Commentary - The Beginning of the End of General Motor (GM)?

This chart (click here) shows that the 5-year credit default swap (CDS) spread of GM has jumped from 280 basis points over treasuries on March 15 to over 700 basis points today. A CDS is essentially a bond insurance and spread is the premium. The usual buyers of CDS are hedge funds because that's what they do for living. When hedge funds buy GM's CDS from GM's bondholders (banks, mutual funds, insurance companies etc.), they are paid premium. In return, hedge funds bear the credit risks embedded in those bonds. This week's blowup in GM's CDS shows that hedge funds are demanding higher premium to offset higher risks of bond default. Is such high premium really warranted? Is GM really going broke? That depends on whom you ask.

GM is NOT going broke if you ask Wall Street equity analysts. Their recommendations have improved since last month. In fact, GM's rating is higher than the average rating for the industry or even the average rating for the broader market. GM is also good investment according to the octogerian, Armenian-American, owner of MGM Grand in Las Vegas, swashbuckling investor named Kirk Kerkorian. He dropped a bomshell on May 4 when he made a tender offer for 4%-5% of GM's share at $31 per share. GM's share promptly rose from $25 to $30.

GM is going broke if you ask the S&P. Why else would they downgrade GM’s bond to junk on May 5. On that fateful day, S&P lowered its long- and short-term corporate credit ratings on GM and its finance affiliate, General Motors Acceptance Corp (GMAC) to BB/B-1 from BBB-/A-3; a rating below BBB is considered junk. In addition to the two-notch downgrade, S&P maintained a negative outlook on GM and GMAC.

Does S&P know something Wall Street analysts and Kerkorian don't? May be, may be not. GM's problems are all very well known. The only debate between the optimists and the pessimists is whether GM will be successful in working around those problems. GM's problems are (1) its huge legacy obligations. GM provides healthcare to 1.1 million people, second only to the U.S. government. It spends $5.5 billion a year on medical costs and has an additional $57 billion unfunded obligations [FASB does not require healthcare obligation to be funded]. GM's pension obligation stands at a whopping $87 billion. The company has had to pump money into its pension fund to shore it up - in 2003 it dumped $18.5 billion to close a $19.6 billion deficit. (2) GM is losing customers to the Japanese and the Korean competitors. GM's North American marketshare has gone down from +45% in the early 1980s to +35% in the early 1990s to <25% most recently (see the chart). (3) A huge amount of its debt are coming to maturity soon (see the chart). (4) High oil price is hurting its most lucrative segment, the SUVs. (5) GMAC, the only business making money for GM is going to be hurt by the flattening yield curve.

I am not an expert on GM but my intuition says that GM is more likely to declare bankruptcy than not. My reasons (1) GM is not a car company but a finance company. Its $31 stock price is entirely made up of GMAC. GMAC is valued around $30-$35, which means the market has assigned a negative value to its automotive division. A finance company's life-blood is its ability to cheaply refinance its debt. GMAC won't be able to do so with junk ranting. Moreover, no finance company has survived with a junk rating. (2) GM will find it lucrative to take the UAL's route, which is to declare bankruptcy, dump its pension obligations to Pension Benefit Guaranty Corp (PBGC), exit the bankruptcy with a clean slate and compete like crazy. (3) Unlike the Reagan administration in the early 1980s, which bailed out Chrysler, the current Bush administration is unlikely to come to GM’s rescue.

Given GM’s owes, it is probably the time for Michael Moore to make a sequel to his 1989 documentary on the GM-town and also his hometown, Flint Michigan, “Roger and Me” and name it “Toyota, Kia & the End of GM”.