The 3 Keys to Fixing GM

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Americans love a good comeback story. Since its IPO one year ago today, though, General Motors' (NYS: GM) tale has played out more like Boogie Nights than Rocky II. The CFO who marshaled the company through its IPO bailed in March, the company's European business is still floundering, and Uncle Sam is still sitting on his stake. The stock has tanked 36%.

Count me among the disappointed. I was bearish all the way down as GM cascaded into bankruptcy two years ago, but new management and a streamlined business changed my tune. And while I've been wrong about GM so far, I'm still convinced that both its business and stock are fixable sooner rather than later. The company has right-sized its cost structure, ramped up product development, gained market share, and centered itself around the four core brands of Chevrolet, Buick, GMC, and Cadillac.

The trouble
There's more GM's leadership should be doing to unlock and create shareholder value. I'll walk you through those three keys in a moment. But first, let's zero in on the root cause of GM's ills: Car sales in its key U.S. market are still stuck in a ditch.

Sources: Bureau of Economic Analysis and author's calculations.

GM has actually managed to turn a profit for the past seven quarters despite this tough slog, but lackluster demand is a pox on the houses of all automakers. That curse has pushed crosstown rival Ford's (NYS: F) stock down just as hard as GM's over the past year while foreign rivals Toyota (NYS: TM) , Honda (NYS: HMC) , and Nissan (NAS: NSANY.PK) have also underperformed the market.

The good news is that new vehicle sales should snap back thanks to an economic recovery and pent-up demand. The average age of cars on U.S. roads is now a record 10.6 years, according to Polk, as a tough economy has forced drivers to grind out just a few more miles on their clunkers. As those vehicles get more and more expensive to fix and used car prices hover near record highs, new vehicle demand will get pushed upward whether the economy comes along for the ride or not.

The fix
And so a rising tide should lift all boats. The bad news is that there is more to be done at GM beyond the great work current management has already done to turn around the business. Here are my three steps for turning around GM's business and stock price.

Step 1: Put the cash to work
GM's bankruptcy taught the company the value of a large cash stockpile. While I appreciate a newfound conservatism, GM needs to put some of its $33 billion war chest to work. Specifically, it should invest about $11 billion with two moves.

The first is the most controversial: buying back half of the U.S. government's stake in the company. Uncle Sam is in a catch-22 when it comes to GM. It doesn't want to dump its stake at a loss, but the stock is stuck in neutral because many investors don't want to buy shares only to have the largest shareholder dump its shares shortly thereafter. An easy and actionable solution would be for GM to spend about $6 billion buying back half of the government's 32% stake in the company.

Buying back part of the government's stake would create value for smaller shareholders because it would be at an attractive price. Plus, it would get the monkey one step closer to being off the backs of GM, its investors, and Uncle Sam, and potentially reverse negative sentiment around the stock. That would allow the government to sell the rest of its stake later at a price that could help it get closer to saving face.

The second step is also important but less flashy: simultaneously announcing a voluntary $5 billion contribution to the underfunded U.S. pension. GM's underfunded retirement obligations, which we'll get more transparency on around at the end of this year, are a favorite bear talking point and drag on the stock. GM can put a dent in that case and, ahem, do the right thing by more actively shoring up the shortfall.

Step 2: Market aggressively
GM has stepped up its marketing over the past year, but there's room for more. The company should aggressively attack consumers with brand-building -- not sales -- campaigns. Specifically, GM should double down on new and improved display and video advertising opportunities to better connect with affluent consumers and young buyers who view GM's brands as tired. Hammering home messaging about GM's improved style and quality will not only drive sales both for the short and long term, it will also help wean GM off its long-standing addiction to discounting, which has crimped margins and hurt the entire industry.

Step 3: Get out of Europe
Here's one GM's management won't want to hear: The company needs to exit Europe by any means necessary. It hasn't been close to consistently profitable there since the Clinton administration, and the efforts to turn things around are a huge suck on cash and management's time. Instead of spinning its wheels trying to cost cut its way to success in fading economies stuck under crushing sovereign debt loads, GM should cut its losses and redeploy its resources toward its key profit center, North America, and emerging economies such as China, where GM is already a leader.

And how can GM exit? As the soundtrack to Rocky IV hammered home, there's no easy way out. Finding a willing buyer for the entire unit isn't realistic and GM won't get much for its assets. Still, even a worst-case exist scenario of liquidating the business and selling brand rights piece by piece beats the alternative of throwing time and money down a bottomless pit. It is a painful decision, but the right one.

The Foolish bottom line
I think any of those three steps would prove a boon for GM, though I'd nudge them to consider all three. The good news is that its strong balance sheet, the tailwind of an eventual recovery in U.S. auto sales, and a stock selling for only around five times earnings mean GM's stock could soar even without making any of these changes. Meantime, I'm content to sit back and wait for this story to play out -- even if it makes for a bumpy, pun-riddled ride.

At the time this article was published Joe Magyer owns both GM shares and warrants. The Motley Fool owns shares of Ford. You can kick the tires on his newsletter service,Inside Value, free for 30 days. GM and Ford are recommendations of Motley Fool newsletter services. The Motley Fool's disclosure policy brakes for no one.

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