OxBowBusiness: General Motors: one to watch

19 March 2006

General Motors: one to watch

General Motors: one to watch

Now, I don’t like being the harbinger of doom but you really ought to keep your eyes on General Motors (GM), the giant American car manufacturer. GM is suffering exceptionally badly at the moment from a variety of ills that include:

sales problems

profitability problems

pension fund problems

Today the BBC reported that GM now has accounting problems:

the company has restated its profits for 2005 and will be restating profits for 2000 - 2004 as well. Not only have they restated their profits for 2005 but they have done so to the tune of $2 BILLION.

The company now says its losses totalled $10.6bn last year, with the additional $2bn caused by errors at a mortgage subsidiary.
http://news.bbc.co.uk/1/hi/business/4818950.stm 180306

Where are GM’s problems coming from? Market share for a start, you can download an Excel file (see link below) containing the company’s market share data from 1996 to 2003: for North America (the USA, Canada, Mexico), for Europe, South America and Australasia. Sorry reading it is as their car market share in North America has fallen from 1996 - 2003 from 32.7% to 25.7% (with a low of 25.4% in 2002). Trucks have held their market share in that market although even that fell, to 27% in 2000.

GM’s world wide market share has fallen over the 1996 - 2003 period from 16.2% to 14.6%.

Take a look at that Excel file and you’ll see that GM has suffered most in these markets over the whole period:

Loss of market share (absolute % change from 1996 - 2003)
United States: cars      -7.0%
Other North America      -6.8%
Mexico           -5.1%
Germany           -5.1%

On the other hand, some markets have gained market share:

Gain in market share (absolute % change from 1996 - 2003)
Argentina           +7.3%
Venezuela           +7.2%
Other South America      +6.8%
Source: http://www.gm.com/company/investor_information/docs/sales_prod/market_share.xls

More up to date information will be released by the company shortly no doubt but at least we can see from these figures the source of at least some of GM’s problems.

Is market share such a problem? Well, for a huge fixed cost based operation as GM must be, the answer has to be yes. Fixed costs are a problem because a company with a large fixed cost base will have a small margin of safety … remember cost volume profit (break even) analysis?

Moreover, GM says it will now delay publishing its 2005 annual report. Here’s a top tip for the future: whenever any business delays the publication of its annual report, it is more likely than not to be in trouble.

GM is well known to be in trouble but this latest restatement has come as a surprise to everyone as far as I can tell. You can find the following Investor Information on the GM website dated 16th March 2006:

General Motors Corp … today provided updated preliminary financial results for 2005 and said it will delay filing its annual report … due to an accounting issue regarding the classification of cash flows at ResCap, the residential mortgage subsidiary of GMAC.

The ResCap accounting issue relates to the erroneous classification of cash flows from certain mortgage loan transactions as cash flows from operations instead of cash flows from investing activities. Although the company has not completed its review of this matter, the issue will not impact either net income or the balance sheet presentation but is expected to impact the presentation of cash flows from operating and investing activities. This issue may impact the statements of cash flows for 2005 and prior periods at ResCap, GMAC and GM and the impact may be material in some or all of the affected periods.
http://media.gm.com:8221/servlet/GatewayServlet?target=http://image.emerald.gm.com/gmnews/viewmonthlyreleasedetail.do?domain=589&docid=24262 180306

The misclassification of assets as expenses and vice versa is a classic example of what accountants can do to distort the truth: it’s a fundamental error, by the way; and something that can happen through innocence or through criminal intent. I have no way of knowing which is the case at GM; but at the time of writing, it is being presented as a mistake.

GM is desperately looking to raise cash from the liquidation of some of its assets/investments. The BBC again:

Earlier this month GM announced plans to raise $2bn through the sale of 17.4% of its stake in Japanese carmaker Suzuki.
http://news.bbc.co.uk/1/hi/business/4811014.stm 180306

As a measure of GM’s problems, they have been rumoured for many months now to be considering selling its most profitable segment, its financing segment: want to buy a car but don’t have the cash … borrow it from GMAC (what does GMAC stand for?). All large companies have their own financing arm these days, British, American, German …

GMAC Financial Services includes automotive financing, commercial finance, insurance and mortgage products and real estate services. We have a presence in more than 40 markets around the world and have been a wholly owned subsidiary of General Motors since 1919.
http://www.gmacfs.com/us/en/about/business/index.html 180306

How large and profitable is GMAC? From their annual accounting filing report (Form 10K-A) their total revenue (sales) in 2004 was $20.331 billion and their post tax profit was $2.913 billion. 2004 is the latest year for which information is available from the company.
Source: GMAC Form10K-A Amendment 1 14th March 2005 page 7

Why would they want to sell their stake in GMAC after almost 90 years of ownership? Why sell of their most profitable segment? Well, according to another report from the BBC, this is why:

Analysts speculate that GM wishes to sell a stake in GMAC both for the immediate cash injection, but also to improve GMAC's credit rating, which has been dragged down by GM's own "junk" score.
This would enable GMAC to borrow additional funds at a cheaper rate.
http://news.bbc.co.uk/1/hi/business/4811014.stm 180306

Notice that they are speculating that GM would not sell all of GMAC but just a part of it. Did you also notice that GM’s own bonds (loans) now have junk status? They are no longer valued very highly by the market because they are seen as being risky now.

Why are GM’s bonds considered to be risky? Ever heard of the trade off between risk and return? On average, if a business is not risky, we might accept, say, a 5% return (net profit, return on investment, whatever you are measuring). If, on the other hand, a business is seen to be risky, you might say, OK I’ll invest but I want a return of, say, 12% because of the risk of earning nothing or losing everything.

That’s the way risk and return really are traded off against each other.

What makes a business risky? Consider these and add examples of your own:

poor sales record

poor profits record

poor product portfolio

weak management

threat from other competitors

end of a product life cycle with no new products in the pipeline

operating in an emerging economy

operations overseas have currency restrictions

Still not convinced that GM is in trouble? Go to their Investor Relations page and take a look at all of the corrections to their annual report that they have issued recently. There are a lot more than a normal company should issue: go to http://www.gm.com/company/investor_information/sec/ (accessed 180306)

Conclusions

GM is definitely a company in serious trouble. The share price has nose dived over the last 9 months or so and should GM go under, there will be serious repercussions given the level of its sales and the number of people it employs. A dead GM would cast a long shadow over the USA and the motor industry.

As a matter of interest, GMAC stands for General Motors Acceptance Corporation … not a lot of people know that!

Duncan Williamson