I Brake for Bargains
By James B. Stewart
April 11, 2006
BY NOW THE WOES of the U.S. auto industry are so well known they hardly bear repeating. Every month brings news of falling sales, even lower market shares, soaring pension and health-care costs, the end of lifetime employment guarantees, potential strikes, even the threat of bankruptcy. General Motors (GM1) has been the poster child for decades of automotive mismanagement, though Ford Motor (F2) is faring only slightly better. No wonder the few shreds of good news get lost in the avalanche of bad.
So it was last week, when GM's latest sales decline overshadowed the long-awaited sale of a majority stake in General Motors Acceptance Corp. to hedge fund Cerberus Capital Management in a transaction that will generate $14 billion in cash for GM over the next three years. Apart from the cash, GM will be getting something that could prove even more important in the long run: an infusion of new blood. Cerberus is known for investing in near-bankrupt companies and turning them around, which is exactly the kind of expertise that could benefit GM. It's also politically well connected, which could help GM in Washington. I don't know him personally, but Cerberus principal Steve Feinberg has a reputation on Wall Street as a financial whiz. Now if he could only design cars.
Last week's announcement made no mention of any GM board seats for Cerberus, but GM stressed that the firm has a "keen desire" to improve GMAC's beleaguered credit ratings and is also committed to long-term growth at GM. Surely Cerberus people will be intimately involved with GM's management and board. Together with a board seat for Jerry York, representing GM investor Kirk Kerkorian, this strikes me as revolutionary change in the once insular world of Detroit auto makers, and augers well for some kind of turnaround.
GM's determination to raise its credit ratings sent me to the latest quotes on the myriad of bonds GM has outstanding. The big credit-rating agencies took no immediate action in the wake of the GMAC sale, leaving GM's and GMAC's bonds deep in junk territory. But their reaction was slightly more positive than their inaction might suggest. Fitch revised its outlook on GMAC bonds to "positive"; Standard & Poor's said it might raise GMAC a notch (though still leaving it in junk territory), and Moody's said it expected to take no action, and might even downgrade GMAC. GM debt remains at junk levels with "negative implications" in S&P's analysis.
Let's ignore the ratings agencies for a moment and apply the Common Sense test: Is GM more or less likely to default in the next few years now that it has a new partner in Cerberus and the prospect of an additional $14 billion in cash? (Separately, GM sold its equity stake in Japan's Isuzu on Monday for about $300 million, further solidifying its cash position.) Of course you know the answer, which is that default is less likely. Indeed, I would argue that it's highly unlikely GMAC will default within the next two years, and I hereby upgrade shorter-term GMAC bonds to investment-worthy status. (I'd still stay away from longer maturities.)
I would've expected GMAC bonds to rally on what seems to me to be these positive implications. But if you think car dealers are offering some good deals, take a look at some of the bargains persisting in GMAC bonds. They remain stuck at a fraction of their face value, with many bonds maturing in two years or less yielding more than 10%.
Last year, after the ratings agencies first downgraded GM's bonds to junk, triggering near-panic selling by institutions limited to investment-grade debt, I urged readers to step into the breach, and I bought some GMAC paper. It rallied off its lows, but all I really cared about were the interest payments. These bonds mature in a few months, and I fully expect to be repaid all of my principal. I've also reaped the generous interest payments over the past year. With last week's good news, it strikes me as an excellent time to add some more GMAC bonds, especially at current low prices.
As I said, there are a myriad of issues to choose among, and judging by the varying interest rates to maturity, there must be some variation in their terms. This is an instance where you could probably benefit from the advice of a broker or financial professional who understands these issues. But to cite just a few examples from the NASD web site3, there are numerous issues maturing in 2007 yielding over 9%, many in 2008 at 10% or more, and, if you're willing to risk another year, bonds maturing in 2009 at 11% or more.
Should Cerberus and GM ever convince the ratings agencies to return GMAC bonds to investment grade, there will be a massive rally as institutional buyers return. But that doesn't really matter if GMAC has the means to service the debt and repay the principal over the next few years, which I believe it does.
If this theme appeals to you, and you want to take a deep breath and really shoulder some risk, take a look at GM bonds (as opposed to GMAC). No one expects GM to regain an investment-grade rating anytime soon, if ever.
But little noticed in the GMAC sale is the fact that GMAC is going to pay GM $2.7 billion of the proceeds, and GM is retaining ownership of $20 billion in GMAC auto loans. In other words, GM is benefiting from this deal, too, not just GMAC. If you think GM can meet its debt obligations for just the next two years, consider the GM 6.375 bonds maturing May 1, 2008. When I checked recently, they were yielding an eye-popping 18%.
Links in this article:
1http://www.smartmoney.com/cfscripts/Director.cfm?searchString=GM
2http://www.smartmoney.com/cfscripts/Director.cfm?searchString=F
3http://www.nasdbondinfo.com/
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