When Harry met Mary
About halfway through his account of the U.S. government’s rescue of the automotive industry, “Overhaul,” Steven Rattner describes a Eureka moment. As President Barack Obama’s former car czar tells it, a young financial whiz on his staff, Harry Wilson, bounded into his office in the bowels of the White House waving a sheaf of papers, saying: “We’ve been thinking about this the wrong way.”
Wilson’s epiphany was a simple one. The country’s biggest manufacturer, General Motors was too weak to support the debt load being contemplated by the government. The only way to make the bailout work would be to convert its borrowings into equity, thus making Uncle Sam the company’s majority owner. Though the administration was initially opposed to the idea, Wilson eventually prevailed.
So it’s ironic – perhaps even bordering on a conflict of interest – to see Wilson back at the gates of GM’s aptly named Renaissance Center headquarters in Detroit arguing quite the opposite: that the company doesn’t need such a pristine balance sheet anymore. Wilson is now an agitator, representing shareholders controlling 2.1 percent of GM, insisting on a board seat and a pledge that the company hand back $8 billion of the cash in its vaults to owners by way of repurchasing stock.
“Leverage can be a good thing,” Rattner wrote of Wilson’s proposal. “But debt can be particularly risky for companies in cyclical, capital-intensive industries like automobiles. A streamlined, relatively debt-free GM would have the flexibility and financial cushion to succeed.” According to Rattner, Wilson maintained that a GM without the weight of debt “can compete and win.”
As paradoxical as these two versions of Harry Wilson may appear, they are not necessarily at odds. The young former banker who tirelessly worked on civil-servant wages in 2009 and the activist pocketing carried interest from a gaggle of hedge funds today want the same thing: a strong and profitable GM.
History suggests that a fat and happy GM – that is, one with an excess of capital sloshing through the ballast of its enormous underbelly – is a dangerous thing for investors and America. Such a beast overspends on everything, from factories and equipment to executive compensation. It negotiates poorly, making promises as profligate as the ones Greek sanitation workers received a decade ago. Without externally imposed fiscal discipline, GM is at risk of repeating the mistakes of the past.
Don’t expect Wilson to express the crusade in these terms. Even the oft-rapacious money managers supporting his candidacy to the board – Taconic, Appaloosa, HG Vora and Hayman – couch their demands in polite argot. David Tepper’s Appaloosa, for example, says it wants “greater efficiency in allocating shareholders’ capital.” The arithmetic is nevertheless on their side.
Going into 2015, the GM led by Mary Barra could boast a flush balance sheet with some $25 billion of cash and $37 billion of liquidity. True, the company faces obstacles ahead, including a possible Department of Justice fine and payouts to the poor souls who were injured or lost loved ones because of GM’s negligence in producing, and outrageous moral failure to fix, faulty ignition switches. And GM’s financing arm needs to keep rating agencies comfortable.
Yet to carry cash more or less equivalent to what a pre-bust 2007 GM held seems excessive. The company has since dramatically reduced its liabilities, a Wall Street euphemism for silly promises made by prior management in similarly bloated days. GM also was producing 9.3 million cars around the world at the time and recording a net margin of just under zilch. Last year, it sold 9.9 million vehicles and generated $2.8 billion for stockholders.
Thanks to the discounts U.S. taxpayers forced on creditors and workers, today’s GM is a more efficient engine, capable of cranking out $5 billion in free cash flow annually, analysts at RBC Capital Markets estimate. The company’s operations are so much fitter today that they would break even in a recessionary scenario akin to what occurred during the financial crisis, when the seasonally adjusted annual rate of North American sales dipped to near 10 million. They’re now at over 17 million.
In GM’s darkest hours, back when Wilson, Rattner and a young analyst named Clay Calhoon who, surprise, now works for GM cage-rattler Taconic, were figuring out its future, the biggest drawdown on its working capital amounted to $5 billion in its worst quarter. To think GM would need seven times that much liquidity in its current shape today takes caution to a new level.
Having been put through the wringer once, Barra and her team understandably want the extra protection. The worry, however, is that GM will revert to its cultural and historical norm and, for instance, make too many promises during its next contract negotiations with the United Auto Workers, or simply spend shareholders’ money frivolously.
There’s some evidence it’s already happening. GM has raised its targeted outlays for fixed assets to $9 billion, some 28 percent more than last year, according to RBC’s numbers. Does it really need to spend that much? It’s hard to say. But it’s always easier to say yes when the capital cup is overflowing.