GMAC sale, the Good, the Bad, and the Ugly

Jim Jubak is writing Bad for GM, bad for America

General Motors has launched a time bomb that could push the company into Chapter 11 and take down the financial markets with it.

Leave it to the guys who are driving General Motors off a cliff to make things worse. Thanks to their most recent "solution" -- selling off a 51% stake in the company's profitable General Motors Acceptance Corp. financial arm -- CEO Rick Wagoner and his team have actually raised the odds that General Motors will have to seek bankruptcy protection. And made sure, as an added bonus, that they can do nothing to stop what they’ve set in motion.

So how does a CEO manage to put his company and the entire financial market at risk with a single deal?

By making it contingent on the whims of the not-so-rational combatants at Delphi and the United Auto Workers, who have locked horns over wages and benefits in Delphi's bankruptcy proceedings.

General Motors did this by "selling" 51% of GMAC to a private investment group including Citigroup and headed by hedge fund Cerberus Capital Management for $14 billion. Of course, GM won't get that $14 billion all at once. When the deal closes, Cerberus and its partners will pay General Motors $7.4 billion. GM will collect another $2.7 billion in cash from GMAC as a return of the higher taxes that GM paid on GMAC's income when it owned the financial company. GM will receive another $4 billion over three years from GMAC as income on $20 billion in leases and retail assets that GM will retain after the deal.

This isn't exactly a great deal for General Motors. GMAC is the company's most profitable unit, earning $2.8 billion in 2005, and GM has been able to tap GMAC for capital during what has become a perennial rough patch. The investor group is paying about five times net income for its 51% stake in GMAC -- and part of that price is cash from GMAC itself. If you look just at actual cash from the investor group and subtract the cash from GMAC, the price is closer to two times income.

The no-sale sale
But price isn't the real, company-crushing bad news in this sale. I'd save that moniker for this oddity: The sale isn't a sale at all. Cerberus and the rest of the group can walk away from this deal before it closes some time in the fourth quarter of 2006 if the credit rating on General Motor's unsecured long-term sinks to less than a triple-C rating from Standard & Poor's. A rating like that would be two notches deeper into junk-bond territory than General Motors' current rating of single-B. (The deal is also off if GMAC's own credit rating slips below its current double-B rating, just two notches below investment grade.)

What could drive General Motors bond ratings down another two notches just about overnight? A strike set off by supplier Delphi’s efforts to break its contracts with its unions in bankruptcy court. The company has filed a reorganization plan that includes closing or selling all but eight to 12 of its 33 North American plants and cutting as many as 30,000 jobs. For U.S. workers who keep their jobs, Delphi has proposed an immediate wage cut of $5 an hour (or 18%) to $22 an hour for production workers and another cut to $16.50 an hour -- for a package of cuts totaling $10.50 an hour -- in 2007.

The United Auto Workers, as you might imagine, has branded the proposal unacceptable and threatened a strike. Delphi has responded by asking the bankruptcy judge for a ruling that would allow the company to unilaterally break its union contracts with the company's 34,000 union workers and its 12,000 union retirees. The first hearing in this game of chicken is scheduled in U.S. Bankruptcy Court in New York on May 9-10. A ruling on the labor contract is unlikely until June.

It's hard to know where to begin.
Let me start by saying that Jubak is one of the better writers that MSN Money has. Forget the overhyped Cramer (a service you have to pay for) and take Jubak for free. That is my "No Brainer Pick of the Day".

That said, let's take a look at the Good, the Bad, and the Ugly of this sale.

The Good

The good is that GM got rid of it. I disagree with Jubak that this was some sort of crown jewel. If it was a "crown jewel" GM would have gotten a better deal for it. About a year ago on the Motley FOOL and Silicon Investor I recommended that GM dump this financing unit while they could get something for it. At the time I heard all sorts of absurd claims that it might fetch $50 billion or so. You know what? It MIGHT have. Who knows? What we do know is that GM delayed doing this transaction until not only was it clear that GM car sales sucked but it was clear that the economy was headed into a slowdown as well. Still, GM got the deal done, well sort of (and more on that later). That is the good. It is good because in an economic slowdown the value of its receivables are going to take a hit. Perhaps a huge hit.

The Bad

GM is getting a lousy $14 billion for this deal of which a mere $7.4 billion is up front. If that seems like a far cry from the $50 billion figures that were tossed around less than a year ago, well it seems that way because it is that way. Still I contend that GM was right to dump GMAC. Any car company that makes more on financing car loans and mortgages should either decide to become a loan company or a car company. Hmmm Perhaps this is a good. Well yes it is except that GM delayed too long and that makes it bad. Except of course that the transaction is far uglier than it is either good or bad.

The Ugly

I was wondering why GM sold off on the news of this completed deal. I had been puzzled by this for days. Well, Jubak enlightened me today of "The Ugly". The sale isn't a sale at all. Cerberus and the rest of the group can walk away from this deal before it closes some time in the fourth quarter of 2006 if the credit rating on General Motor's unsecured long-term sinks to less than a triple-C rating from Standard & Poor's.

I am surprised that Jubak did not comment on this but GM did not sell GMAC, GM sold an option on GMAC. If Jim is correct (and I have no reason to believe that he is not correct), GM sold a "No Cost" call on GMAC. IF, in the timeframe specified GMAC is worth the agreed upon price, then the call will be executed, if not the buyers will walk away.

Not only is that ugly, that is desperate on behalf of GM. If Delphi strikes, the buyers walk away. If GMAC credit ratings tank the buyers walk away. If and a big if, everything looks ok, the buyers just bought GMAC for a fraction of what it was worth.

There is only one word for this and that is ugly.
This chart shows the ugliness of it all.



The Market did not think too much of the sale and neither do I. Interestingly enough, the chart showed the weakness long before either Jubak or I noted the details. A tip of the hat to Jubak must be given for explaining what happened.

Mike Shedlock / Mish
http://globaleconomicanalysis.blogspot.com/