GMs Road To Recovery, Part 3

It was just a year ago that shareholders of General Motors were getting ready to watch their stock certificates become worth more as toilet paper than investments. And bondholders, especially retirees who were counting on the income and never thought they’d have to worry about GM defaulting on a debt payment, were being told that they had bet wrong.

Now that GM has been stripped of onerous debt and brands that were suffocating its ability to grow profitably, the question that will face investors of every stripe, from big-time portfolio managers to retirees and even recent college grads looking make money in the market, when the “new GM” issues stock perhaps as early as this November or December is this: Would you buy GM?

A decade ago when the Internet bubble was inflating, Initial Public Offerings were the rage. Any new company with an “e” in front of its name came out of the shoot like a horse hopped up on steroids for the Kentucky Derby. Why not? According to Renaissance Capital, a firm that specializes in IPOs, investors could expect an average 64% return on the first day of trading when a new stock was issued in 1999 and 2000. Getting in on an IPO on the first day was like buying a winning lottery ticket.

It hasn’t been that way recently, however. Since 2006, the average return on an IPO stock after one year has been 3%, while the return after two years has been a 42% loss. And in that time, only 26% of the companies that went public have been profitable. “It’s a much different IPO market today than individual investors remember from a decade ago,” says Kathleen Smith, chairman of Renaissance Capital, which has been tracking IPO performance.

One of the factors ginning up enthusiasm among investors anticipating a GM IPO has been the enormous returns by investors who bought Ford shares in early 2009, or the shares of auto parts makers. From March 9, 2009 to May 7, 2009, Ford’s shares climbed 600%. Parts maker TRW Automotive’s shares climbed 1,800% during the same period. Other parts companies like American Axle and ArvinMeritor were penny stocks in March of last year, and have roared back with similar returns for those nervy enough to have bought the stocks off the lows. “You can’t look at that, though, because those gains came off artificially low, panic prices,” says Joseph Philippi of Auto Trends Consulting, Short Hills, NJ, who was a long-time Wall Street auto industry analyst before becoming a consultant.

A GM spokesperson says the company is not ready to discuss the timing of its IPO, and did not offer comment about speculation that it will come as early as the fourth quarter of this year.

Beforehand, GM will do what is called a “road show” in which GM and its advisors will make a series of presentations to portfolio managers who buy big chunks of stock, and who will examine GM’s finances and give GM their input on what price the stock should be offered at. GM will issue new shares to the public, probably equaling 20%-30% of the company, as is the case with most IPOs. But GM and the investment banks that syndicate the IPO to investors will determine the right number of shares that will be offered to the public.

The Federal Government, Canada, the UAW and bondholders, which own GM today, will have the private stock they hold today exchanged for public stock, but will be restricted for a period of time after the IPO from trading their stock. In truth, they wouldn’t want to sell right away anyway because the idea is to let the public stock trade high enough that they could cash out of their private equity position at break-even or at a profit.

Stock analysts following GM today say the company is worth about $68.6 billion. GM would have to raise a total of $80 billion from new investors in order for all four groups to break even. With 500 million shares outstanding held by the four groups, their break-even share price is about $137.00.

So, for example, while President Obama has said that he intends to unwind the government’s ownership stake in GM as soon as is practical, the taxpayers could potentially do better than break-even if the government holds shares longer and GM’s fortunes improve. On principle, though, the government is not looking to make a killing on GM stock. There is political pressure for Uncle Sam to sell its stake soon after the shares hit the break-even point.

So, How Good An Investment Will GM Make?

Until the automaker starts making its case to institutional investors and investment bank advisors, there are more questions than answers. And because Congress was, and is, so divided about whether the government should have bailed out GM, as well as Chrysler, some of the questions that will be raised will be political in nature. To that end, GM will surely wait until after this November’s mid-term elections are over before it gets into the details of an IPO.

Do We Know About What One Share Of GM Will Cost?

Not yet. Wall Street will look at how the market is valuing other automakers such as Ford, Nissan, Toyota, as well as major auto parts suppliers. Right now, many of those companies are trading at a share price that is around six to ten times earnings per share. So, if GM through the third quarter of this year is on track to earn, say, $3 billion, that would be $6 a share based on 500 million shares outstanding. Eight times that amount would be $48. Once the IPO occurs, and there are, say, 100 million new shares issued to the public, the value of the shares held by the U.S., Canada, UAW and the bondholders will be equal to the market price of the new shares.

Will GM Executives Get A Better Deal On GM Stock Than Average Investors?

Given the taxpayers’ skin in this game, this is sure to be a debating point among members of Congress and investors previously burned on GM stock and bonds before the bankruptcy. But Renaissance Capital’s Smith says that outside investors want to see management invested in the IPO and performance of the stock. “Management will get in on the IPO, which is what you want. And from a political standpoint, no one will complain until it goes up and insiders get wealthy.”

Will Wall Street Firms Only Give Their Big And Best Customers Access To The Shares At The Opening Price?

There will be some of that, for sure. But this IPO climate is not the same as it once was, so it’s unlikely that those investors will have much of an advantage over other investors. The Renaissance Capital IPO Fund, for example, last year gained about 50% in a year when stocks were coming off their historic lows in March. But, so far this year, the Fund is actually lagging the return of the S&P 500.

What Will The Portfolio Managers Be Looking For Before They Decide On Investing In The New GM?

First is fundamentals. They will scrutinize the financial results GM has been providing since it emerged from bankruptcy: profits, cashflow, earnings before interest, taxes, depreciation and amortization (EBITDA), which is what many investors look at as best indicator of profitability. They will look at net profit margin, which is how much the company is earning on every dollar of revenue, and compare GM’s with that of company’s like Nissan, Toyota and Ford. And they will evaluate whether they think GM’s product line is gaining momentum in the marketplace.

Will corporate governance factor into how GM’s IPO is received?

Absolutely. GM’s previous board of directors was considered ineffectual, and too close to management. Today’s board is completely new, made up of chairman Ed Whitacre, who was brought in by the White House auto industry task force; Stephen Girsky, vice chairman, who had advised the task force, plus 12 other experienced managers from companies like Coca-Cola, Northrop Grumman and Alcatel-Lucent. Girsky in particular is very influential, and carries the currency of having been one of GM’s sharpest and most strident critics while working as a Wall Street analyst covering the company.

What Are The Clearest Signs That GM’s Value Will Climb?

Auto Trends’ Phillippi points to a few factors: The best and most competitive designs he has seen coming out of GM relative to what Asians are selling. “GM’s designs are exciting to look at, and that’s new.” GM has a dominant position in China, the fastest growing market in the world, and it will top 2 million in sales this year in a market that will be around 16 million-plus. GM is still the leader overall in light trucks in North America. Toyota and Nissan haven’t been able to make a dent in that highly profitable category. As the economy roars back, and housing picks up again, the light truck market will still be dominated by Ford and GM, with GM having the bigger market share. Lastly, GM like Ford, is proving it can earn a profit when the industry is limping along at 11.5 million-12 million in sales. If forecasts of U.S. auto sales reaching 15 million again by 2015 prove accurate, GM will be in a position to earn huge profits from that additional sales volume.