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Editor's note: Porter Stansberry first started reporting on the debacle at General Motors back in 2007, with a "tongue in cheek" letter from the company chairman. Since then, Porter's predictions have come true. The company went bankrupt, wiping out shareholders and bondholders. Today, you might think GM's problems are behind it. But as Porter shows, things are dire...
Thursday, June 21, 2012
The GM situation is a microcosm of what's gone wrong in our country.
In the June issue of my Investment Advisory, I argued that the bankruptcy process resolved none of GM's core problems. The process was subverted by the political establishment, which sought to protect one class of citizen at the expense of the regional economy, GM's bondholders, and its customers.
If we can't apply the rule of law and sound economics to fixing one of the world's most important manufacturing concerns... it doesn't bode well for anyone else being afforded these privileges, either.
That's why it's so important for you to understand what happened.
Most people simply don't realize that the bailout of GM wasn't a bailout of the company. It wasn't a bailout of its shareholders, who lost everything... or its bondholders, who lost almost everything. Where did the money go? To the union. The United Auto Workers (UAW) ended up with all the money.
Let me show you how...
GM slid into bankruptcy primarily because it couldn't profitably manufacture cars. (Yes, there were plenty of other issues, like too much debt, investments in subprime mortgages, etc. But the primary reason it couldn't solve these other problems was that it hadn't been making routine profits from manufacturing cars in about 20 years.) And the biggest single reason it couldn't profitably make cars was because its labor costs had soared.
Well, guess what? At $56 per hour, GM still has the highest labor costs in the industry.
The bankruptcy process didn't deal with the biggest financial hurdle GM faces, which is an enormous (and growing) unfunded pension liability. When the company entered bankruptcy, it owed $20 billion to the trust that was established to pay for the health care of its retired workers. Its pension program, with $100 billion in obligations, was also underfunded by roughly $10 billion. That's $30 billion in legitimate claims, which the union had to present to the bankruptcy court on behalf of GM's employees.
It could have received a mixture of cash and equity in the new GM – just like any other unsecured creditor. But there wasn't really a bankruptcy court. Instead, there was Steve Rattner – "the Rat," as we call him – the crooked Democratic political operative under investigation for bribing New York State pension officials. Obama made him the "car czar."
His job wasn't to fix GM. It was to deliver billions to the union and, thus, deliver Michigan for Obama in the next election.
Bondholders at GM were owed $30 billion, too. A legitimate bankruptcy would have sold or liquidated the company's assets and split the proceeds between the two major claimants, the bondholders and the unions. GM had roughly $20 billion in tangible assets, plus probably another $10 billion in intellectual property. These sums could have either been liquidated or put into a new company, with the equity split between bondholders and unions.
Not surprisingly, the current market cap of the new GM is $34 billion, right around the same number that could have been raised in a liquidation. The bankruptcy court should have given the unions roughly $15 billion worth of cash or new equity and the same thing to bondholders.
Everyone would be square. And the company (or at least the company's assets) would have been freed from the stranglehold of huge debts and pension obligations.
Taxpayers shouldn't have paid a dime in this process because, frankly, it's none of our business.
Remember... the purpose of bankruptcy isn't to repay creditors. They're screwed. They're not getting all their money back because they bet on the wrong horse. That's how capitalism works. That's the price of liberty – you're free to make bad choices.
The purpose of bankruptcy is to free productive assets from the burden of debts that can't be repaid or refinanced. We do this because it's good for society, not because it's good for creditors. Had the bankruptcy been handled legitimately, GM's assets would have ended up in the hands of better entrepreneurs. Its workers could have found new, productive jobs at a rate the market would bear. (Other carmakers are paying $47 per hour – these aren't bad jobs.)
Yes, GM's retirees, its pension program, and its bondholders would have taken a hit. But they wouldn't have walked away empty-handed. They would have been the owners of a profitable company, operating debt-free and without the burden of almost endless obligations to a pension fund.
But that's not what happened. Instead, the government injected an amazing $50 billion into the company and, at last count, has lost roughly half of it.
How did taxpayers lose $25 billion on a company whose total tangible assets were only worth $20 billion? How did bondholders lose almost all of their $30 billion, too? And most importantly, how did our country end up with a GM that can't earn a genuine profit because of never-ending obligations to its pension fund?
I think you probably know, dear subscriber. The Rat did what he was being paid to do. He delivered billions and billions of dollars to the union... amounts that will never be recovered... billions that will never be found.
Here's what we do know about where the money went... Bondholders got 10% of the new GM – about $4 billion worth of stock at the time of the IPO. However, they weren't allowed to sell until much later, so that value dropped about one-third by the time they could have actually liquidated. Thus, bondholders ended up getting about 10 cents on the dollar. The unions, on the other hand, got paid 100% of the pension liability – about $10 billion, which was simply passed onto the new GM and has now grown to $13 billion.
In addition, the union's health care trust got 17.5% of the new equity (worth about $6 billion), plus $9 billion in preferred stock and notes. These securities are not only worth more, but they will also likely end up with essentially all the company's cash flows for the next decade.
In total, the unions walked away with about $28 billion in cash and stock (out of $30 billion owed). Not surprisingly, that's almost exactly the amount of money that's gone missing from the government's accounts. The union also retained a position of absolute control over the company's earnings.
In short, the unions got paid 93% of what they were owed and will likely continue to have a legal claim to virtually all of GM's cash flow. The bondholders got a few pennies. The taxpayers lost $25 billion. And GM still can't make a real profit. Bravo!
I'm sure folks as virtuous, thrifty, and honest as the good people of the UAW will prove to be excellent stewards of GM's assets and reputation. Surely, GM's future has never been brighter. And Obama's legacy as the savior of Detroit is assured...
By the way... the numbers above are all real. Most of the stuff you see reported about GM is not. There's a good reason for this, of course... The government continues to own a large portion of GM's stock, and GM is one of the largest advertisers in the U.S.
Nobody wants to take on those two powerful interests.
Take, for example, what Morgan Stanley's GM analyst, Adam Jonas, told the Wall Street Journal earlier this month... He claimed GM had gotten rid of 20% of its roughly $100 billion total pension obligation by spending only "$3 billion." Imagine if that were true!
If the company was able to resolve $20 billion in obligations by spending $3 billion now, well... that would dramatically improve the financial standing of the business and probably double or triple its stock price. Strangely, that's not what happened. Instead, the credit ratings agencies warned they "might" have to downgrade GM's debt. And the share price continued to fall...
I don't know Adam Jonas. And I don't know that the paper is quoting him fairly. But whatever the case, nothing could be further from the truth.
GM unloaded $26 billion in future pension liabilities by contributing $25 billion in pension fund assets, $1 billion in cash, and paying $3 billion in an insurance premium. So what actually happened is that the company put virtually all of its earnings – $4 billion – toward its pension (again) and saw the total unfunded liability drop by a mere $1 billion, from $14 billion to $13 billion.
Assuming the rest of these liabilities could be extinguished at the same rate, it would cost GM roughly $50 billion to wipe out all its remaining pension liabilities. Strangely, neither Jonas nor the Wall Street Journal saw fit to mention that part...
I'll leave you with these two simple questions...
If we can't count on the media to keep us informed about the major problems of our country's most important companies... and if we can't count on the government (which still owns 26% of GM's equity) to deal with its pension obligations honestly and fairly... what does this say about the likely future prospects of GM? What does it say about our country?
DailyWealth classic: Back in 2007, Porter wrote one of the most popular essays of his career. In it, he predicted the bankruptcy of General Motors (GM) – two years before the company filed for Chapter 11... making him one of the first analysts in the business to do so.
After reading GM's annual press release that year, Porter concluded: "Either the people in charge of GM don't want you to know how the business is doing, or they themselves don't know. Regardless, the result is a disaster in the making..." Read the full essay here: A Letter from General Motors' Chairman. And read his follow-up here: More from the Chairman of General Motors...
A PERFECT CASE OF "BUY THE RUMOR, SELL THE NEWS"
Shares of Arena Pharmaceuticals (ARNA) have tripled over the past month.
The company expects a decision from the Food and Drug Administration next Wednesday on its experimental, prescription diet drug, lorcaserin. In early May, an FDA Advisory Panel gave the drug a "thumbs up." Since then, the stock has skyrocketed. And expectations are high for further gains after final approval is announced. Maybe too high...
At $10 per share, ARNA commands a market capitalization of $1.8 billion. The stock trades at 165 times sales and 40 times book value. There is no price-to-earnings ratio since the company has never posted a profit. And the stock's chart has gone parabolic.
ARNA should get final FDA approval for lorcaserin next week. Looking at the chart, though, this setup could turn out to be a perfect case of "buy the rumor, sell the news." ARNA may be headed lower from these extended levels.
– Jeff Clark
In The Daily Crux