U.S. stocks finished higher for a third straight day, but the S&P 500 could not break through the 1100 mark. 

The sole economic release was a rise in mortgage applications that was driven by refinancing, which rose 17.1% for the week. Purchases though fell 3.4%.

Consumer discretionary shares led the market, thanks to strength among retailers as Target reported a 14% increase in quarterly earnings and improved credit card operations.

Energy shares were the big losers yesterday as oil hit five-week lows on a Department of Energy report that showed oil and gasoline inventories remain unusually high.

Catching most of the headlines by the end of the day was that GM filed for an initial public offering.  GM’s public offering is the focus of the newsletter after the jump.

Market Activity for August 18, 2010

General Motors IPO

GM filed for Chapter 11 bankruptcy protection on June 1, 2009, after posting $88 billion of losses since 2004, the last year the company reported an annual profit.  After finally the company has posted a profit – albeit in a year where the government stimulated car sales with Cash for Clunkers – GM filed for an initial public offering in an effort to reduce the government’s majority ownership stake.

GM’s plan to return to the public markets includes selling preferred stock along with common shares that will be sold exclusively by some of GM’s current shareholders.  Who are these shareholders?  The U.S. government has a 61% stake in GM, the United Auto Workers (UAW) union has 17.5%, the Canadian government 12%, and the old GM’s bondholders roughly 9.5%.  The government aims to sell about one-fifth of their stake, so that they will only own 48.8% of the automaker – still sounds like “Government Motors” if you ask me.

The U.S. and Canadian governments will, however, give up their right to nominate directors to the GM board after the stock offering.  Still, GM’s strategic plan they outline in their filings is largely influenced by politicians and I have to imagine that they will carry significant influence going forward.  To borrow an analogy from an article in this week’s Economist: the government would never have made a success of an iPod, iPhone, or iPad whereas Steve Jobs at Apple was able to anticipate demand for such hand-held devices.  In other words, I don’t believe politicians are fit to run an auto company.  They may think that focusing on fuel efficient cars and maintaining as many employees as possible is what is best for the company, but I remain skeptical.

Working against their plans is the auto industry’s longer-term structural overcapacity – an overhang of productive capacity that is as much as 20% higher than demand.  In other industries, a cleansing wave of mergers and acquisitions often scrub away the excess.  This just isn’t happening in the automotive industry.  Instead, governments are propping up weak companies.

There is a certain familiarity that individuals have with GM the company as well as GM the stock, which for many years produced steady dividends for investors.  But years of sub-par products, debt, and high industry costs have caught up with them. The automaker’s share of new vehicle sales in the U.S. has fallen every year since 2002 from 28.4% to just 19.2% through this July, the lowest level since 1925.

Since filing for bankruptcy, GM has only two quarters of profit, and those were largely a result of the government stimulus via Cash for Clunkers.  And while sales are up, GM has also sold more vehicles this year to rental and government fleets, which tend to be less profitable than retail sales.  Another red flag to future profits is that GM’s pension plan is underfunded by $27 billion.  Meanwhile, the CEO is stepping down and GM’s regulatory filing lists a lack of experience among its new management team as a potential risk. 

Before buying stock in any company, the crucial question me must ask ourselves is: Would we want to own shares of this company 10 years from now?  20 years from now?  I’m not sure this company will be around forever.  They simply are not financially viable – this is evident by the multiple bailouts they have received from the U.S. government over the years.  Overcapacity and a lack of competitive advantage spell trouble for the long term.

Unfortunately, we as taxpayers already have “invested” $50 billion by bailing out GM since 2008.  GM gave $6.7 billion of that back in April (remember that feel-good commercial with CEO Ed Whitacre claiming GM had paid back its debt to the U.S. government?) and turned the rest of the debt into $2.1 billion in preferred stock and a 61% stake in GM’s common equity.  To breakeven, according to Bloomberg, GM shares must be worth at least $69.4 billion and even more if bondholders and the UAW exercise warrants for 106 million shares.  That’s more than three times GM’s stock market value at the end of the last U.S. bull market and 65% higher than Ford Motor’s current capitalization of $42 billion. Bloomberg’s data shows that current bond prices imply GM’s equity value is about $50 billion.

I think it’s safe to say the government made a losing investment with taxpayer dollars.  Don’t make the same mistake with your personal money.

Have a great day!

Peter Lazaroff, Investment Analyst

Phone: 636-449-4900