A Letter from the Chairman of General Motors
Dear shareholders,
Moody's Investors Service last week upgraded General Motors' rating.
The major credit-rating agency bumped our rating from Ba1 to Baa3 ? its lowest tier of "investment grade" credit.
Nobody was more surprised than me. Let me tell you plainly, I do not believe our company is an investment-grade credit. Nor are our operations likely to improve in a way that would have led any reasonable analyst to conclude such. That is why all of the other major ratings houses (S&P, Fitch, Egan Jones) continue to rate our corporate obligations as "junk" ? speculative debts that have a significant risk of default.
I now understand what Bill Gross means when he says investors shouldn't trust Moody's ratings because the company has become a de facto arm of the U.S. government. Or as he put it this week: Moody's and the U.S. Treasury are just one big "happy family."
Gross manages hundreds of billions of dollars in private capital for the investment management firm PIMCO. So he has the luxury of being able to say whatever he wants in public.
I don't have that luxury. I'm the chairman of a publicly owned corporation, whose debts are soaring, whose margins are collapsing, and whose capital structure is still controlled by the government and our unions. So when the reporters called me to ask about the Moody's upgrade, I said: "Good things happen when you build great cars and trucks and deliver strong financial results."
It's a great line. It still makes me chuckle.
Read it carefully. You'll notice? I didn't say anything about GM.
What I couldn't say is that our business is already beginning to collapse, again. Look at our core automotive operating profits. In the first six months of 2012, we generated $2.8 billion in automotive operating profits. In the first six months of this year, we made a little more than $2.1 billion. Thus, our core, global automotive business has seen its operating profits decline substantially? by more than 24%.
We are approaching another crisis at GM, one that has its roots in the bailout of 2008/2009. The faulty bankruptcy process caused this crisis by failing to address our largest obligations (pensions and retired employee health care). And the crisis results from the motivations of our government owners ? motivations that do not square with capitalism.
Like my predecessor, Rick Wagoner, did? I plan to write to you from time to time, privately, here in these pages. I will tell you what is actually happening with our great company ? an institution that was once the largest privately financed endeavor in human history. You'll get the truth here, even if I'm not allowed to say it anywhere else?
What's happening with GM is a microcosm of what's happening with the rest of our society. Where once we sought only a fair opportunity for greatness, now we seek the false security of collectivism. I see it happening right in front of me every day.
I believe an honest discussion of what's happening with our business could help educate the public about the failure that's inevitable when resources ? like our capital, plants, and people ? are governed by politics rather than by markets.
At GM, we abandoned capitalism in 2010 when we emerged from bankruptcy. Instead of treating all of our creditors fairly, we gave the lion's share of the company's assets to the federal government and the UAW health care trust. Meanwhile, we didn't do anything to mitigate our enormous pension liability, which today stands at $26 billion. At the end of the bankruptcy process, none of our 400,000 retired workers lost a nickel. On the other hand, our shareholders, creditors, and many of our suppliers were wiped out.
That's not the way capitalism is supposed to work. And still today, GM isn't really privately owned. Instead, the company is a kind of public-private "partnership," where actual control rests with the government. Today, GM is more like a Ponzi scheme than a real business.
How so? Ponzi schemes don't generate any actual profits. They require greater and greater sums of money to work. Sooner or later, there simply isn't enough capital available to maintain the mirage of a functioning business. That's exactly what's happening at GM.
Don't take my word for it. Consider the facts below. Then, decide for yourself.
Is GM a real business, owned by capitalists, driven to create real profits, to be shared by its owners as they see fit? Or is it a kind of elaborate, government-sanctioned scheme, meant to enrich a few chosen, special interests?
PART I: Who Are the Real Owners? All of Our Profits? and More? Are Going to Retired Workers
Since GM emerged from bankruptcy protection in mid-2010? we've done great.
The last few years are the best years in the history of our company. We've never built better cars. The market research firm JD Power says GM has the highest-quality cars of any major carmaker. Our trucks, it says, compete with Porsche for the highest-quality vehicles made anywhere in the world. We've never generated more revenue. In total, we've made about $26 billion in operating cash flow ? what our main business generated before paying capital expenses and similar costs ? since we emerged from bankruptcy.
It all sounds good, I know.
The bad news is that our business requires massive amounts of capital to sustain its operations. These so-called capital expenditures consumed roughly $20 billion of those operating profits. That left us with roughly $6 billion-$7 billion in actual cash that we could, in theory, return to our true owners (our shareholders) or re-invest into profitable lines of business.
So where did this money ? the so-called free cash flow ? go?
All the money ? and a lot more ? went to retired workers, unions, and the government.
In total, we've sent around $18 billion in cash to these interests ? far more than we've been able to earn. These payments started with $3.9 billion in dividends on special "preferred" shares the union, the U.S. Treasury, and the Canadian government got during the bankruptcy process. Keep in mind, our creditors got none of these shares, and we've never paid a cash dividend to regular, common stockholders.
Another $8.5 billion went to repay debts to the U.S. Treasury and the union, obligations that we were saddled with in bankruptcy.
And that's not all. In 2012, we announced with great fanfare that our operating results were so good, we were going to begin buying back shares. Normally, that's great for common shareholders.
But in this case, the $5.1 billion worth of stock we bought back ALL came from the U.S. Treasury. No former creditor or any other public shareholder was able to sell to us. That's not all? We paid a $2-per-share premium to the actual market price of our stock. We simply gave the U.S. Treasury another $400 million "gift" for allowing us to buy back the shares it held.
Remember? private investors didn't have a chance to sell their shares to GM at a $2 premium. That deal was nothing less than a crime. It was the U.S. Treasury stealing $400 million from the shareholders. If any other business in the country did something like this, it would get hit with a hundred lawsuits overnight. But when GM did it? The press cheered. How can you explain that?
So we continue to owe far more to unions and governments than we're earning. If that were our only problem, perhaps we could envision a light at the end of the tunnel. But these obligations are only the beginning?
That $26 billion in operating cash flow already accounted for about $8.8 billion in cash payments we made to support our pension plan and other retirement benefits. Without those obligations? our number would have looked even better, with operating cash flow of nearly $35 billion. That anchor around our neck isn't going anywhere.
In addition to the cash, we contributed in 2011 60 million shares of stock (worth $2 billion) to the pension plan. No, that wasn't a cash expense. But believe me, shareholders should wish it was, as the expense will end up coming out of their pockets, instead of ours.
Just think about what that means?
Instead of the workers supporting the shareholders? at GM, the shareholders are supporting the workers. Sounds a little bit like communism, doesn't it? Well, just wait. The nonsense is only getting started?
In 2012, we announced a big deal to eliminate our entire legacy, white-collar-salary pension obligations. We paid the Prudential insurance firm around $3.5 billion to manage $25 billion worth of our pension liabilities, taking them off our books. Don't forget? we also gave Prudential $25 billion from the pension fund to manage.
Think about that for a little while. When is the last time you had to pay your broker 14% of your assets upfront to manage your account? Hedge funds normally charge 2%. They're considered expensive. Paying 14% sounds a little steep, doesn't it? No one ever explained it to me, either. My guess is a lot of that fee ended up in union offices or political piggy banks.
Whatever happened, all of the money is gone. In the three years after bankruptcy, we made roughly $6 billion-$7 billion in "free cash flow." Somehow, that cash was supposed to cover $18 billion in obligations? including almost $1 billion a year in preferred-stock dividends to the union's health care trust and the Canadian government. That also includes the $400 million "gift" to the U.S. Treasury and the $5.1 billion worth shares we bought from it.
And for our common shareholders, our real owners? We haven't paid a cent.
So who really benefits from our brands? our research and development? our decades of investment? and the tens of billions of capital we have at stake? Is it our shareholders? No, it isn't. It's the union. It's the retired workers. And it's the government.
Is any of this likely to change any time soon? No, it's going to get worse? a lot worse.
Look at our preferred shares. They were created to make sure the union got most of the value out of our remaining assets. (Our bondholders didn't get any of these preferred shares.) The shares pay a 9% annual dividend. Try to find any other preferred stock issued by a major corporation that pays a coupon that large. You won't find another example.
We were simply hijacked by the bankruptcy court and the Obama administration. And we have to pay this dividend before we pay anything else. If we don't, these obligations accrue, a situation that would rapidly warp our entire capital structure, placing the whole company in the union's control.
So one of my most important jobs is to buy back these securities as quickly as I can. The problem is, they're extremely expensive. I've just negotiated a deal to buy back 120 million preferred shares at $27 each from the union's medical trust. That's $3.25 billion. Believe it or not, the medical trust will still own 140 million of these preferred shares. The Canadian government also owns a few of these shares (16 million). We can redeem all of these remaining shares in 2014, but it will cost us almost $4 billion ? in cash.
To pay off the union then, we'll have to borrow money? billions.
Now, you know the real reason why Moody's just raised our credit ratings. I'm sure the government told Moody's to help GM raise the money so we can pay off the unions.
Shall I feign indignation that the country's most politically powerful union is able to manipulate Moody's credit ratings?
PART II: Since Government Can't Let Automakers Fail, Overcapacity Is Getting Worse and Worse
I'm proud of GM's cars.
As I mentioned, we've made huge strides in increasing the quality of our vehicles. But guess what? So has every other carmaker in the world. The competition makes it harder and harder to make a profit.
Just look at our actual numbers. In the first six months of 2012, we sold $74.5 billion worth of cars around the world (automotive revenues). We made an operating profit of $2.8 billion. That's a minuscule operating profit margin of 3.8%.
The situation is getting worse. In first half of 2013, we sold $74.6 billion worth of cars around the world, fractionally more revenue. But we earned a lot less, only $2.1 billion. Our costs rose, and we could not pass these costs on to our customers. Our operating margin declined to less than 3%.
These are razor-thin margins. Margins this small are dangerous to operating companies, like ours, that have huge volumes. If anything were to happen to consumer demand ? for example, if the economy were hit with a recession or we were unable to finance our customers (more about this below) ? these puny margins would disappear overnight. The result would be sudden, large losses.
You should know: An "accident" like this is inevitable. It's going to happen. And it's going to happen soon. The auto industry suffers from a tremendous glut of capacity. According to different sources, 20%-30% of global production isn't profitable.
My counterpart at Nissan, Carlos Ghosn, is one of the few senior executives who has spoken honestly about this major problem. At a recent car show in Geneva, he said, "All of the car manufacturers have capacity problems ? all of them."
Sergio Marchionne, the chief executive of Chrysler and Fiat and the president of the European Automobile Manufacturers' Association, estimates the auto industry needs to cut capacity in Europe by 20%.
Automakers employ or support 2.3 million people in Europe. Just like in the United States, the auto industry is too politically powerful to be allowed to fail. It's the same thing, all around the globe. So how likely is it that any automaker, anywhere, will be able to significantly reduce production?
Capitalists making tough, but realistic, decisions no longer control this industry. Instead all of the capital-allocation decisions are being driven by politics. Whether you call it "welfare," "socialism," or "communism" doesn't matter. As long as this continues, it's inevitable that GM's operating margins will continue to deteriorate. And that means, it's only a matter of time before we're dealing with huge quarterly losses.
Bernd Bohr is the head of the automotive group at Bosch, the privately held German company that's the world's largest manufacturer of car parts. He explains the current problems by pointing out that none of the major carmakers was allowed to fail in 2008/2009. "It was a peculiarity of the 2008-09 crisis," Bohr said, "that practically no capacity was taken out of the market due to state intervention?"
While hard to fix, the problem is easy to understand. As long as no carmakers are allowed to fail, the ability of the entire industry to earn a profit will be greatly compromised. GM is the largest car company in the world (roughly tied with Toyota). It has the highest labor costs. It is heavily burdened by its pension obligations. It has, despite my best efforts, several weak brands.
In this scenario, GM is extremely vulnerable, the most vulnerable large carmaker in the world.
My advice? Don't pay attention to our revenue figures. Watch our margins. It's overcapacity that will kill us this time, not quality or a lack of demand.
PART III: We're Doing It Again: Selling Cars to Unqualified Buyers
Think about the dead-end GM faces strategically.
We can't compete on brand. No one under 40 years old would rather drive a Cadillac than a BMW. Almost no one at any age would rather have a Chevy Malibu than a Honda Accord. And even though our trucks are great, Ford's are just as good (if I'm being honest).
We can't compete on price because we don't have the cheapest costs. Instead, we have the highest.
And no matter how much money we make, all of it (and more) will end up being siphoned off to either the union's health care trust or the pension fund.
What would you do in this scenario?
I've thought about this question every single day for three years. There's only one answer. And it's a lousy one.
GM will have to compete on credit. We'll have to work out a deal with Wall Street to borrow billions and billions and funnel the money to car buyers who the other makers won't lend to. Our only chance is to, once again, become too big to fail.
In the fall of 2010, we acquired a financial business, now called GM Financial. It exists to provide financing to buyers of our cars in dealer showrooms. You might recall that our company's last foray into finance didn't end well? huge losses at our former finance subsidiary were one of the primary reasons our company spiraled into bankruptcy back in 2008.
We're doing it all again.
As our margins have declined, we've attempted to grow by making more and more loans. Our loan book has ballooned to $11.5 billion. We made about
75% of these loans to borrowers with FICO scores lower than 600. Unbelievably, we're even lending billions (more than $3 billion, actually) to folks with FICO scores less than 540.It seems implausible to me that these loans will work out for us in the end. By the end of 2012, nearly $1 billion of these loans was already in default. Just imagine what will happen to these weak borrowers when we eventually enter another recession. Just as our sales are declining, all of these bad debts will come due. All the repossessed cars will flood the market, driving down recovery values and destroying demand for new cars.
Haven't we learned anything from the last financial crisis? Apparently not.
You will see as we move forward, our margins will continue to decline because of the global problem of overcapacity. Charities ? which is what all of the major car companies have become ? don't make a profit. As our margins decline and our cash flow disappears, the union and retiree demands on our remaining capital resources will grow more intense. We'll have to borrow more and more simply to fund our pension obligations.
We will also be borrowing, massively, from Wall Street to finance our car buyers.
Sooner or later, we will end up losing money on every transaction, while trying to make it up on volume? and financing that volume using our own balance sheet.
It's insane? unless you understand it's my only hope. I've got to borrow billions and billions over the next few quarters. I've got to scale up, so that we're so big we can't be allowed to fail. It will be the same madness we saw in 2008 all over again.
But this time, it won't take decades to unravel. It will happen much faster. My guess is within five years, we'll be in a crisis again. And our stock, which is currently valued at $50 billion, will be worth nothing.
Please invest accordingly.
Best regards,
The Chairman of General Motors