Strategy

GM is on the road again

Faster than anyone could have hoped, "Government Motors" is back on track.

In April, General Motors tried to score PR points with a TV ad boasting it had “repaid our government loans, in full, with interest, five years ahead of the original schedule.” Angry critics, who have long considered the company a lost cause, immediately noted GM was paying bailout dollars back with money left over from the risky equity investments in the fallen industrial giant that taxpayers were also forced to make last year. Lost in all this was GM’s sudden readiness to start supporting itself. But that point was hammered home in August, when America’s so-called Government Motors — which lost more the US$80 billion in the three years leading up to its failure — informed the world it had earned US$2.19 billion in the first six months of 2010.

The credit for this surprising turnaround, believe it or not, goes to former CEO Rick Wagoner, who — before getting the boot — single-handedly put GM’s recovery on the fast track.

Decades ago, when GM controlled more than 50% of the U.S. vehicle market, anyone who suggested the storied company was destined to end up a ward of the state would have been considered a nut. But the unthinkable happened. And when the company filed for creditor protection in mid-2009, more than a few industry watchers thought that the people pushing for a bailout were the nutty ones.

Nevertheless, amid the panic of the Great Recession, American and Canadian politicians handed the company more than US$50 billion in risky equity investments and emergency loans. (The U.S. currently owns 61% of GM while Canada has an 11.7% stake. Former creditors and a health-care trust own the rest.)

In Canada — where GM production dropped 41% in 2008, while our percentage of North American operations slipped to 14% — the goal was to save what was left of GM Canada. But auto analyst Dennis DesRosiers ranted against the bailout, noting Canadian taxpayers were risking about $10 billion to hopefully save about 4,400 jobs, or more than $2 million per GM worker, at a company with “zero prospects” of stemming market share losses, at least in the near term, and where the chances of profitability are “slim at best.”

And yet, despite a revolving door to GM’s executive suite, which led to a flip-flop on plans to sell struggling European operations to Frank Stronach’s Magna International, GM has managed to post back-to-back quarterly gains shortly after emerging from bankruptcy. And with a public offering in the works, taxpayers appear to have a real shot at getting their money back.

So what exactly did Wagoner do to make the unthinkable happen again? He got on the wrong jet.

Each of the Detroit trio formerly known as the Big Three have been lurching from restructuring plan to restructuring plan for a long time. At GM, Wagoner did an impressive job of improving product quality over the past decade. He also shut plants, cut workers and negotiated significant labour concessions. But after years of mounting retiree obligations, operational mismanagement and unrealistic union demands, GM’s cost structure remained uncompetitive.

Furthermore, thanks to leaner European and Asian players, GM’s share of the all-important U.S. market plummeted from over 40% in the early 1980s to 22.4% in 2008. Meanwhile, light trucks as a percentage of the company’s U.S. sales increased from 17.2% to about 60%, leaving GM exposed to the waning American love affair with SUVs.

When GM tried to celebrate its 100th birthday in September 2008, soaring gas prices and financial market turmoil were pushing it to the brink. But Wagoner refused to seriously consider using bankruptcy courts to gain a fresh start. History suggests that would have resulted in a long and deadly game of chicken between stakeholders, which would scare even the most loyal consumers into avoiding GM dealers like the plague.

In the months that followed, GM contemplated a government-funded merger with Chrysler, which would have been a disaster. But Wagoner basically set out to convince Washington that GM could turn things with just a little help from taxpayers.

With hundreds of billions being tossed at Wall Street at the time, Uncle Sam might have just handed GM enough money to survive the economic downturn which, based on past performance, would simply have delayed the day of reckoning. But everything changed in November 2008, when Wagoner, along with the CEOs of Ford and Chrysler, travelled to Capitol Hill in high-flying style to seek aid after claiming to have moved mountains to cut expenses.

Congressman Brad Sherman, a California Democrat, offered some hope when he noted it would be crazy for America to abandon its auto sector. But he added: “It would also be insane, if the top executives from the three automakers came here on private jets. I am going to ask the three executives here to raise their hand if they flew here commercial.”

No hands moved, and the negative publicity set the stage for the government takeover of GM and Chrysler. (Ford had enough resources to remain free.)

After Barack Obama entered the White House, Detroit’s future was placed in the hands of Wall Street restructuring gurus who decided bankruptcy was the only way out. After telling Wagoner to get lost, they stretched the law and ignored the hierarchy of debt obligations by holding a shotgun to the head of everyone involved. That allowed GM to close more than a dozen plants, shed thousands of workers, cut dealers and dump underperforming brands. In the past year, the company has closed Saturn, Pontiac and Hummer divisions while Saab was sold off.

The government-run bankruptcy also forced bondholders to trade debt for equity while pressuring North American workers to negotiate contracts more in line with non-union standards. And all of this took place in a matter of weeks, not years, allowing GM to emerge from bankruptcy with a relatively healthy balance sheet and significantly lower cost structure before too many consumers started worrying about warranties.

GM still faces challenges, ranging from lousy financial controls and stiff competition to a workforce that will eventually seek to recover concessions. But when it returns to the ranks of public companies under new CEO Daniel Akerson (a private equity player who recently replaced Ed Whitacre, the former AT&T executive who took the helm earlier this year from Fritz Henderson, Wagoner’s replacement, not to mention the last GM boss with industry experience), its books will look nothing like the ones that cost Wagoner his job.

The company — which ended the second quarter with US$32.5 billion in cash — entered bankruptcy owing creditors and retiree health-care plans more than US$100 billion. Today, GM debt sits around US$10 billion, not counting its pension hole.

In August, U.S. sales at GM and most of its competitors plummeted (Chrysler posted a gain) on a year-over-year basis, thanks to new economic worries. But Greg Newman, a senior wealth adviser with ScotiaMcLeod’s Newman Group, notes global vehicle sales are still forecast to grow at a relatively decent clip over the next five years. And if that happens, he likes the new GM’s chances of rewarding shareholders, providing the stock auction is fairly priced.

Newman points out high-growth emerging markets generated 44.5% of GM’s revenue last year, so “it appears well-regarded and well-positioned in the markets that are growing most rapidly.” August sales in China, where GM is the industry leader, increased 19%.

DesRosiers remains skeptical. Warning investors without a high tolerance for risk to stay away from GM until a clearer picture emerges, he notes the company books revenue when vehicles leave factories, not after they are sold, so GM’s earnings could be misleading. And if the market goes south, DesRosiers says GM “will have to close factories or significantly discount, which would put them behind the eight ball one more time.”

At Connecticut’s Renaissance Capital, IPO analysts note Washington hasn’t just played around with GM’s finances. The government restructuring, they point out, requires GM to develop energy-saving technologies, including biofuels, hybrids and fuel cells. And “there is little evidence that all but a few subset of car buyers are willing to pay large sums for small vehicles with limited driving range and no fueling infrastructure.”

So before investors bet on GM, it might be a good idea to wait and see if the much-hyped Volt electric vehicle jolts more consumers into thinking green.

Then again, nobody should downplay how much GM has surprised its critics. Although its latest monthly numbers were down 25% from last year, when U.S. sales were juiced by the Cash for Clunkers program, GM has still sold 1,462,308 vehicles to Americans this year, despite its fewer brands and dealer cuts. And that’s up 6% from 2009, not to mention better than year-to-date results at GM’s Detroit cousins (so far this year Ford and Chrysler have sold 1,308,887 and 720,149 units respectively to Americans) and arch rival Toyota, which has moved 1,164,154 units in the States this year.

The upshot is that going bust clearly didn’t do GM any harm.