Can we get a return on our $50 billion GM investment?
If General Motors emerges from bankruptcy in 60 to 90 days, the U.S. (meaning we taxpayers) will own 60 percent of the new GM, a slimmed down version with brands Chevrolet, Cadillac, GMC and Buick. We've lent the old GM $50 billion -- $19.4 billion before the bankruptcy and $30 billion during it -- in the form of debtor-in-possession financing. Unfortunately, there is a very low probability that we'll ever see our $50 billion again.
Before getting into my reasoning for why our $50 billion is a lost financial cause, it's worth spending a moment discussing whether President Obama will be able to resist the calls he'll get from politicians around the country to stop the closure of plants and dealerships.It will also be a challenge for Obama to decide how much to restrain himself when it comes to meddling in decisions about GM's new products. What happens if the new GM finds out it can't sell enough electric cars or hybrids to turn a profit?
To answer these questions, it's worth revisiting why the U.S. decided to put $50 billion into GM in the first place. The primary reason was to limit the number of lost jobs -- some have estimated that two to three million people would have been fired if GM had simply liquidated.
Because of the job concerns that set the U.S. on a course to bail out GM, Obama will have a hard time avoiding these calls not to close down facilities. As a politician who will seek a second term, there is a limit to how many campaign contributors and vote gatherers he can anger by ignoring their pleas either not to close a plant or to locate a new one in their district.
Moreover, Obama has some objectives of his own. For example, he wants the U.S. auto industry to produce more fuel efficient vehicles. But unless the price of gasoline gets very high, there is a good chance that there won't be enough demand for such vehicles to earn a profit off the fuel efficient vehicles -- even if they were a much better value than those already made by competitors.
So why won't we get our $50 billion back? At its peak value on April 28, 2000, I estimate GM was worth $57.2 billion, which was 9.7 times GM's peak net income of $5.9 billion for the previous year (1999). Just for argument's sake, if the U.S. had owned 60 percent of that GM, its stake would have been worth a mere $34 billion, which is $16 billion less than the $50 billion that the U.S. has invested so far.
As it turns out, since $8.8 billion of the $50 billion will remain in the form of loans, the U.S. will convert $41.2 billion worth into its 60 percent equity stake. This means that In order to break even on that $41.2 billion equity portion of our investment -- this does not even take into account getting a profit for taxpayers after taking on the risk -- the new GM would need to have a market capitalization of $68.7 billion -- 20 percent higher than the old GM was at its peak.
With the North American vehicle market expected to be at best nine million units in 2009 -- 44 percent below its 16 million peak -- it is hard to imagine a scenario where the new GM would ever have a market capitalization over $68.7 billion.
Here are three things to consider:
- Managing GM to that level of value -- even with the world's best management team and board -- would be tough in this economic climate,
- Decision-making conflicts will arise from the trade-offs between political and economic considerations, and
- The new GM will be smaller -- taking out Hummer, Saab, Saturn, and Pontiac will bring GM's current 19.2 percent market share down to 16.4 percent at current rates -- which could make it harder to achieve the level of profit needed to justify a 20 percent-higher-than-peak net income.
Our $50 billion investment in GM is gone, baby gone.
Peter Cohan is president of Peter S. Cohan & Associates. He also teaches management at Babson College. His eighth book isYou Can't Order Change: Lessons from Jim McNerney's Turnaround at Boeing. He has no financial interest in the securities mentioned.