Shake Up Coming To GM? Thoughts On Earnings

| About: General Motors (GM)

Summary

Revised U.S. Executive Severance Program effective February 2, 2016.

Change in control triggered at 40% unless shares purchased from the company or a result of repurchase activity.

Change in “Incumbent Board” may trigger change in control.

Ratio of earnings to fixed charges.

The timing of the 8-K filed by GM that revised its U.S. Executive Severance Program is interesting. It was recorded at 17:19:34 the same day of the 10-K. The changes might be minor and be nothing more than routine housekeeping.

On February 2, 2016, the Executive Compensation Committee of the Board of Directors (the "Compensation Committee") of General Motors Company (the "Company") approved the General Motors LLC U.S. Executive Severance Program (the "ESP"). The ESP, which provides for the payment of severance benefits to eligible U.S.-based executive employees of General Motors LLC, replaces and consolidates various current severance programs. Pursuant to the ESP, if a participant's employment is involuntarily terminated by General Motors LLC due to the elimination of the participant's role with General Motors LLC as a result of a reduction in force, a reorganization or a staffing reduction, or if General Motors LLC and the participant mutually agree to the termination of employment, General Motors LLC shall pay the participant a single payment in cash equal to (1) a multiple based on the participant's executive position times the participant's annual base salary, plus (2) a multiple based on the participant's executive position times the participant's annual target bonus amount, plus (3) a specified healthcare equivalent payment multiple times the COBRA cost for the coverage level as most recently in effect for the participant (collectively, the "Cash Severance Benefit"). General Motors LLC shall also make an additional cash payment equal to all or a portion of the value of the participant's applicable equity awards vesting within 12 months following the participant's termination, depending on the employment level held at the time of the participant's termination of employment.

Additionally, on February 2, 2016, the Compensation Committee approved Amendment No. 1 to General Motors Executive Retirement Plan (the "ERP Amendment") and Amendment No. 1 to General Motors Company 2014 Short-Term Incentive Plan (the "STIP Amendment"). The ERP Amendment incorporated a definition of "change in control" in the General Motors Executive Retirement Plan and assured the vesting of active participant benefits under that plan in the event of a change in control. The STIP Amendment also included the definition of "change in control" in the General Motors Company 2014 Short-Term Incentive Plan and amended that plan to assure that active participants in the plan will receive the greatest of their prior year bonus, target bonus or actual bonus for the fiscal year in which a change in control occurs. Payments under each plan will made under the existing terms of the applicable plan.

The Executive Retirement Plan does not consider it a change of control if a Person becomes a beneficial owner of 40% because of GM's repurchase activity or GM selling shares to the Person.

Change in Control

"Change in Control" means the occurrence of any one or more of the following events:

[A] Any Person other than an Excluded Person, directly or indirectly, becomes the "beneficial owner" (within the meaning of Rule 13d-3 under the Exchange Act) of securities of the Company constituting more than 40 percent of the total combined voting power of the Company's Voting Securities outstanding; provided that if such Person becomes the beneficial owner of 40 percent of the total combined voting power of the Company's outstanding Voting Securities as a result of a sale of such securities to such Person by the Company or a repurchase of securities by the Company, such sale or purchase by the Company shall not result in a Change in Control; provided further, that if such Person subsequently acquires beneficial ownership of additional Voting Securities of the Company (other than from the Company), such subsequent acquisition shall result in a Change in Control if such Person's beneficial ownership of the Company's Voting Securities immediately following such acquisition exceeds 40 percent of the total combined voting power of the Company's outstanding Voting Securities;

[B] At any time during a period of 24 consecutive months, individuals who at the beginning of such period constituted the Board and any new member of the Board whose election or nomination for election was approved by a vote of at least a majority of the directors then still in office who either were directors at the beginning of such period or whose election or nomination for election was so approved (the "Incumbent Board"), cease for any reason to constitute a majority of members of the Board;

[C] The consummation of a reorganization, merger or consolidation of the Company or any of its Subsidiaries with any other corporation or entity, in each case, unless, immediately following such reorganization, merger or consolidation, more than 60 percent of the combined voting power and total fair market value of then outstanding

Voting Securities of the resulting corporation from such reorganization, merger or consolidation is then beneficially owned, directly or indirectly, by all or substantially all of the individuals and entities who were the beneficial owners of the outstanding Voting Securities of the Company immediately prior to such reorganization, merger or consolidation in substantially the same proportion as their beneficial ownership of the Voting Securities of the Company immediately prior to such reorganization, merger or consolidation; or

[D] The consummation of any sale, lease, exchange or other transfer to any Person (other than a Subsidiary or affiliate of the Company) of assets of the Company and/or any of its Subsidiaries, in one transaction or a series of related transactions within a 12-month period, having an aggregate fair market value of more than 50 percent of the fair market value of the Company and its Subsidiaries immediately prior to such transaction(s).

The stock price has declined since the Board approved a $5 billion share purchase plan that spent $3.5 billion for 102 million shares, or $34.49 per share, during 2015. The Board increased the size of the repurchase plan originally $5.0 billion to $9.0 billion. The chart below shows the stock price and market capitalization since March 2015.

GM Chart

GM data by YCharts

When GM began repurchasing stock, in March 2015, it paid $38.03 and June 2015, GM paid an average of $35.72 for shares. The June conference call had the comment below.

Overall, on stock buyback, consistent with the commitments that we made when we rolled out the capital allocation framework, we've been aggressive. We've been aggressive within the overall objective to drive our target cash down to $20 billion, bought back $2.1 billion thus far of a $5 billion program and we're going to, as aggressively and prudently, as possible continue to act because clearly our stock is undervalued.

Recently, Goldman Sachs is reported reduced GM's price target to $40.00, down from $46.00 while Deutsche Bank has a $37.00 target price. The Deutsche Bank target is below where GM began repurchasing shares. I would argue that GM shareholders would have fared better had GM paid the $2.19 per share, (used to repurchase stock), as a special monthly or quarterly dividend.

Cash Balance Target

In March 2015, GM set a $20 billion target for cash and marketable securities. At December 31, 2015, cash was $15.238 billion with marketable securities of $8.163 billion for a total of $23.401 billion. This would suggest that GM is nearing its targeted balance.

Fixed Charges Ratio

The 10-K has a table that computes the earnings to fixed charges ratio. The interest and related charges on debt have steadily increased since 2011 when it was $799 million. In 2015, it totaled $2,044 million. Earnings available for fixed charges in 2011 were $8,302 million. During 2015, earnings were $9,839 million. The ratio of earnings to fixed charges declined from 7.90x in 2011 to 4.35x in 2015.

Shares Repurchases

Thoughts on the recent results

GM's earnings release read; "GM Reports Record Net Income of $9.7 Billion and Record EBIT-Adjusted of $10.8 Billion for 2015." What the headline did not tell the reader was that $1.897 billion of the $9.7 billion was a result of tax benefit. Or, that operating income excluding goodwill impairment of $4,897 million was lower than that during 2013 ($5,672 million), 2011 ($6,942 million) or 2010 ($5,084). The results were good, but records results were not seen across the board.

Automotive interest cost per share was $0.20 in 2013 increasing to $0.24 in 2014 with the total increasing to $0.27 in 2015. This is a reduction in the income available to shareholders. Automotive interest expense totaled $443 during 2015. Given the widening of corporate bond spreads and the Federal Reserve action to increase short-term interest rates, it is likely that 2016 interest expense will surpass that paid during 2015.

Total revenues have been stable with the 2010-2015 average of $150.306 billion, producing an average gross profit of $3.505 billion or 2.36% of revenues. The return on equity has averaged 14.91% and the return on gross profit of 9.04%. Normally the return on gross profit would be higher than the return on equity, but GM has had a number of items that increased the net income figure above the gross profit. Therefore, the gross profit figure is the most conservative to use at this time. The average gross profit per share is $2.14 using 2015 share count. A PE of 15x would imply a price of $32.10. However, income based investors might consider the shares cheap. If $2.14 was the low or base case for earnings and GM paid $2.14 per share in dividends, which is less than GM spent repurchasing shares during 2015. Then GM would trade at $35.67 with a 6.00% yield or $42.80 with a 5.00% yield.

Yearly Figures

Click to enlarge

Bottom line

GM closed February 5th at $28.54, which is below the IPO price of $33.00 and where shares were repurchased. The average price paid for repurchased shares was $34.49 during 2015. Clearly, the market is questioning the capital allocation. The 102.45 million shares repurchase for $3.5 billion has declined in value by $610 million.

A Dutch tender or a special variable (monthly/quarterly/annual) dividend might be a better method to create shareholder wealth. It could also provide investors with information on how the Board values GM. Currently, it appears that the GM Board values the firm higher than some Wall Street firms. A change in the capital allocation from share repurchase to dividend payment might be all that is required to unlock value.

If GM wants to increase investor confidence then they should clearly state which metric(s) are used to back up their undervalued belief.

An investment that reduces risk by paying a dividend is a preferred holding over a firm that repurchases shares and increases investment risk. When shares are repurchased debt per share increases and earning per share become more volatile. By some metrics GM has a low valuation, and it might be thanks to its more risky profile as a result of the share repurchase plan.

Disclosure: I am/we are long GM.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: May sell covered calls, puts or add or sell position bases upon market conditions.