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The Five Factors That Could Save “Government Motors”

Tuesday, June 23, 2009

[Editor's Note: This is the first of two parts. Next up: How China Could Save GM.]

By William Patalon III
And Jason Simpkins
Money Morning Editors

Critics have wailed about the years of mismanagement, which has created the company’s present plight. And they’ve howled about a government bailout, which they see as nothing but good money following bad. 
But when the company these critics sarcastically refer to as “Government Motors” - General Motors Corp. (OTC: GMGMQ) - emerges from bankruptcy as expected early next year, it could be leaner, meaner and perfectly positioned for the smaller, highly competitive and truly global auto-making market that has been one of the major outgrowths of the worst financial crisis since the Great Depression.
General Motors “is going to light it back up before long,” says Gary Dilts, a DaimlerChrysler veteran who now serves as a senior vice president for global automotive analysis at J.D. Power & Associates, the marketing information heavyweight. “They’re going to be in a good position once they’re out of bankruptcy. GM has a pretty good product plan, and they’re leaving 10 years of debt on the side of the road.”
That’s somewhat of a contrarian viewpoint. But five factors favor a GM turnaround:
  • Bankruptcy will transform GM from a bloated company with too many products and too many dealers into an organization whose smaller size is better suited to the permanently crisis-diminished U.S. auto market.
  • The bankruptcy process will also allow the company to turn billions in liabilities into equity, taking cash that would otherwise have been used for debt service - or to finance healthcare or retiree benefits - and making it available for investments in new products, new auto technologies, new marketing initiatives, as well as for global expansion.
  • GM has a stronger stable of products than most observers realize.
  • The consumer backlash against the bankruptcy likely won’t be as damaging as had been initially feared. In fact, as rival U.S. carmaker Chrysler LLC already discovered in its own bankruptcy, potential defections and severed relationships can be avoided with aggressive discounts and strong marketing efforts.
  • And, in what many U.S. consumers may be surprised to find is a key to GM’s overall long-term success, General Motors has established an incredibly strong position in China - a strength that will let it capitalize on the world’s fastest-growing (and eventually, largest) overall market and that will enable it to utilize that low-cost market to produce vehicles and ship them back into the United States, in order to sell them at competitive prices.
The decline of the U.S. auto industry has been a drawn-out and difficult affair, inflicting pain on current workers, retirees, suppliers, and many others throughout the global economy. In some cases - such as with the many family owned and small-community GM and Chrysler dealerships that will be shuttered as part of the bankruptcy-induced streamlining and restructuring - that pain will only increase in the near term.
The long-term goal, of course, is to create an automaker that can sustain itself, meet its existing commitments and eventually even grow - as opposed to merely surviving. Without the bankruptcy and reorganization, in fact, GM wasn’t even going to hold its own, one economist says.
“I think everyone needs to keep in mind that if this company fails, that’s the worst case scenario," Michigan State University Economics Professor Charles Ballard told NBC affiliate WILX TV-10 in Lansing. “It would be really good for the people of Michigan and for Lansing for GM to become a viable company.
Right now, it’s not."
Adjusting to the Auto Market’s Long, Slow Decline
GM has struggled in recent years to compete, hurt by its truck and SUV-dominated vehicle line-up and a deep plunge in U.S. vehicle demand. The upshot: The No. 1 U.S.-based automaker - which once employed 500,000 people - has lost an aggregate $82 billion in the past four years even as it slashed production capacity, cut back on the number of nameplates it sold under and eradicated more than 100,000 U.S. jobs. It needs to cut another 19,000 workers by 2012 to bring its domestic employment down to 72,500 jobs. And some critics say even that won’t be enough.
But here’s one factor that should help: By downsizing, GM’s leadership has admitted that the financial crisis has reduced the size and makeup of the market for new cars and trucks in the United States - probably permanently.
The U.S. Big Three of GM,Chrysler and Ford Motor Co. (NYSE: F) will have to adjust to this post-financial-crisis “new reality.” Automakers will sell only 10 million cars and trucks in the U.S. market this year, the worst showing in at least three decades - and roughly 38% less than the 16 million vehicles that were sold in the United States annually in recent years before the financial collapse caused auto sales to nosedive.
Part of the reason for the slump in new vehicle sales is that consumers are increasingly turning to used cars. Pre-owned car sales are up 10% this year over last, as credit availability increases, but buyers focus on affordability. In fact, according to the most-recent report, used-car sales jumped in April, and that trend is expected to continue at least until the middle of the year as pent-up demand for affordable, pre-owned vehicles revs up the used-vehicle segment of the auto marketplace.

Goodbye GM, Hello “Government Motors”

Criticisms aside, GM actually has some highly alluring assets - some of which it’s already agreed to sell. By taking GM through bankruptcy, company leaders and the Obama administration expect to slash debt, free up cash flow to invest in those assets, and actually put the behemoth back on the growth path.
With a reported $82.3 billion in assets and $172.8 billion in debt at the time of the June 1, filing, GM was the fourth-largest bankruptcy in U.S. history and the largest ever by an industrial company.
The U.S. government is supposed to bankroll the “new” GM with an additional $30 billion in financing. That brings the government’s total investment to roughly $50 billion, which it will convert to a 60% stake in the new company. 
In a last minute change to the bankruptcy plan, Canada agreed to provide $9.5 billion in funding and would get a 12% stake. The United Auto Workers (UAW) union would have 17.5% share of the GM, and bondholders would get a 10% stake.
“The New GM will have a dramatically stronger balance sheet, with far less debt, which will allow us to better invest in our business and our future,” new Chief Executive Officer Frederick A. “Fritz” Henderson said in an open letter to customers and shareholders. “It will have fully competitive labor costs and the ability to generate sustained and positive bottom-line performance. From Day One, the New GM will be well positioned to capitalize on the award-winning vehicles we have developed and launched in past years.
The plan calls for General Motors to become a publicly traded company in the first or second quarter of next year - at the earliest, GM Chief Financial Officer Ray G. Young said last week.
“In terms of the timing of that, ‘09 would be impossible because we’re just starting up the new General Motors," Young told reporters last week. “There’s going to be a lot of accounting issues that we’re going to work through in order to get the books of new GM set up."
Young said he was unsure when the U.S. and Canadian governments would begin to sell their stakes, noting that both want “an orderly sell-down in order to both not hurt General Motors, the share price of General Motors and, frankly, also in order to maximize the value to the Canadian and U.S. taxpayers. So I think this is something that is going to be worked out into the future.”
Once that is worked out, GM will officially no longer be “Government Motors.”

Pedal to the Metal

Even as the company navigates the tricky rapids of corporate bankruptcy, Henderson, the new CEO, must develop a finely tuned operational plan, and start implementing it immediately.
Fortunately, Henderson - who took over after CEO G. Richard Wagoner Jr. was ousted in late March - has more to work with than most experts think.
The "new GM" will have a number of key vehicle launches in 2009, 2010 and 2011 - including the Chevrolet Camaro, Chevy Cruze, and "the revolutionary Chevy Volt, an extended-range electric vehicle that can travel up to 40 miles on battery power alone," GM said in a letter to customers and media interviews last week.
Though it’s a reincarnation of the late-1960s muscle car, the new Camaro (along with the Dodge Challenger) is one of the most-talked-about new offerings on the market today. The styling was spot-on and it’s fuel-efficient.
(It also doesn’t hurt that the Camaro has a nice role as “Bumblebee,” one of the characters in the soon-to-open movie, “Transformers: Revenge of the Fallen.”)
GM’s Chevrolet Malibu - a mid-sized that offers exceptional fuel mileage for its category - and the highly regarded Cadillac CTS are considered “world-class vehicles.” GM needs to realize this and showcase such offerings, says Daniel Roos, an engineering professor at the Massachusetts Institute of Technology who studies the automobile industry.
"The quality of its cars was horrible in the ’70s and ’80s, but it’s much better now,” Roos told reporters. It has world-class vehicles [in] the Malibu and the Cadillac CTS. They should be [promoting] those and capitalizing on their strengths."
Taking a page from Chrysler, General Motors did move aggressively to reassure current GM vehicle owners that warranties would be honored. It will likely step up its marketing efforts and could offer incentives to GM vehicle owners who purchased models or brands that it is phasing out. GM has just launched a new ad campaign whose brutal frankness has sparked controversy about its potential effectiveness, Time magazine reported.
However, the point that even many of the media experts discussing the campaign are missing is that, well, everyone’s discussing the campaign. And in an era in which there literally are millions of competing media messages, getting noticed is half the battle.
All told, all these efforts could keep GM’s post-bankruptcy sales from plunging - and might even hold them somewhat steady. But to actually induce sales growth, the company will have to turn to its secret weapon.
And for GM, that secret is China.

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