Bring Out Yer Dead! (thud)

I’ve been beating the avoid the US automakers drum for six years now.  When I was a corporate bond manager, one of the first things that I did was sell 90% of my Ford and GM bonds that I inherited from the prior manager.  When I began writing for RealMoney, I wrote pieces like this:

David Merkel
Open Letter to General Motors’ CFO
By David Merkel
RealMoney.com Contributor

12/9/2004 11:11 AM EST
URL: http://www.thestreet.com/p/rmoney/davidmerkel/10198313.html

General Motors (GM:NYSE)BEARISH
Price: $38.14  |  52-Week Range: $36.90-$55.55

  • GM should refinance at least half its 2005 and 2006 maturities while rates remain low.
  • The company’s future is threatened by any increase in bond yields.
  • Position: None

    Sir: Though I am not as bearish as my friend Peter Eavis on the prospects for your company, I do want to give you some friendly, if unsolicited, advice: Refinance at least half of your 2005 and 2006 maturities while rates remain low.

    With over $50 billion of principal coming due in the next two years, the future of GM (GM:NYSE) is threatened by any increase in bond yields. With the likely weakness in the dollar, yields on Treasury obligations are unlikely to remain this low, in my opinion. Further, though spreads for GM and GMAC are not at historically tight levels, spreads in the corporate bond market are at levels not seen since 1997. Take advantage of the demand (both domestic and international) for yieldy paper while you can. For that matter, do another convert deal. It may put a ceiling over your stock price (but, hey, isn’t there one there now?), but the convertible arbs will give you cheap financing while you figure out how to make your auto operations profitable (and design cars that people crave).

    Though your ratings are stable from Moody’s and Standard & Poor’s at present, who can tell how long that will last? GM and GMAC debt are only one notch above junk at S&P, and I can tell you that you will have a hard time selling debt if you ever do get downgraded by S&P. Even if Moody’s leaves you an investment-grade rating, I will tell you that there is not enough buying capacity in the bond market for crossover credits of your size. Your yields would have to rise to the point where equity investors find your bonds an interesting speculation, as was true of auto bonds in mid-2002.

    Further, do you want to be subject to the vicissitudes of your cousin Ford (F:NYSE) ? If they catch cold, you may too, at least in the eyes of the ratings agencies. But I digress.

    It is always better to seek financing when it is offered, rather than when you need it. Your spreads are not going to get materially tighter, in my opinion, absent a partial refinancing that gives the bond market more confidence in how you will meet your short-term obligations.

    I wish you nothing but the best, if for no other reason than as a U.S. taxpayer, I don’t want to bail GM or Ford out.

    Sincerely,

    David J. Merkel

    P.S. To the CFO of Ford: This goes for you as well. The numbers differ, your spreads are currently tighter than those of GM, but you lack one thing that GM has. GM could sell the non-auto financing assets of GMAC in a pinch, which is presently a very valuable franchise that you don’t possess. Refinance while the bond market is friendly.

    I also wrote pieces like this:


    David Merkel
    GM on “Death Ground”
    11/17/2005 5:15 PM EST

    The last time I used the phrase “death ground” it was with respect to Fannie Mae. It engendered some confusion then so let me explain the term. “Death Ground” is a term from Sun Tzu’s The Art of War. It is when a General faces a situation where an army unit is in nearly hopeless shape, and the General manuevers the unit into a place where flight is impossible, so that the unit will fight to the death, because they have nothing to lose. Soldiers that motivated sometimes win; it is a last-ditch strategy.

    That describes GM today. The CEO announced that in a letter posted on the Financial Times website, “I’d like to just set the record straight here and now: there is absolutely no plan, strategy or intention for GM to file for bankruptcy” GM faces a host of issues, revolving around legacy liabilities, poor design, poor marketing (reliance on sales, rather than everyday low pricing), high production costs, low flexibility, and high debt. Almost everything has to go right for GM to survive against much stronger competition; to me, that’s death ground.

    That’s not an exhaustive list. Add into that the possible sale of GMAC, which is the crown jewel of GM, and you can sense the desperation. This is not a company to be playing around with on the long side; truth is, the world doesn’t need GM when it has Toyota. Maybe the US government will bail out GM the way they did Chrysler, but I really wouldn’t expect that.

    Long GM debt was trading in the mid-60s this morning for a 12%-ish yield. It improved after the CEO’s statements this afternoon; the longs got a gift. I would take the opportunity to lighten up on long positions in GM stock, and any bonds dated past 2010. Take the $10-15 buck haircut off par, lest you have to settle for a recovery in the $30s five years out. (The 2036 7.75% zero-to-fulls are trading in the low $20s. Assuming an interest rate of about 7-9%, and a default 5 years out, that discounts a recovery in the mid-$30s.)

    Position: short FNM, long TM

    And this:

    GM: Less Has Changed Than Meets the Eye, by David Merkel

    6/30/2006 8:24 AM EDT

    The story of GM over the past few decades has been to sell off desirable assets to fund the core auto operations, close factories and reduce jobs in North America. Its recent round of adjustments is only different because of the desperateness of the situation. Even with the labor concessions being discussed, GM’s cost structure will remain higher than most of its competition.

    Consider the ratings agencies that are “inside the wall” and possess more information than other market participants. Even after the changes made, GM’s debt is rated Caa1 (negative outlook) by Moody’s and B (negative watch) by S&P. The ratings on GM’s debt reflect a highly speculative company with an uncertain future. The debt of GM, though the price is up from its lows still reflects significant uncertainty of full payment. Long debt trades in the mid-$70s.

    We still don’t know whether the Pension Benefit Guaranty Corporation will go for the sale of 51% of GMAC. GM has only made a dent in the total liabilities that it faces in pension and health care (active and retiree). Does the PBGC want to lose a claim on one of the more valuable aspects of the firm should it go under?

    Finally, sales have been disappointing, and discounting must be resorted to in order to “move the metal.” GM’s offerings have improved of late, but that might only be enough to get someone to buy a GM instead of a Ford. The improvements at GM don’t place the company on the same footing as Toyota or Honda from either a cost or marketability basis.

    GM may be able to eke out a small GAAP operating profit in the short run from the changes made. It is still in a lousy competitive position against firms with stronger balance sheets and lower cost structures. My estimate of the long-run outcome has not changed. Avoid the stock and unsecured debt of GM.

    P.S. At least GM is showing a little vigor relative to Ford (F:NYSE) , but that’s not saying much. Ford’s situation, if judged by the asset markets (stock, bond and credit-default swaps), has worsened relative to GM. Credit-default swaps now show Ford as more likely to default over the next five years than GM. What a mess.

    At the time of publication, Merkel and/or his fund was short GM and Ford, though positions may change at any time.

    FInally there is this piece four months ago, where I said: As I have said many times before GM common is an eventual zero.  Same for Ford.  All the errors in labor relations over the years, compounded with interest, are coming back to bite, hard.

    Why throw good money after bad?  Why reward exceedingly lousy managers, and unions that have sucked the carcasses of the auto companies dry? Throw in $25 billion.  It won’t be enough.  Toyota and Honda are so much better managed, that they will win anyway.

    In 2002, we let 20+ steel companies die.  The valuable assets were bought up, union contracts were torn up, and the industry regained sanity.  The industry is in much better shape today, and able to compete against the rest of the world.

    We should do the same with the autos.  Let GM, Ford and Chrysler die.  Let Toyota, Honda, Daimler, Renault, Hyundai, Magna, Kirk Kerkorian (dreamer), etc., bid for the assets in bankruptcy.  Many jobs will be retained, though at fairer levels of compensation.  Remember my piece Rethinking Comparable Worth?  We are facing international comparable worth issues in labor in the auto sector now.

    Before there were the possibilities with government bailouts, GM and Ford said they had more than enough cash.  But when the carrot of cheap financing is in front of them, they tell their tales of woe.  Examples from the media:

    I could add to the examples in other sectors — MBIA and Ambac seem to be  headed to zero as well.  Another set of examples of too much debt and too little transparency.

    But to close on the automakers, I highlight the well-written article at the Curious Capitalist.  The companies are not as critical as their assets, which will be bought by others, and many of the jobs will be retained.  Any bailout will throw good money after bad, and will not preserve the auto industry here in the long run.

    Full disclosure: long HMC MGA