,
> I can't comment your article, I haven't any knowledge to do that,
> but please let me say : I worked 40 years with my wife and two years
> ago we put all our money in a simple long term investment (GM bonds)
> because we are retired. Now we are forced to become stock players
> with a little part of our money and absolutly no experience for that.
>
> What must we say? THANK YOU AMERICA !!!
With the UAW and Government running GM how much faith do you have that your warranty work will be performed? I live in a small town and GM is closing all the dealers in the area, how does that sit with you...it doesn't with me. I can still count on my local Ford dealers and that gives me confidence my warranty will be honored.
What parts company in their right mind would continue to make parts for GM, especially the way they have been treated.
In my opinion you would have to be out of your mind to trust the UAW and the government to run anything successfully, let alone GM.
See the link below for the prospectus.
phx.corporate-ir.net/E...
His profile states the following :
"For the last ten years he has consistently beat the S&P 500 with a strategy of buying undervalued technology stocks combined with shorting companies whose weak fundamentals are not reflected the price of their stock."
I see you've learned something. In your previous articles, if you didn't understand the accounting, you just made up your own numbers.
The UAW's retirement plans will not control the new GM. Trust law does not allow them to keep their assets in a single concentrated position. They will sell nearly all the shares they get as soon as they can. Press reports have confirmed this.
TX Publisher's calculations are wrong because they deal with current pre-bankruptcy stock. The reverse stock split would be in the event a deal is worked out that avoids bankruptcy, which I assume will not happen.
A new class of shares will be issued after bankruptcy to GM's current creditors. I don't know how many shares will be issued, so you can't even begin to talk about price of those shares, only the market cap of the whole company and what % note holders get.
Thanks
aaasoliman@yahoo.com
On May 24 12:13 PM PastTense wrote:
> But post bankruptcy, GM will still have the same incompetent management
> and the same greedy unions. And the unions will have the controlling
> stake the company (with the government deferring to them for political
> reasons).
>
> In the future I also see the Chinese as developing as major competitors
> to GM.
>
> And lots of people on Seeking Alpha don't see the economy recovering
> much--and people won't be buying many new cars unless they see this
> recovery.
>
> So I think following the OP's suggestion is too risky.
On May 25 03:48 PM A Soliman wrote:
> I have a question. If GM go bankruptcy, How much my stock will worth?
> If I hold on the stocks and GM do well My GM shares will be worth
> anything in 2-3 years? Please let me know. I bought 1000 shares @3.85
> per share.
>
> Thanks
>
> aaasoliman@yahoo.com
As I mention in this article, if you want to invest in autos, I think your best bet is to buy GM retail bonds, which will likely be converted in bankruptcy into shares of the new company.