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By Porter Stansberry |
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Wednesday, October 2, 2013
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Dear shareholders,
Moody's Investors Service recently upgraded General Motors' rating.
The major credit-rating agency bumped our rating from Ba1 to Baa3 – its lowest tier of "investment grade" credit.
Nobody was more surprised than
me. Let me tell you plainly, I do not believe our company is an
investment-grade credit. Nor are our operations likely to improve in a
way that would have led any reasonable analyst to conclude such. That is
why all of the other major ratings houses (S&P, Fitch, Egan Jones)
continue to rate our corporate obligations as "junk" – speculative debts
that have a significant risk of default.
I now understand what
Bill Gross means when he says investors shouldn't trust Moody's ratings
because the company has become a de facto arm of the U.S. government. Or
as he put it recently: Moody's and the U.S. Treasury are just one big
"happy family."
Gross manages hundreds of billions of dollars in
private capital for the investment management firm PIMCO. So he has the
luxury of being able to say whatever he wants in public.
I don't
have that luxury. I'm the chairman of a publicly owned corporation,
whose debts are soaring, whose margins are collapsing, and whose capital
structure is still controlled by the government and our unions. So when
the reporters called me to ask about the Moody's upgrade, I said: "Good
things happen when you build great cars and trucks and deliver strong
financial results."
It's a great line. It still makes me chuckle.
Read it carefully. You'll notice… I didn't say anything about GM.
What
I couldn't say is that our business is already beginning to collapse,
again. Look at our core automotive operating profits. In the first six
months of 2012, we generated $2.8 billion in automotive operating
profits. In the first six months of this year, we made a little more
than $2.1 billion. Thus, our core, global automotive business has seen its operating profits decline substantially… by more than 24%.
We
are approaching another crisis at GM, one that has its roots in the
bailout of 2008/2009. The faulty bankruptcy process caused this crisis
by failing to address our largest obligations (pensions and retired
employee health care). And the crisis results from the motivations of
our government owners – motivations that do not square with capitalism.
Like
my predecessor, Rick Wagoner, did… I plan to write to you from time to
time, privately, here in these pages. I will tell you what is actually
happening with our great company – an institution that was once the
largest privately financed endeavor in human history. You'll get the
truth here, even if I'm not allowed to say it anywhere else…
What's happening with GM is a microcosm of what's happening with the rest of our society.
Where once we sought only a fair opportunity for greatness, now we seek
the false security of collectivism. I see it happening right in front
of me every day.
I believe an honest discussion of what's
happening with our business could help educate the public about the
failure that's inevitable when resources – like our capital, plants, and
people – are governed by politics rather than by markets.
At GM,
we abandoned capitalism in 2010 when we emerged from bankruptcy.
Instead of treating all of our creditors fairly, we gave the lion's
share of the company's assets to the federal government and the UAW
health care trust. Meanwhile, we didn't do anything to mitigate our
enormous pension liability, which today stands at $26 billion. At the
end of the bankruptcy process, none of our 400,000 retired workers lost a
nickel. On the other hand, our shareholders, creditors, and many of our
suppliers were wiped out.
That's not the way capitalism is
supposed to work. And still today, GM isn't really privately owned.
Instead, the company is a kind of public-private "partnership," where
actual control rests with the government. Today, GM is more like a Ponzi
scheme than a real business.
How so? Ponzi schemes don't
generate any actual profits. They require greater and greater sums of
money to work. Sooner or later, there simply isn't enough capital
available to maintain the mirage of a functioning business. That's
exactly what's happening at GM.
Don't take my word for it. Consider the facts below. Then, decide for yourself.
Is
GM a real business, owned by capitalists, driven to create real
profits, to be shared by its owners as they see fit? Or is it a kind of
elaborate, government-sanctioned scheme, meant to enrich a few chosen,
special interests?
PART I: Who Are the Real Owners?
All of Our Profits… and More… Are Going to Retired Workers
Since GM emerged from bankruptcy protection in mid-2010… we've done great.
The
last few years are the best years in the history of our company. We've
never built better cars. The market research firm JD Power says GM has
the highest-quality cars of any major carmaker. Our trucks, it says,
compete with Porsche for the highest-quality vehicles made anywhere in
the world. We've never generated more revenue. In total, we've made
about $26 billion in operating cash flow – what our main business
generated before paying capital expenses and similar costs – since we
emerged from bankruptcy.
It all sounds good, I know.
The bad news is that our business requires massive amounts of capital to sustain its operations. These so-called capital expenditures consumed
roughly $20 billion of those operating profits. That left us with
roughly $6 billion-$7 billion in actual cash that we could, in theory,
return to our true owners (our shareholders) or re-invest into
profitable lines of business.
So where did this money – the so-called free cash flow – go?
All the money – and a lot more – went to retired workers, unions, and the government.
In
total, we've sent around $18 billion in cash to these interests – far
more than we've been able to earn. These payments started with $3.9
billion in dividends on special "preferred" shares the union, the U.S.
Treasury, and the Canadian government got during the bankruptcy process.
Keep in mind, our creditors got none of these shares, and we've never
paid a cash dividend to regular, common stockholders.
Another
$8.5 billion went to repay debts to the U.S. Treasury and the union,
obligations that we were saddled with in bankruptcy.
And that's
not all. In 2012, we announced with great fanfare that our operating
results were so good, we were going to begin buying back shares.
Normally, that's great for common shareholders.
But in this case,
the $5.1 billion worth of stock we bought back ALL came from the U.S.
Treasury. No former creditor or any other public shareholder was able to
sell to us. That's not all… We paid a $2-per-share premium to the
actual market price of our stock. We simply gave the U.S. Treasury
another $400 million "gift" for allowing us to buy back the shares it
held.
Remember… private investors didn't have a chance to sell
their shares to GM at a $2 premium. That deal was nothing less than a
crime. It was the U.S. Treasury stealing $400 million from the
shareholders. If any other business in the country did something like
this, it would get hit with a hundred lawsuits overnight. But when GM
did it? The press cheered. How can you explain that?
So we
continue to owe far more to unions and governments than we're earning.
If that were our only problem, perhaps we could envision a light at the
end of the tunnel. But these obligations are only the beginning…
That
$26 billion in operating cash flow already accounted for about $8.8
billion in cash payments we made to support our pension plan and other
retirement benefits. Without those obligations… our number would have
looked even better, with operating cash flow of nearly $35 billion. That
anchor around our neck isn't going anywhere.
In addition to the
cash, we contributed in 2011 60 million shares of stock (worth $2
billion) to the pension plan. No, that wasn't a cash expense. But
believe me, shareholders should wish it was, as the expense will end up
coming out of their pockets, instead of ours.
Just think about what that means…
Instead
of the workers supporting the shareholders… at GM, the shareholders are
supporting the workers. Sounds a little bit like communism, doesn't it?
Well, just wait. The nonsense is only getting started…
In
2012, we announced a big deal to eliminate our entire legacy,
white-collar-salary pension obligations. We paid the Prudential
insurance firm around $3.5 billion to manage $25 billion worth of
our pension liabilities, taking them off our books. Don't forget… we
also gave Prudential $25 billion from the pension fund to manage.
Think
about that for a little while. When is the last time you had to pay
your broker 14% of your assets upfront to manage your account? Hedge
funds normally charge 2%. They're considered expensive. Paying 14%
sounds a little steep, doesn't it? No one ever explained it to me,
either. My guess is a lot of that fee ended up in union offices or
political piggy banks.
Whatever happened, all of the money is
gone. In the three years after bankruptcy, we made roughly $6 billion-$7
billion in "free cash flow." Somehow, that cash was supposed to cover
$18 billion in obligations… including almost $1 billion a year in
preferred-stock dividends to the union's health care trust and the
Canadian government. That also includes the $400 million "gift" to the
U.S. Treasury and the $5.1 billion worth of shares we bought from it.
And for our common shareholders, our real owners? We haven't paid a cent.
So
who really benefits from our brands… our research and development… our
decades of investment… and the tens of billions of capital we have at
stake? Is it our shareholders? No, it isn't. It's the union. It's the
retired workers. And it's the government.
Is any of this likely to change any time soon? No, it's going to get worse… a lot worse.
Look
at our preferred shares. They were created to make sure the union got
most of the value out of our remaining assets. (Our bondholders didn't
get any of these preferred shares.) The shares pay a 9% annual dividend.
Try to find any other preferred stock issued by a major corporation
that pays a coupon that large. You won't find another example.
We
were simply hijacked by the bankruptcy court and the Obama
administration. And we have to pay this dividend before we pay anything
else. If we don't, these obligations accrue, a situation that would
rapidly warp our entire capital structure, placing the whole company in
the union's control.
So one of my most important jobs is to buy
back these securities as quickly as I can. The problem is, they're
extremely expensive. I've just negotiated a deal to buy back 120 million
preferred shares at $27 each from the union's medical trust. That's
$3.25 billion. Believe it or not, the medical trust will still own 140
million of these preferred shares. The Canadian government also owns a
few of these shares (16 million). We can redeem all of these remaining
shares in 2014, but it will cost us almost $4 billion – in cash.
To pay off the union then, we'll have to borrow money… billions.
Now,
you know the real reason why Moody's just raised our credit ratings.
I'm sure the government told Moody's to help GM raise the money so we
can pay off the unions.
Shall I feign indignation that the country's most politically powerful union is able to manipulate Moody's credit ratings?
PART II: Since Government Can't Let Automakers Fail,
Overcapacity Is Getting Worse and Worse
I'm proud of GM's cars.
As I mentioned, we've made huge strides
in increasing the quality of our vehicles. But guess what? So has every
other carmaker in the world. The competition makes it harder and harder
to make a profit.
Just look at our actual numbers. In the first
six months of 2012, we sold $74.5 billion worth of cars around the world
(automotive revenues). We made an operating profit of $2.8 billion.
That's a minuscule operating profit margin of 3.8%.
The situation
is getting worse. In first half of 2013, we sold $74.6 billion worth of
cars around the world, fractionally more revenue. But we earned a lot
less, only $2.1 billion. Our costs rose, and we could not pass these
costs on to our customers. Our operating margin declined to less than 3%.
These
are razor-thin margins. Margins this small are dangerous to operating
companies, like ours, that have huge volumes. If anything were to happen
to consumer demand – for example, if the economy were hit with a
recession or we were unable to finance our customers (more about this
below) – these puny margins would disappear overnight. The result would
be sudden, large losses.
You should know: An "accident" like this is inevitable. It's going to happen. And it's going to happen soon.
The auto industry suffers from a tremendous glut of capacity. According
to different sources, 20%-30% of global production isn't profitable.
My
counterpart at Nissan, Carlos Ghosn, is one of the few senior
executives who has spoken honestly about this major problem. At a recent
car show in Geneva, he said, "All of the car manufacturers have
capacity problems – all of them."
Sergio Marchionne, the chief
executive of Chrysler and Fiat and the president of the European
Automobile Manufacturers' Association, estimates the auto industry needs
to cut capacity in Europe by 20%.
Automakers employ or support
2.3 million people in Europe. Just like in the United States, the auto
industry is too politically powerful to be allowed to fail. It's the
same thing, all around the globe. So how likely is it that any
automaker, anywhere, will be able to significantly reduce production?
Capitalists
making tough, but realistic, decisions no longer control this industry.
Instead all of the capital-allocation decisions are being driven by
politics. Whether you call it "welfare," "socialism," or "communism"
doesn't matter. As long as this continues, it's inevitable that GM's
operating margins will continue to deteriorate. And that means, it's
only a matter of time before we're dealing with huge quarterly losses.
Bernd
Bohr is the head of the automotive group at Bosch, the privately held
German company that's the world's largest manufacturer of car parts. He
explains the current problems by pointing out that none of the major
carmakers was allowed to fail in 2008/2009. "It was a peculiarity of the
2008-09 crisis," Bohr said, "that practically no capacity was taken out
of the market due to state intervention…"
While hard to fix, the
problem is easy to understand. As long as no carmakers are allowed to
fail, the ability of the entire industry to earn a profit will be
greatly compromised. GM is the largest car company in the world (roughly
tied with Toyota). It has the highest labor costs. It is heavily
burdened by its pension obligations. It has, despite my best efforts,
several weak brands.
In this scenario, GM is extremely vulnerable, the most vulnerable large carmaker in the world.
My
advice? Don't pay attention to our revenue figures. Watch our margins.
It's overcapacity that will kill us this time, not quality or a lack of
demand.
PART III: We're Doing It Again:
Selling Cars to Unqualified Buyers
Think about the dead-end GM faces strategically.
We can't compete
on brand. No one under 40 years old would rather drive a Cadillac than a
BMW. Almost no one at any age would rather have a Chevy Malibu than a
Honda Accord. And even though our trucks are great, Ford's are just as
good (if I'm being honest).
We can't compete on price because we don't have the cheapest costs. Instead, we have the highest.
And
no matter how much money we make, all of it (and more) will end up
being siphoned off to either the union's health care trust or the
pension fund.
What would you do in this scenario?
I've thought about this question every single day for three years. There's only one answer. And it's a lousy one.
GM will have to compete on credit. We'll have to work out a deal with Wall Street to borrow billions and billions and funnel the money to car buyers who the other makers won't lend to. Our only chance is to, once again, become too big to fail.
In
the fall of 2010, we acquired a financial business, now called GM
Financial. It exists to provide financing to buyers of our cars in
dealer showrooms. You might recall that our company's last foray into
finance didn't end well… huge losses at our former finance subsidiary
were one of the primary reasons our company spiraled into bankruptcy
back in 2008.
We're doing it all again.
As our margins have declined, we've attempted to grow by making more and more loans. Our loan book has ballooned to $11.5 billion.
We made about 75% of these loans to borrowers with FICO scores lower
than 600. Unbelievably, we're even lending billions (more than $3
billion, actually) to folks with FICO scores less than 540.
It
seems implausible to me that these loans will work out for us in the
end. By the end of 2012, nearly $1 billion of these loans was already in
default. Just imagine what will happen to these weak borrowers when we eventually enter another recession. Just
as our sales are declining, all of these bad debts will come due. All
the repossessed cars will flood the market, driving down recovery values
and destroying demand for new cars.
Haven't we learned anything from the last financial crisis? Apparently not.
You
will see as we move forward, our margins will continue to decline
because of the global problem of overcapacity. Charities – which is what
all of the major car companies have become – don't make a profit. As
our margins decline and our cash flow disappears, the union and retiree
demands on our remaining capital resources will grow more intense. We'll
have to borrow more and more simply to fund our pension obligations.
We will also be borrowing, massively, from Wall Street to finance our car buyers.
Sooner
or later, we will end up losing money on every transaction, while
trying to make it up on volume… and financing that volume using our own
balance sheet.
It's insane… unless you understand it's my only
hope. I've got to borrow billions and billions over the next few
quarters. I've got to scale up, so that we're so big we can't be allowed
to fail. It will be the same madness we saw in 2008 all over again.
But
this time, it won't take decades to unravel. It will happen much
faster. My guess is within five years, we'll be in a crisis again. And
our stock, which is currently valued at $50 billion, will be worth
nothing.
Please invest accordingly.
Best regards,
The Chairman of General Motors
