GM Bankruptcy Is Watershed for Investors

06/16/2009 10:48 am EST

Focus: MARKETS

Richard Lehmann

Publisher, Forbes/Lehmann Income Securities Investor

Richard Lehmann, editor of the Forbes/Lehmann Income Securities Investor, says the government’s interference in the GM and Chrysler bankruptcies set a bad precedent.

The General Motors bankruptcy filing, like that of Chrysler, represents a new chapter in what investors can expect in bankruptcy. It is a shameful example of putting politics before established investment principles and practices and thus erodes investor confidence where special interests such as a labor union hold sway.

We now see this expanding to any work place, even those whose very survival depends on staying competitive. With card check labor legislation just around the corner, things don’t bode well for our competitive abilities in a world market.

The last offer to bondholders to which the GM bondholder negotiating committee agreed was for a 10% ownership now and warrants for another 7.5% when the company reaches a certain capitalization level and another 7.5% when it reaches a higher level. The [government’s] intent here appears to be [to] release portions of its ownership as the market capitalization reaches a level at which its remaining holdings will equal the funds advanced to GM. Such warrants can be expected to trade as a separate security in the meanwhile.

The prospects for improving on this bondholder offer in bankruptcy [are likely] slim. The company goes into bankruptcy with book assets of $82 billion and liabilities of $173 billion. This means that without government intervention, there is no practical way for the company to exit bankruptcy. Since the government will be putting up all the money for the new GM, as well as for any payments to bondholders and the union claims, they are in a position to define who gets what—and this is what they have in effect done. It explains why they can offer the unions a better deal than bondholders despite the relative equal priority of their claims.

The question for bondholders then is, what is their proposed package worth in terms of market value? Assuming the new equity in GM trades at book value, we may see a recovery of about 22 cents on the dollar for this package. This would translate into an equivalent value of about $5.50 in common stock for the $25 par preferreds. Since they currently trade below $3.00, this leaves some up side value which I expect will continue until a fuller picture emerges from the bankruptcy process. No interest accrues or is paid on any of the preferreds or bonds as of June 1st, and all interest accrued prior to that date will also not be paid.

Looking out two years GM will probably emerge as a profitable entity, even a very profitable once the economy turns around. This means we can then expect the stock to trade at a multiple of the book value. Longer term, however, the outlook is less promising given government’s track record for running businesses that have to compete in the public market. We can only hope that the government will sell its interest in GM as soon as the market value allows this to be done at minimal cost to taxpayers.

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