Thursday, November 11, 2010

The GM IPO: Our Analyst’s View

November 11, 2010. The GM IPO is without a doubt the most anticipated IPO in decades, and has a great deal of interest all over the world from the largest institutions to the smallest retail investor. Obviously a company that is emerging from bankruptcy virtually debt-free and with a lot of cash, is much better off than its debt ridden, cash strapped predecessor. I do, however, have some concerns about the long term prospects of GM from an investment standpoint. During the crisis, GM had to severely cut back its R&D spending and therefore has a lag in its pipeline of new models for the next several years, which in the car business is a big handicap. Additionally, GM is still a huge organization despite the changes they have made, and I think that changing the culture that led to its demise will be a slower process than people may realize; this is not a small hurdle for GM.

GM has been showing some decent sales numbers and revenues the last few quarters, but as evidenced by the most recent report we are already starting to see some slowing. Auto sales are inextricably tied to GDP growth, and historically need more than a 3% increase in GDP to show any real upside in sales. Although the economy is recovering, it is not a robust recovery and it may be several years before we see consistent 3+% GDP growth. More likely we will see fits and starts rather than sustained growth in the near term. This will definitely affect sales.

Despite the tremendous concessions the UAW made, I think they will not sit idly by and let the shareholders keep the lion’s share of future profitability (even though the UAW are indirect shareholders). As the company recovers the UAW will again pressure the company for a share of the profits.

There are few other issues that could limit the upside potential of the stock. Even after this offering the UST (US Treasury), Canada Holdings, the new VEBA, and MLC (Motors Liquidation Corp.) will still own 1,135,000,000 shares that will without a doubt hit the market sometime in the future. I think this will weigh heavily on the stock. In addition, there are a large number of warrants held by the VEBA and MLC, further adding to potential dilutive shares.

GM Management has been telling Wall Street in its road shows that they are concentrating on having appropriate market share goals and a ‘fortress’ balance sheet. But actions speak louder than words, and we all know people have short memories. Only time will tell if they can stick to that, or if they will once again attempt to buy market share at the expense of profitability to return to their former glory of being General Motors. As an investor, I’ll take profitability over market share any day.

To sum up: I firmly believe that the IPO will do well. It almost has to, no one wants to see this deal fail and everyone has a vested interest in it doing well. The investment bankers will price the deal appropriately, the large international and institutional interest will lead to an oversubscription which will assist in the success of the deal, and I think the market will support it. The underwriters also have 54,750,000 ‘Green Shoe’ shares. A ‘Green Shoe’ is the underwriters’ ability to purchase additional shares to cover over-allotments at the public offering price. This gives the deal support. I do think they will increase the offering price from the $26-$29 range and I would expect to see a $32 price when all is said and done (just my thought). I do not think they will increase the number of shares offered, but it is not out of the question. If you can buy IPO shares at the IPO price I would, but I would have an extremely short holding period and look to take advantage of the hype and euphoria surrounding this deal. If you really want to invest in the company I would wait a couple months for the dust to settle. Let the market digest the issue, let all the flippers and fast money exit.

If you cannot get IPO shares I’m not sure I would buy on the open market at the offering date. I think it will be too volatile, once again I would wait a couple of months before making the investment.

Brad Reynolds, CFA
Chief Investment Officer