A little knowledge is a dangerous thing, and that’s what I have when it comes to the oil business. I can neither read a seismic survey nor explain the best method to drill for gas in a fractured reservoir. That said, for more than twenty years, I have been involved with oil and gas companies, read their financial statements, listened to their traders, and studied their results. I have visited oil fields in Kuwait and Texas, and refineries in a far-flung Russian province. In Riga, the Latvian capital, I even went to an old U-boat pen that the government wanted to convert into a storage terminal (for oil, I was told, not U-boats).
In this time, I have formed a few conclusions about the petroleum industry, along these lines: a lot of people in the so-called upstream side of the business (that is, those companies exploring for new oil and gas) tend to have the personalities of riverboat gamblers, if not the matching pearl-lined vests. Rarely do they see an underground prospect that does not contain the reserves of the next Saudi Arabia. On the downstream side—that making its money in the chain between refining and service stations—location and borrowed money rule the balance sheet. The companies that do well are those with the lowest debt-to-equity ratios and the best locations. An inefficient refinery in Rotterdam with little debt will last longer than a modern but debt-laden plant in Belarus, because it is closer to the consumer markets of Western Europe. The same is true of gas stations or pipelines.
I thought of my petroleum clichés recently in England when I met a series of people connected to different segments of the oil and gas business. At times, or so it seemed, everyone at the table was $50 million short and looking for ways to drill into the proven reserves of Middle East money. In general at oil exploration meetings, one group shows up with a dream, and the other party supplies the money, although everyone at the table tends to have divining rods, if not conical hats.
During some of the meetings, I found my mind wandering to the larger questions: Is the North Sea running on empty? Did the recent spike in oil prices mark the beginning of petroleum’s end or for the next fifty years, as prices increase, will the world’s proven energy reserves also move up? Is it necessary for countries to be energy independent? To what extent should the struggle against terrorism be known as The Oil Wars?
Whither the North Sea?
A lot of the discussions in England touched on the future of the North Sea, which, in terms of global production, once represented about 10 percent of global oil production (now it’s below 5 %). At one meeting, I met a geologist who was present at the creation of the offshore oil industry. I asked him if North Sea oil was in decline and, if so, how long would it take to run dry.
He said he expected such established fields as Norway’s Brent to last until around 2024. But then he made the trenchant remark that the only way to run out of oil—in the North Sea or anywhere else—“is to stop looking for it.” He spoke of new technologies, available only in the last three years, which would allow geologists to estimate the hydrocarbons in fields adjacent to those pumped dry. He thought that giant new fields (known in the trade as “elephants”) might be found 30,000 feet under the seabed. But the only way to verify such possibilities is to drill into them, and drilling to 10,000 meters presents a host of technological and legal challenges. Technologically, the deeper you go, the more expensive a well costs; legally, it is not clear who owns the rights to petroleum assets potentially below existing but shallower oil fields.
Another problem in the North Sea is that while its oil is depleting, it is also short of rigs. With the boom in petroleum prices, day rates of deep-sea oil rigs have skyrocketed, which means that even if you want to search North Sea acreage for new reserves, the cost of employing a rig is more than $300,000 a day, making it the province of the multinationals. As a result of the rig shortage and day rates, smaller companies, some with so-called “promote licenses,” risk losing their grubstake claims if within two years they cannot develop their chosen fields. Only those companies in the North Sea with access to rigs will make money there.
Given such platform demand and short supply, you might think it better to own shares in a rig outfit than those of an oil exploration company, especially a small one. But the problem with that strategy is one of price. For example, shares in a leading North Sea rig company, Transocean Inc., trade at 47 times earnings, which indicate for its shareholders the well has already come in—even if for the exploring company it may be a dry hole.
Is the Oil Tank Half Empty or Half Full?
In the circles of geological and petroleum sciences, there is a lively debate as to if and when the world, in general, has or will have depleted more than half of its petroleum reserves. Some scientists argue that the hydrocarbon bell-curve will keep moving to the right, as new technology allows companies to find more oil and, as the price of oil increases, its extraction becomes more economically efficient. Nevertheless, one report I have read claims global oil production will peak before 2010. Meanwhile alchemists employed by the U.S. Department of Energy keep stirring their vats to prove that oil production will only peak long into the future, presumably after the last barrels have been extracted from the last deposits of molten lead. But whenever the oil wave crests, the reality is that most of the easy money has been made from Western reservoirs, and that increasingly the world’s petroleum spigots will be turned in countries where despotism, or at least some form of Islamic fundamentalism, may have a hand on the tap.
The problem for the Western democracies is that the bell curve has certainly sounded on their domestic oil production. You can argue with the finer points in the data, but essentially oil production in the North Sea peaked around year 2000 while in the US the high-oil mark came around 1971. Based on current rates of exploitation, the oil fields in the North Sea, and in East Texas and the Gulf of Mexico, will run dry a lot sooner than the wells in places like Iran, Iraq, and Saudi Arabia. At present neither the U.S. nor any European country appears on the list of countries with large proven oil reserves. Saudi Arabia tops the chart with some 261 billions barrels of proven reserves. Others include Iran with 125 billion barrels, Venezuela with 77 billion, and Russia with 60 billion. With nearly all the countries on this list, is it surprising that, in the last thirty years, the US has fought either a hot or cold war?
In terms of proven oil reserves, the United States, with 22 billion barrels, ranks ahead of Qatar, but behind China, in 13th place on the world’s reserves table. At the same time, the U.S. consumes more barrels of oil a day than are used by the next six countries combined, and those economies include Japan, China, Germany, Russia, South Korea, and Brazil. Recent statistics have tried to downplay the importance of oil in western economies, arguing that its price hikes are less inflationary than they were in the 1970s and 80s—when energy costs were more significant in the consumer price index. But domestic U.S. oil production only fulfills about 40 percent of the country’s consumption demands, which may explain why Washington is always preaching from The Democratic Book of Virtue to countries like Venezuela, Iran, and Nigeria but is strangely silent to genocide in places like oil-dry Rwanda.
Declarations of Energy Independence?
In addition to being a political resource—something largely traded by state oil companies, or oil companies that run states—petroleum has qualities of an aesthetic commodity. North Sea oil evokes the same virtues of energy independence as does the gas extracted in Oklahoma or the power generated by the windmills in Holland. By contrast, Nigerian oil is synonymous with African corruption, and purchasing barrels of Iranian crude implies sympathy for a nuclear devil. Although many countries—including the U.S.—take the measure of their national security as a ratio between homegrown and imported oil, there are only small degrees of difference (most having to do with sulfur content) between, for example, Libyan crude and that bubbling to the ground in Titusville, Pennsylvania. Thus does it matter what countries, or which governments, own an oil field? In the era of naval historian Alfred Mahan’s imperial fleets, countries wanted to control the sea-lanes to keep markets stocked and the empire running. But, in the 21st century, should we care whether the oil turning over the engine of an SUV comes from Alberta’s tar sands or Iranian mullahs?
Keep in mind that there is little price differential between high-test fermented in the Gulf of Mexico or that drilled along Colonel Muammar al-Qaddafi’s Line of Death. Once a barrel of oil reaches the high seas, it becomes a commodity as fungible as coffee, sugar or cocoa: something difficult to trace to its wellhead, especially if it is blended. The recent report on the UN Oil-for-Food Program in Iraq, undertaken by His Moral Conscience, Paul Volker, makes it clear that the international community was tilting at oilrigs when it thought it could control the distribution of Saddam Hussein’s Iraqi petroleum. Once the crude passed the Straits of Hormuz, it was anybody’s game. Ironically, to line his pockets and palaces, Saddam flooded the oil market as best he could, helping to lower world petroleum prices, while the American invasion has mostly crippled Iraq’s output, thus pushing prices skyward. Instead of declaring a war on terror, the Bush administration might just as well have asked the Texas Railroad Commission to draw up the by-laws of a new Greater Economic Co-Prosperity Sphere. When OPEC rallies its faithful, are American oilmen on their feet or knees?
Filling Up al-Qaida?
A few years ago, I read a doomsday scenario by the former National Security expert on terrorism, Richard Clarke, who wrote a celebrated book about September 11th. In the conclusion he imagines fundamentalist control of Pakistan, instability in Afghanistan, Iranian Shiite control of southern Iraq, and a revolutionary al-Qaida-like government in Saudi Arabia. It is not an impossible scenario to imagine, given the inequality that divides many of the Middle Eastern sheikdoms from their impoverished citizens, among whom al-Qaida has a niche market.
For the U.S. and its industrial partners, the question is whether radical or fundamentalist Muslim Middle East would cut off oil shipments to the West. They might try, but somehow I doubt they would succeed, if for no other reason than that cheating on OPEC quotas is one of the great petroleum sports. (Right up there with embargo busting and pretending that high-test or STP does anything for your engine.) Whether the West would want to transfer billions of dollars of its wealth, in exchange for oil, to its sworn enemies is a more difficult question. I would say we should not, but then I tend to be a Luddite, and would develop an Interstate bicycle highway and bring back the Twentieth Century Limited.
You can’t have a nation of single-passenger commuters and a Route 66 mentality in the White House, and then have any illusions about energy independence. Anyone who has spent time on the highways of America knows that the U.S. is a gas-guzzling republic, hostage to the fortunes of oil-producing entities. For some years, the words “fill her up” have been a muezzin’s call to the faithful. I wish it were otherwise, but you don’t win the Great Game by ripping up train tracks or driving Hummers to the mall.
Wednesday, December 21, 2005
Friday, December 02, 2005
GM: A Genetically-Modified Balance Sheet
I may be missing something in the financial print, but isn’t General Motors already bankrupt? Or at least insolvent? If you read the press releases coming out of Detroit, or the dispatches from the shill automotive press—there to test drive the new Corvette, not to read cash flow statements—the news about General Motors is not all bad. It has about $19 billion in cash on its balance sheet, and the wizards of Grosse Point have a plan to streamline the company, close some plants, gradually lay off 30,000 workers, and downsize an SUV-sized company into a mean lean machine, although presumably something with tighter lines than the old AMC Gremlin.
I hope the reorganization plan works, just the way I hope, whenever I am in a GM car, that I can open the trunk or find the gas-cap release. But before we dream about a new Camaro saving GM, let’s go through the GM numbers, which ought to be giving anyone sticker shock, including those selling used-car economics in Washington.
Through the third quarter of 2005, GM reported a net loss of $3.8 billion. It would have been $6.4 billion had the company not had tax-losses carried forward that tipped $2.2 billion to the bottom line. But the news is actually worse than that. The car division lost almost $10 billion in the first nine months, red ink that was offset by more tax-loss carryforwards and another $2.2 billion earned at General Motors Acceptance Corporation (GMAC), which is essentially the GM house bank. It does more than provide financing for the family Bonneville, although that’s a major part of the business. As an asset-based lender, GMAC provides mortgages, commercial credit, and other banking services that have nothing to do with all those documents the car salesmen make you sign before you can drive a Hummer H3 into the desert storm that is Little League baseball.
Car enthusiasts and GM believers will argue that the current losses are beyond the control of the company’s management. High gas prices choked off SUV sales (that’s because of Bush, Rummy, Katrina, and Rita). Blame the Japanese and the Koreans for GM’s drop in market share (in the US, 44 percent in 1983 to about 22 percent now; GM’s share of the global market is currently14 percent). Blame Asia in general for paying their workers about $1 an hour and limiting pension and health benefits to a few bowls of watery soup. You can thank the Germans for making all those Audi and BMW black sedans a must-have rung on the ascendant corporate ladder. Because of the Electoral College, Michigan is an important Democratic swing state, where unemployment is not a hot option. Plus sleazy Enron-like accountants tanked Delphi, the former GM parts division that was spun off and is now bankrupt, threatening GM’s ability to source inventory. Take away GM’s generous labor contracts, the pension shortfall, the prescription invoices, the competition in Asia and Europe, the odd recall here and there of 300,000 cars, the memory of the Chevy Vega, and you could say we’ve got a pretty good company.
Still, GM’s balance sheet has breakdowns that might perplex even Mr. Goodwrench. Yes, at September 30th, 2005, the company lists $55 billion in “cash and marketable securities,” and total assets of $469 billion. Although the company has to mail out a few “Red Tag” rebate checks before the end of 2005, that cushion should see GM into the future, even if it loses $5 billion for a few years or revives the Corvair. Except that, under a bankruptcy-court’s hammer, I have a hard time imagining that a GM will net $469 billion.
To come to terms with GM’s liquidation value, you have to understand the corporation as not one company, but at least four: a car company, which has a death rattle; a Health Maintenance Organization (HMO), where none of the patients pay; a pension plan, in which the company took the actuarial gamble that no one would get old; and a bank, which, while making money and well-managed, still has a lot of Chevy Impalas backing up its loan portfolio. I am sure there are buyers for the bank (GMAC), and at 12-15 times earnings, maybe it could fetch $34-40 billion. But if a part of GM is worth that amount, what does it say about the rest, given that the entire company, including GMAC, has a current market value of $13 billion. It says the car business of GM is in a $20 billion hole.
If some of GM’s assets are questionable in a distressed sale, the liabilities are stubbornly real. Total liabilities amounted to $446 billion, which, in theory, leaves the shareholders with $23 billion in capital, although balance sheet equity is what in accounting is called a plug figure. For example, among its assets GM lists $28 billion in deferred taxes and inventory of $14 billion—assets of value so long as GM is a going concern. Shut the doors, and there is not much of a secondary market for its tax credits or Caddy mufflers. The same would be true of halted assembly lines.
Other liabilities include the often-reported health benefits that are due to retirees. $32 billion due is carried on the balance sheet as “post-retirement benefits other than pensions,” which explains why GM is the world’s largest HMO, albeit one without doctors. Another $10 billion is due to the pension plan. Together these obligations are often imagined as a “$1,600-per-vehicle handicap” that is chained to the bumper of every new GM car. These numbers are those of September 30th. I have read elsewhere that GM’s unfunded pension liability is closer to $17 billion—but all these figures are the difference between calculated future pension obligations and the current market value of GM’s pension investments. GM’s pension nut is covered in a buoyant stock market, like that of the roaring 1990s, but crushed in a bad one. The company may even get hit with another $11 billion in similar pension/health charges if its supplier, and former subsidiary, Delphi, is liquidated, and some of their personnel charges are shifted back to the seller, GM, which agreed to cover those liabilities in a liquidation.
Despite boasting of a cash surplus on the balance sheet, the challenge at GM is to avoid a run at the bank. In 2006, according to one report, the company has to pay off or refinance some $44.7 billion in outstanding debt. But since those notes went on the books, GM’s credit rating has been lowered to junk-bond status, which means that instead of paying 5 or 6 percent for five-year money, GM may be looking at coupons in the range of 10-15 percent. In the land of loan sharking, that is a lot of vigorish.
Already in 2005, GM has paid $11 billion in interest expense, although most of that ($9.3 billion) has been to fund the finance company, which draws about $260 billion from the market. The $3 billion that it will cost in 2005 to fund the car companies will jump next year as interest rates increase and GM has to raise junk money to fund their losing propositions in the pension and health-care portfolios. At the moment GM’s 30-year, 2033 bonds (with 8.375 percent coupons) sell at $0.74 on the dollar, giving them an effective yield to maturity of 11.7 percent. But 30-year GM bonds don’t sound to me any more realistic than the illusion of keeping of a Chevy Caprice for 30 years.
Other than selling a lot more cars, what’s the solution to GM’s problems?
The persistent rumor is that, beyond sticking the pension obligations to the U.S. government, laying off 30,000 workers and closing some plants, GM plans to sell down enough of GMAC to move the finance company off the balance sheet. As a stand-alone business, GMAC would not be saddled with its parent company’s distressed credit rating. But as a stand-alone, it might also look for loan collateral other than a Buick LaCrosse. GMAC was set up to finance GM car sales. Dealers without easy money, however, will feel like they are back to the challenge of talking up the horsepower or handling abilities of the Chevy Nova.
Official bankruptcy might give the company a chance to renegotiate its union contracts, or pass more of the pension and health liabilities on to the federal government. Airlines in the same bind have used this strategy. But it would also start a run at the bank, which funds some $260 billion in the institutional market. Hence the GM dilemma: it can sell GMAC and lose its in-house financing arm, or it can keep GMAC and watch its balance sheet become a hostage to the high-coupon misfortunes of the car industry.
In recent months, the financier Kirk Kerkorian—who has previously held large stakes in the likes of MGM and Chrysler—has acquired 9.9 percent of GM. His capital invested in GM is roughly $1.68 billion, according to published reports of his stake. Mr. Kerkorian is a smart investor but you have to wonder why he would be eager to own 10 percent of a company that has more than $300 billion in debts, less than $30 billion in equity, and is betting the ranch on selling suburban vehicles that get the gas mileage of armored cars. He might be of the view that GM is, as they say of other large banks, “too big to fail,” and that the Bush administration will assume the pension and health care cost in exchange for GM avoiding bankruptcy. After all, the Carter administration bailed out Chrysler, and it lived another day to sell mini-vans, much to the profit of Mr. Kerkorian, although he bought into the company after the bailout.
He might also push the GM board to spin off GMAC to existing shareholders, and then encourage the remaining GM shareholders to pull the plug on the car division. (That could double his investment if 9.9 percent of GMAC is worth about $3.5 billion.) But I think GM’s creditors, unions and shareholders will fight to keep GMAC under the parent company corporate umbrella. Meanwhile, he financed part of his investment with a $400 million line of credit from Bank of America, which can’t love the drop of $350 million on the position, although his wealth dwarfs these losses. At the same time, so long as GM clings to its $2 dividend (an 8.7 percent yield at current prices), Mr. Kerkorian can pocket about $29 million a quarter in dividends. But that yield will pale compared to equity losses if his chips remain on the table while GM’s shares slide away.
Despite the company’s reputation for industrial dominance, it has been a long time since the business of America was GM. Compare its $13 billion market capitalization with Intel’s $142 billion, Exxon Mobil’s $357 billion, or even the Gap’s $15 billion. At the same time GM’s revenue of $193 billion sets a lot of tables, and anyone who has recently sat in a traffic jam knows that it is impossible to go broke selling cars in America. With lower sales than GM, Toyota’s market cap is $181 billion, a point not lost on shrewd investors like Kirk Kerkoiran. But more than most businesses, GM is hostage is to many misfortunes, not to mention special interests.
During the 1980s, I spent two weeks in Detroit, assessing the industry. I met Edsel Ford (the corporate executive, not the 1950s car model with fins) and inspected injured crash dummies. My conclusion was that the US auto sector is part of the fashion industry, expected one month to have a complete line of gas-efficient hybrids and in the next to roll out some new muscle cars. But it takes years to retool a factory to turn out mini-vans instead of Firebirds. Sometimes it is even cheaper to close down a plant and build a new one elsewhere. Meanwhile GM has lost the luxury market to the Germans, and the fuel-efficient market to Japan, leaving Detroit to base its sale pitch on mid-range gas-guzzling sedans with “rich Corinthian leather.”
In a larger sense, GM and its creditors, which will soon fight over the spoils of a fading empire, are also hostage to the fashion catwalks in Washington. One administration speaks of empty oil reservoirs, and out comes the Ford Pinto. A few years later another administration preaches that oil is plentiful and that it is okay to cruise Route 66 in wood-paneled station wagons. Nor do companies like Ford or GM ever get the word on whether they are obliged to play by the rules of capitalism or socialism. If the rulebook is capitalistic, why does GM have to “buy American” and why can it not outsource its high costs to the same sweatshops that make Intel and Nike so successful? If the game is socialism, can GM not be proud of employing 350,000 workers, paying so many pensions, filling all those prescriptions, and making reasonable products, even if its balance sheet has the accounting air of a Soviet collective. A lot of lines are now blurred, and I imagine the real problem at GM is that senior management does not know whether it is coming or going.
Wasn’t the business of America easier to understand when everyone could be classified along the lines of being a “Chevy,” “Ford,” or “Pontiac” man?
I hope the reorganization plan works, just the way I hope, whenever I am in a GM car, that I can open the trunk or find the gas-cap release. But before we dream about a new Camaro saving GM, let’s go through the GM numbers, which ought to be giving anyone sticker shock, including those selling used-car economics in Washington.
Through the third quarter of 2005, GM reported a net loss of $3.8 billion. It would have been $6.4 billion had the company not had tax-losses carried forward that tipped $2.2 billion to the bottom line. But the news is actually worse than that. The car division lost almost $10 billion in the first nine months, red ink that was offset by more tax-loss carryforwards and another $2.2 billion earned at General Motors Acceptance Corporation (GMAC), which is essentially the GM house bank. It does more than provide financing for the family Bonneville, although that’s a major part of the business. As an asset-based lender, GMAC provides mortgages, commercial credit, and other banking services that have nothing to do with all those documents the car salesmen make you sign before you can drive a Hummer H3 into the desert storm that is Little League baseball.
Car enthusiasts and GM believers will argue that the current losses are beyond the control of the company’s management. High gas prices choked off SUV sales (that’s because of Bush, Rummy, Katrina, and Rita). Blame the Japanese and the Koreans for GM’s drop in market share (in the US, 44 percent in 1983 to about 22 percent now; GM’s share of the global market is currently14 percent). Blame Asia in general for paying their workers about $1 an hour and limiting pension and health benefits to a few bowls of watery soup. You can thank the Germans for making all those Audi and BMW black sedans a must-have rung on the ascendant corporate ladder. Because of the Electoral College, Michigan is an important Democratic swing state, where unemployment is not a hot option. Plus sleazy Enron-like accountants tanked Delphi, the former GM parts division that was spun off and is now bankrupt, threatening GM’s ability to source inventory. Take away GM’s generous labor contracts, the pension shortfall, the prescription invoices, the competition in Asia and Europe, the odd recall here and there of 300,000 cars, the memory of the Chevy Vega, and you could say we’ve got a pretty good company.
Still, GM’s balance sheet has breakdowns that might perplex even Mr. Goodwrench. Yes, at September 30th, 2005, the company lists $55 billion in “cash and marketable securities,” and total assets of $469 billion. Although the company has to mail out a few “Red Tag” rebate checks before the end of 2005, that cushion should see GM into the future, even if it loses $5 billion for a few years or revives the Corvair. Except that, under a bankruptcy-court’s hammer, I have a hard time imagining that a GM will net $469 billion.
To come to terms with GM’s liquidation value, you have to understand the corporation as not one company, but at least four: a car company, which has a death rattle; a Health Maintenance Organization (HMO), where none of the patients pay; a pension plan, in which the company took the actuarial gamble that no one would get old; and a bank, which, while making money and well-managed, still has a lot of Chevy Impalas backing up its loan portfolio. I am sure there are buyers for the bank (GMAC), and at 12-15 times earnings, maybe it could fetch $34-40 billion. But if a part of GM is worth that amount, what does it say about the rest, given that the entire company, including GMAC, has a current market value of $13 billion. It says the car business of GM is in a $20 billion hole.
If some of GM’s assets are questionable in a distressed sale, the liabilities are stubbornly real. Total liabilities amounted to $446 billion, which, in theory, leaves the shareholders with $23 billion in capital, although balance sheet equity is what in accounting is called a plug figure. For example, among its assets GM lists $28 billion in deferred taxes and inventory of $14 billion—assets of value so long as GM is a going concern. Shut the doors, and there is not much of a secondary market for its tax credits or Caddy mufflers. The same would be true of halted assembly lines.
Other liabilities include the often-reported health benefits that are due to retirees. $32 billion due is carried on the balance sheet as “post-retirement benefits other than pensions,” which explains why GM is the world’s largest HMO, albeit one without doctors. Another $10 billion is due to the pension plan. Together these obligations are often imagined as a “$1,600-per-vehicle handicap” that is chained to the bumper of every new GM car. These numbers are those of September 30th. I have read elsewhere that GM’s unfunded pension liability is closer to $17 billion—but all these figures are the difference between calculated future pension obligations and the current market value of GM’s pension investments. GM’s pension nut is covered in a buoyant stock market, like that of the roaring 1990s, but crushed in a bad one. The company may even get hit with another $11 billion in similar pension/health charges if its supplier, and former subsidiary, Delphi, is liquidated, and some of their personnel charges are shifted back to the seller, GM, which agreed to cover those liabilities in a liquidation.
Despite boasting of a cash surplus on the balance sheet, the challenge at GM is to avoid a run at the bank. In 2006, according to one report, the company has to pay off or refinance some $44.7 billion in outstanding debt. But since those notes went on the books, GM’s credit rating has been lowered to junk-bond status, which means that instead of paying 5 or 6 percent for five-year money, GM may be looking at coupons in the range of 10-15 percent. In the land of loan sharking, that is a lot of vigorish.
Already in 2005, GM has paid $11 billion in interest expense, although most of that ($9.3 billion) has been to fund the finance company, which draws about $260 billion from the market. The $3 billion that it will cost in 2005 to fund the car companies will jump next year as interest rates increase and GM has to raise junk money to fund their losing propositions in the pension and health-care portfolios. At the moment GM’s 30-year, 2033 bonds (with 8.375 percent coupons) sell at $0.74 on the dollar, giving them an effective yield to maturity of 11.7 percent. But 30-year GM bonds don’t sound to me any more realistic than the illusion of keeping of a Chevy Caprice for 30 years.
Other than selling a lot more cars, what’s the solution to GM’s problems?
The persistent rumor is that, beyond sticking the pension obligations to the U.S. government, laying off 30,000 workers and closing some plants, GM plans to sell down enough of GMAC to move the finance company off the balance sheet. As a stand-alone business, GMAC would not be saddled with its parent company’s distressed credit rating. But as a stand-alone, it might also look for loan collateral other than a Buick LaCrosse. GMAC was set up to finance GM car sales. Dealers without easy money, however, will feel like they are back to the challenge of talking up the horsepower or handling abilities of the Chevy Nova.
Official bankruptcy might give the company a chance to renegotiate its union contracts, or pass more of the pension and health liabilities on to the federal government. Airlines in the same bind have used this strategy. But it would also start a run at the bank, which funds some $260 billion in the institutional market. Hence the GM dilemma: it can sell GMAC and lose its in-house financing arm, or it can keep GMAC and watch its balance sheet become a hostage to the high-coupon misfortunes of the car industry.
In recent months, the financier Kirk Kerkorian—who has previously held large stakes in the likes of MGM and Chrysler—has acquired 9.9 percent of GM. His capital invested in GM is roughly $1.68 billion, according to published reports of his stake. Mr. Kerkorian is a smart investor but you have to wonder why he would be eager to own 10 percent of a company that has more than $300 billion in debts, less than $30 billion in equity, and is betting the ranch on selling suburban vehicles that get the gas mileage of armored cars. He might be of the view that GM is, as they say of other large banks, “too big to fail,” and that the Bush administration will assume the pension and health care cost in exchange for GM avoiding bankruptcy. After all, the Carter administration bailed out Chrysler, and it lived another day to sell mini-vans, much to the profit of Mr. Kerkorian, although he bought into the company after the bailout.
He might also push the GM board to spin off GMAC to existing shareholders, and then encourage the remaining GM shareholders to pull the plug on the car division. (That could double his investment if 9.9 percent of GMAC is worth about $3.5 billion.) But I think GM’s creditors, unions and shareholders will fight to keep GMAC under the parent company corporate umbrella. Meanwhile, he financed part of his investment with a $400 million line of credit from Bank of America, which can’t love the drop of $350 million on the position, although his wealth dwarfs these losses. At the same time, so long as GM clings to its $2 dividend (an 8.7 percent yield at current prices), Mr. Kerkorian can pocket about $29 million a quarter in dividends. But that yield will pale compared to equity losses if his chips remain on the table while GM’s shares slide away.
Despite the company’s reputation for industrial dominance, it has been a long time since the business of America was GM. Compare its $13 billion market capitalization with Intel’s $142 billion, Exxon Mobil’s $357 billion, or even the Gap’s $15 billion. At the same time GM’s revenue of $193 billion sets a lot of tables, and anyone who has recently sat in a traffic jam knows that it is impossible to go broke selling cars in America. With lower sales than GM, Toyota’s market cap is $181 billion, a point not lost on shrewd investors like Kirk Kerkoiran. But more than most businesses, GM is hostage is to many misfortunes, not to mention special interests.
During the 1980s, I spent two weeks in Detroit, assessing the industry. I met Edsel Ford (the corporate executive, not the 1950s car model with fins) and inspected injured crash dummies. My conclusion was that the US auto sector is part of the fashion industry, expected one month to have a complete line of gas-efficient hybrids and in the next to roll out some new muscle cars. But it takes years to retool a factory to turn out mini-vans instead of Firebirds. Sometimes it is even cheaper to close down a plant and build a new one elsewhere. Meanwhile GM has lost the luxury market to the Germans, and the fuel-efficient market to Japan, leaving Detroit to base its sale pitch on mid-range gas-guzzling sedans with “rich Corinthian leather.”
In a larger sense, GM and its creditors, which will soon fight over the spoils of a fading empire, are also hostage to the fashion catwalks in Washington. One administration speaks of empty oil reservoirs, and out comes the Ford Pinto. A few years later another administration preaches that oil is plentiful and that it is okay to cruise Route 66 in wood-paneled station wagons. Nor do companies like Ford or GM ever get the word on whether they are obliged to play by the rules of capitalism or socialism. If the rulebook is capitalistic, why does GM have to “buy American” and why can it not outsource its high costs to the same sweatshops that make Intel and Nike so successful? If the game is socialism, can GM not be proud of employing 350,000 workers, paying so many pensions, filling all those prescriptions, and making reasonable products, even if its balance sheet has the accounting air of a Soviet collective. A lot of lines are now blurred, and I imagine the real problem at GM is that senior management does not know whether it is coming or going.
Wasn’t the business of America easier to understand when everyone could be classified along the lines of being a “Chevy,” “Ford,” or “Pontiac” man?
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