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GM or not GM

COMMON SENSE CORNER 4/13/09

 
A Double-Sided Story
 
GM or not GM? I have to admit I’ve had General Motors automobiles my entire driving life; I enjoy driving them. That said, let me start with my business background. I am an ex-stockbroker with ample analytical skills that I have put to work as an individual investor for some twenty years, so whenever I approach a company such as General Motors, I look at it from a purely business and investment point of view.
            Anyone looking at GM’s 10q and 10k reports at any given time period over the last several years can see that the company is hemorrhaging cash at an alarming rate. Their cash burn rate is ridiculously high and has been for years. The strangle hold the UAW has over General Motors through their high pay structure, medical coverage, retirement coverage, and the most revenue draining of all, the job bank, bleeds into the core of the business. The money GM can save by changing most of these plans can be used for research and development and new technology, which, in turn, will produce superior products, and in the end will produce higher sales. This is commonsense people.
            Instead, GM has been borrowing their way through the years through Bond and Stock offerings and business loans from banks. Now, these are normal ways of doing business, but a healthy company should show a solid return on equity and a strong inflow of cash to pay these loans back. What has actually happened over the years is a juggling act with GM’s debt. They borrow new debt to pay off old debt. It’s not good business if you’re not paying down the debt. Eventually this will reflect in your earnings, which will bring down the price of the company stock, and the rating agencies will lower the rating on your bonds. GM will find it hard to offer more stock with a depressed value, and issuing new bonds with a low rating is out of the question. The only place for a company like General Motors to go is to the banks. Now with the liquidity crisis going on, what bank in their right mind will loan money to a company like GM?
            Hence the Bailout. How does the US government expect General Motors or any of the American carmakers to compete with most of the foreign automakers doing business this way? Just because the overall mindset is that we are America, big and bad, doesn’t give us any special advantage. We have to put our minds where our mouths are. This country has some of the best minds and some of the best technology, yet we are always playing catch up with the foreign carmakers. Like I said earlier, I have been driving GM automobiles my entire life, and I think they make a really good car. I know they had some not so good years, but I think that’s behind them.                       
             Looking at the foreign automakers, you see that they stick with similar models year after year and work on making them better. But for some reason the Big Three won’t do this. They drop certain models just to bring them back several years later or they invent new models because they think they have to. Believe it or not some of the people who live in this country like driving certain American cars so why not take the tried and true and make them better like the competition does. And, for Pete’s sake, stop with the copycat cars already. Slapping a different grill on the front of an automobile and calling it something different is just insulting.
            Now I’d like to talk more about General Motors management and about the UAW, but I’ll have to start with the other side of my story first. See, my experience with General Motors starts with my father. You have to know a little something about him. My father is an Italian immigrant who came to this country when he was a young boy. Throughout his early adult years he made his way in life with employment in various industries until he made his way to General Motors. That’s right my father worked for GM. In fact, he spent almost thirty-five years there, up until his retirement a few years ago.
            Throughout his career with GM my father worked in multiple plants and took several different positions. One particular position he fell into had more to do with the union than the company itself. My father is a strong man with strong views and he always taught his children to speak up and defend their own views. In his first couple of years of employment with GM my father and his coworkers experienced a rather low standard of treatment from management. Poor social skills and crappy working conditions over time made it that much easier to form a labor union. The rest of the production industry throughout America back in those days were not immune to this type of treatment, but the word Union did not take on the same meaning like it did with the American automakers.
            As each new plant popped up, there was the union waiting to move in. And, move in they did. Plant after plant, year after year, the UAW grew into its own conglomerate. My father was all about workers’ rights, so after a few years of experiencing what my dad described as a corrupt management, he became a Head Foreman in the union. The plan was for better working conditions and fair pay and benefits. But, as the years went by, my father’s experiences not only with management but also with the employees themselves changed his views. Although my father never really changed his view of the managers at General Motors, what the union was fostering through the employees was an eye opener.
            I remember one of the stories my father told me about what is known as the job bank. This is a nice, little safety net that was established some years ago to protect laid-off workers. Essentially it keeps the employee on GM’s payroll while he is unemployed. Paying said employee 90-100 percent of his salary for an indefinite period of time. The time period has since been modified to around two years. Still, how does a company make money this way? The point of a layoff is the lack of work to justify the number of employees, so why are they still being paid if there no longer working?
            A more recent story I was reluctant to tell helps to explain even more waste within General Motors. Even though my father has since retired, he still keeps in touch with several of his former coworkers, as we all tend to do throughout our lives. For one particular worker there were a specific set of circumstances. The first being that he was laid off a couple of years earlier and, yes, as you might have guessed, this lucky fellow was put in the job bank. So not only is the company paying him most of his salary every week, but he is still covered under their health plan. Here’s the kicker. This worker is eligible for retirement, but why should he start drawing on social security when he can let that build. So, not only is GM paying this worker’s (ex-worker) salary, they are also contributing to his social security benefits.
            I know it seems like I do not agree with GM’s business practices. From a business point of view I do not. And I don’t know who is more to blame – management with so many poor decisions, and allowing the union to have such a stranglehold on the company’s ability to make the day-to-day decisions, or the UAW with their unrealistic concessions. It’s real easy for us, the American public, to sit back and watch and some even hope for General Motors to fail, but there is a lot more involved.
            The size of the work force, not just with General Motors and the other American car companies, we also have the dealerships and the individual companies that supply the parts for these automobiles. All of these combined are such a significant percentage of America’s GDP that a failure would most certainly have major economic consequences throughout the US.
            By no means am I suggesting any form of a bailout. That’s the easy way out and is much too costly. The first round of funding from the government was so insufficient that it will barely get them through the next couple of months. GM’s financial situation is so dysfunctional that even if they were given 100 million they would burn through it in less than two years. Then what?
            The only way General Motors can turn themselves into an efficient and well-managed company, not to mention a formidable competitor, is to go into bankruptcy protection. They need to clean house of all waste. This means plant closings and a great many people losing their jobs. Now, that’s easy for those of us who don’t work in the auto industry, but I think what if this reality happened years ago and one of those people losing their job was my father. We would not have been able to afford the comfortable lifestyle General Motors and my father presented to us all those years.
            The harsh reality is that jobs will be lost, and they should be. GM is not selling the volume of automobiles that they use to, whether because of competition or the ailing economy; I believe it’s a combination of the two. If sales slow down because of the economy, that’s one thing. Commonsense tells you to restructure, but if you’re losing ground to your competition, then you need to take a hard look internally. Throwing more money at the auto industry will not magically create new employment, but it will most surely create more debt at the taxpayer’s expense.
            Unfortunately, deregulation in its true form allows companies such as General Motors to grow so large, sometimes the size of a small country in relation to GNP. And, if these companies run into difficulty, by economic measurements, they are much too large for a government to let fail. The undulation will be felt across the nation. Regulation is not a bad thing. I’m all for free markets with as little government interaction as possible. But, when companies are able to have leverage at 20 and sometimes 30 to 1 with no police at the post, that’s an economic bomb in the making.   
 
 
Sincerely

Michael Letizia Individual Investor