General Motors' public offering hasn't even been priced yet, but I nonetheless declare it a speculative buy.
My investment thesis is based on a combination of conjecture, intuition and historical experience. Buying a unionized auto maker with a tattered brand image and politicians as lead owners doesn't seem like a splendid idea on paper. But that's precisely what makes it intriguing.
GM lost almost $90-billion (U.S.) in the five years before it filed for bankruptcy protection. The U.S. and Canadian governments, as well as the province of Ontario, pumped tens of billions into the company to breathe life into it. And the resuscitation seems to be working.
GM's restructuring involved taking the best assets and putting them into the new GM while casting some of the lousy ones aside into corporations designed solely to deal with these liabilities.
Freed from those obligations, the balance sheet of the new GM appears very strong. Cash and marketable securities were $32-billion (U.S.) as of June 30, while debt was only $8-billion. The company has no debt maturing until 2015.
It's true the company faces a big pension deficit of $27-billion, but there are no mandatory payments until 2014. Furthermore, low market interest rates bloat the pension deficit because they increase the present value of future obligations. As interest rates inevitably move higher, the pension gap should narrow.
GM has a new cost structure to help it along the way. Almost half the company's cars are made in low-cost places such as China, Mexico, India and Eastern Europe, where all-in labour costs are less than $15 an hour, the company says. And the cost structure is still improving.
Some of us may disdain GM's brands in North America, but the company has extraordinary market share around the world. In Brazil, Russia, India and China, where auto sales are climbing briskly, GM is No. 1, with almost 13 per cent of the market in 2009, and that figure has been rising. The car maker also has a healthy share of the broader emerging market.
Even North America may not be a lost cause: The company is starting to make nice cars again and its reliability ratings are moving up, according to Consumer Reports.
During the first six months of this year, the company says it would have broken even on an operating profit basis.
Where the politics come in
But this by itself is not enough to recommend the stock. My thesis is based on political realities that suggest the IPO expected next month will be priced on the cheap. The evidence stacks up nicely to support the idea.
The U.S. government owns 61 per cent of the company. It obviously has an incentive to show taxpayers that its bailout of GM was a wise investment. But, for a couple of reasons, it can't simply stick a high price on its shares.
First, institutional investors are generally very wary about the economy and about GM, in particular. They are demanding a discounted price to allay their fears.
Second, the government also has an incentive to make sure that a wide swath of retail investors do well. The deal is not being aggressively marketed to foreigners. So North American retail investors (read: voters) are the target buyers.
That political reality is reflected in the structure of the offering. Rather than pricing the shares as high as possible, in search of a quick profit, the company has decided to split the stock so that it can be sold in the $20 to $25 range. That's what you do when you want to attract retail investors.
GM is also actively encouraging employees, retirees and dealers to buy stock, even extending a deadline to do so. You don't do that without some confidence in the performance of the stock.
Yes, the government over time will want to make a profit on this investment. But it can't make gains by pricing the IPO such that investors don't do well. The last thing that government wants to face is an army of small investors who have lost money on the deal.
Instead, the idea seems to be to price the offering low and watch the stock move up, allowing the government to gradually sell down its stake while small investors also prosper.
Many government IPOs follow the same pattern. In this country, while Air Canada was a dud, CN and Petro-Canada both performed very well.
This one might do exceptionally well.
Kicking the tires
U.S. government's net equity investment: $40-billion
% ownership before IPO: 61%
GM global market share: 11.4%
North American market share: 18.3%
Annualized production: 8.3 million
6 months revenue*: $64.7-billion
6 months net income*: $2.2-billion
Emerging markets share: 10.3%
Book value (June 30, 2010): $24-billion
Total debt: $8.2-billion
* to June 30, 2010. All U.S. dollars
Sources: GM, U.S. Department of the Treasury