Should investors test-drive GM's IPO?

Shares would look undervalued at their expected price of $26 to $29.

By MSNMoney partner Nov 5, 2010 2:06PM
David Whiston, MorningstarMorningstar logo


As part of Morningstar's IPO Research Services, Morningstar auto analyst Dave Whiston recently released a company report and preliminary fair-value estimate ahead of GM's public offering later this month.


Although the "Government Motors" stigma is likely to hang over General Motors Co. for years, we think GM's car models have their best quality and design in decades. The company is already a leader in truck models, so a fully competitive lineup, combined with a much smaller cost base, leads us to think that GM will be printing money as vehicle demand recovers.


We think GM's earnings potential is excellent because the firm finally has a healthy North American unit and can focus its U.S. marketing efforts on four brands instead of eight. The most critical cost-saving measure was setting up a voluntary employees' beneficiary association for the retiree health-care costs of the United Auto Workers.

This move saves GM about $3 billion a year, and other wage and benefit concessions have drastically lowered GM's North American break-even point to about 10.5 million to 11 million vehicles. (The actual point varies based on mix and incentive levels.) We think normative demand for U.S. light vehicles is about 16 million to 17 million units, so we expect GM to report excellent earnings growth as vehicle demand comes back over the next few years.


Dramatically better pricing has helped GM be profitable at volume levels that would have meant billions in losses a few years ago. The new Buick LaCrosse, for example, sells for about $7,800 more per unit compared with 2009.


Simply put, GM makes products that consumers are willing to pay more for than they once did. GM no longer has to overproduce to attempt to cover high labor costs and then dump cars into rental fleets (which hurts residual values). It now operates in a demand-pull model, whereby it can produce only to meet demand, and is structured to break even at the bottom of an economic cycle.


We think the largest threat to profitability is Europe, which has been losing money for a long time. The S-1 gives planned GM Europe capacity reduction and annual labor cost reduction targets of 20% and $323 million, respectively.


GM stockholders will have to consider politics as long as the U.S. Treasury, Canadian and Ontario governments and an affiliate of the UAW own large amounts of GM stock. We think this ownership will be an overhang on the stock for some time, since the U.S. government is likely to sell off its stake gradually in order to get the highest possible share price to get its money back. We also expect the VEBA to reduce its stake over time, since it needs to monetize its holdings to pay retiree health care claims.


Although these concerns are valid, we see them as short-term issues. We think the company is about to see the upside to having a high degree of operating leverage.


GM repaid all of its government loan obligations in April, so long-term debt, excluding preferred stock at June 30, was just $2.6 billion, mostly from balances on credit lines for international operations. In October, GM announced a new $5 billion secured credit line but expects it will remain generally undrawn.


It also said it paid off the $2.8 billion VEBA note obligation, which was in short-term debt. We like this move since it is a gesture of good faith with the UAW, and the new credit facility probably has a much lower interest rate than the implied 9% rate on the VEBA notes.


Including short-term debt, we calculate annualized debt/EBITDA for the first half of 2010 to be 0.56 times, versus our calculation of 2.38 times for Ford's (F) automotive segment.

Preferred stock is now part of the capital structure, and including the nearly $7 billion of Series A preferred stock at June 30 gives a debt/equity ratio of 0.63. In October, GM announced that, after the IPO, it will redeem all of the $2.1 billion of the U.S. Treasury's Series A preferred shares.


GM also has large underfunded pension and other postemployment benefits balances at June 30 of $26.4 billion and $9.3 billion, respectively. GM said that, after the IPO, it will fund the pension with $4 billion in cash and $2 billion in GM common stock. We have assumed this stock will be issued at $27.50 per share in our valuation model, which is about 72.7 million shares.


To read more, including analysis on share structure, valuation and risk, read the rest of this report at Morningstar.


More from Morningstar

3Comments
Nov 8, 2010 6:09PM
avatar

Ah geez,  malign GM and mgmt all you want, they deserve it.

But, dont knock the cars, especially when  the big foreign sellers are facing recalls that were kept under wraps for so long.

 

Ive always seen IPOs as coming to the market when the primary owners  have milked the company for all its worth and need to SPIN some money from dumping the dried lemons on the public.

 

Putting a price higher then FORD shares alone is proof that this is not a good IPO.  Plus,  China having a strong interest in owning it, as well as an excess of taxpayer $$$ being put into GM.

(They still hide the facts that  the Stimulus repayment came from other  tax payer sources and not from GM profits!)

 

I love my  OLDS CUTLASS and having a local repairman I can trust.

 

But, GM mgmt and dealers who really work the comission angle to rip customers off are my only rant. (I sold new FORDs for 90 days  until I got fired for trying to stop the dealer from screwing a retired customer.)

 

HARRUMPH!

 

PS  Best advice for buying a new car is to get it from a major rental company after its first year (online options let you choose from across America)  or  get a pre-package from a credit union for the loan. Then let the dealer give you a bigger price break for financing through them first, then the next day bring a check from the credit union  cancelling THEIR financing.

 

BEST REVENGE EVER!!!

Nov 8, 2010 2:44PM
avatar

Your President screwed the American people with the bail out and they are going to screw the tax payer again with a pension fund bail out in the future.  That why I ALWAYS buy foreign...time to end the evil Satan's reign.

VIVA Che

Nov 8, 2010 11:24AM
avatar

I am one investor who refuses to own a GM car or stock....GM and the unions screwed the American taxpayer and their bond holders.

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