8/12/2010
By David Silver, Research Analyst

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This morning General Motors released its operational results for its second quarter of 2010.  The results were better than the first quarter as China and improved operations in North America offset weakness in Europe.  Not only did the Company report earnings of $1.3 billion (above $895 million in the first quarter), but General Motors also announced that it received a $5 billion revolving credit facility.  The credit facility was one of the last hurdles to pass before GM files for its initial public offering.  Rumor has it that GM will file for its IPO tomorrow and is expected to raise approximately $16 billion, but more on that later.

Overshadowing the solid earnings release is the announcement that CEO Ed Whitacre will be stepping down (effective September 1) and that board member Dan Akerson would succeed as the new CEO of GM.  Mr. Whitacre said "It was my plan all along to help return this company to greatness and that I didn't want to stay a day beyond that. The transition will be very smooth. He [Mr. Akerson] is aware of the things going on at General Motors."

Mr. Akerson has been a part of GM's board since July 2009 (right after the Company emerged from bankruptcy), as a representative for the Treasury, so the assumption is that he has the largest shareholder's (the U.S. government) support.  The timing of the announcement is makes you wonder; however, the action should not surprise anyone and the hopes are for a smooth transition.  General Motors is expected to file for its IPO, and Mr. Whitacre has been adamant about turning the Company around and then stepping down.  What investor would want to invest in a Company that would have its CEO imminently stepping down with no predecessor in store? I had expected Chris Liddell to be named the new chief.  Mr. Akerson is said to bring some international understanding to the table that would help the turnaround in Europe as well as facilitate overseas growth. Mr. Akerson doesn't have any auto industry experience, but then again neither did Mr. Whitacre or even Ford (F) CEO Alan Mulally.  It seems to be just what the industry needed, bringing in fresh minds from outside of the industry. Hey, at least the Company didn't name Bob Lutz CEO.

Back to the results, North America performed much better year over year as all the plant closures and shuddered brands helped to boost the bottom line.  The Company is concentrating on its core 4 brands (Chevrolet, Cadillac, GMC, and Buick) and has been performing extremely well.  However, market share fell in the fast growing economies of Brazil, China, and India (also fell in Germany) compared to the first quarter, with improvements in the U.S. and the U.K. offsetting that decline.  Total market share for the second quarter was 11.6% for the world, and 11.4% for the first six months of the year. 

International sales growth has helped the Company turn around its North American operations, but the growth in China is slowing.  India, Russia, and Brazil are very important markets, and despite strong economic growth, have seen auto sales improve at a decelerating rate.  Of course, 40%-50% improvement is not sustainable in the longer term.  However, the sales growth, and more importantly the earnings before interest and taxes (EBIT) growth propelled the Company to its best quarterly profit in more than six years.  General Motors (Mr. Whitacre didn't like the "Government Motors" moniker) reported more than $2.0 billion of EBIT in the second quarter and almost $4.0 billion through the first six months of the year, however, one of the best items was the improvement in operating cash flow (gained $3.8 billion during the quarter and $5.7 billion through the first six months of the year).  Back at the beginning of 2009, the Company was burning through $5- $7 billion of cash per quarter (peaked during the second quarter when it burned through more than $4 billion each month of the quarter). 

So production is higher, and the Company forewent the normal summer shutdown to help increase the supply of the popular vehicles. There was an interesting point made that if the Company is making this type of money with US industry SAAR (seasonally adjusted annual rate of sales) at about 11.5 million units, imagine what it could make over the next few years as vehicle demand bounces back?  We aren't so confident in that statement as many of the popular vehicles are being produced at plants that are at or near max production.  Any increased demand could cause another plant to be needed and then the fixed and variable costs sky rocket, and I doubt that the demand will be high enough to offset that cost increase.

Ok, so back to the highly anticipated IPO of General Motors.  First off, the U.S. government (you know, We the People) owns 61% of the Company, and has invested close to $60 billion in the Company.  So anyone who thinks that the U.S. tax payer will be out of the car business once GM goes public has another thing coming.  The government is going to offload a portion of its ownership, but has said it doesn't want to flood the market and therefore lower the price.  We expect the government's shares to account for approximately $8-$10 billion of the offer (assuming a $16-$18 billion offering). 

The filing tomorrow is nothing but a form that a company has to file with the SEC with an amount of money that is hoped to be raised and a rough estimate for the number of shares.  There will be no specifics on the form tomorrow (if it files it), just a very rough estimate.  For the sake of the money I paid for GM, I hope the estimates are a little on the weak side.  If the Company estimates to only raise $12 billion, then the offering would be extremely oversubscribed bringing either A) the cost per share higher or B) more shares offered.  Either way, the government would have a more successful IPO. 

From the small picture of the financials of General Motors we have seen, and the man dubbed the next CEO, we would actually be buyers of the new GM stock.  Given, we have a long way to go before the shares are even open to the public.  However, the Company is growing quickly in China, and with the turnaround in North America nearly complete, management can set its sights on Europe.  While we don't expect a hockey stick type growth, North America should bounce back and so should Europe.  Austerity measures and the expiration of some government scrappage incentive programs are already baked into the estimates, and therefore the results over the past few months have actually surprised us to the upside. 

David Silver
Wall Street Strategies