Are Taxpayers on the Hook in the GM Deal?
Professor M.P. Narayanan discusses the General Motors IPO.
ANN ARBOR, Mich.---In a June 2009 piece I wrote immediately after the U.S. government announced a workout package for General Motors last year, I argued that the equity value of GM needs to be in the $65-$70 billion range for the U.S. taxpayer to break even. With this week's GM initial public offering (IPO), it is a good time to take a second look at the same question: Is the GM workout designed by the Obama administration a good deal for U.S. taxpayers?
First, let us summarize the details of the IPO. A total of 478 million common shares will be offered, excluding an overallotment option. Initially, the offering per-share price was $33. These common shares constitute 32 percent of GM's 1.5 billion shares and come from the stakes of the U.S Treasury (359 million), Canadian government (30 million) and UAW (89 million). In addition, 80 million Series B preferred shares will also be offered at $50 per share. The amount raised from the common stock offering is expected to be $16 billion, which gives GM an estimated market capitalization of $49 billion. The U.S. Treasury is expected to receive $12 billion from the sale of about 40 percent of its stake, which, in turn, will reduce its stake from 61 percent to 37 percent.
The U.S. Treasury had provided a total of $49.5 billion to GM, out of which $6.7 billion was in the form a loan and $2.1 billion was in exchange for Series A preferred stock. The loan has been repaid with interest and GM expects to buy back the preferred stock using the proceeds from the sale of the Series B preferred. Therefore, to break even, Treasury's equity stake before the IPO needs to be worth $41 billion, which translates to a GM market cap of $67 billion based on the pre-IPO 61 percent stake.
It follows that the Treasury is selling part of its stake in this IPO at a pro-rated market cap of $49 billion, which translates to a discount of 27 percent to the break-even value. It does not take a finance expert to figure out that, selling about 40 percent of its stake below the break-even value raises the break-even value bar for the remaining stake. To get a sense of how high this bar is, note that $29 billion of the original handout will remain unpaid after the expected IPO proceeds of $12 billion (let us be generous and ignore what the Treasury could have earned during the last one-and-a-half years in an equivalent-risk investment). Since this amount constitutes about 37 percent of the taxpayer stake, the break-even GM market cap is now about $79 billion! In other words, by selling part of its stake at a discount to the break-even value, the break-even value for the Treasury's remaining stake has increased by about 18 percent---from $67 billion to $79 billion. The overallotment only makes the break-even value for the remaining stake higher.
How well does GM have to do to justify a current market cap of $79 billion? After taking into account its debt and pension liabilities, GM will have to earn sustained annual operating profits of about $10 billion year after year to justify such lofty market cap. Is it possible? As a comparison, Ford's operating profit before taxes during the 2009 fiscal year was about $10 billion but its market cap was under $60 billion, indicating that the market does not believe it can sustain that level of profits. It should not come as a surprise that for taxpayers to break even on the GM deal the company has to perform extraordinarily well---better than most of its competitors and better than anything it has done in the past few decades.
Did the Treasury shortchange the taxpayers by selling at too low a price? This is a more difficult question to answer. While the government may fully realize that taxpayers will lose financially on the GM workout, it may still justify the decision on the basis of broader economic and social welfare considerations. Therefore, now the issue is how to exit GM with the least financial loss. By selling some of its stake and establishing an open market for GM shares it is possible that the rest of its shares will be valued higher for several reasons. The liquidity that a publicly traded stock brings is valuable. The market discipline arising from being a publicly traded company (as opposed to being a government-controlled one) may lead to better governance and, hence, greater shareholder value. Therefore, even if taxpayers will not get all their money back, the decision to sell part of the stake at lower than the break-even price may be justified.
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