The 3 Keys to Fixing GM

Americans love a good comeback story. Since its IPO one year ago today, though, General Motors' (NYSE: GM  ) tale has played out more like Boogie Nights than Rocky II. The CFO who marshaled the company through its IPO bailed in March, the company's European business is still floundering, and Uncle Sam is still sitting on his stake. The stock has tanked 36%.

Count me among the disappointed. I was bearish all the way down as GM cascaded into bankruptcy two years ago, but new management and a streamlined business changed my tune. And while I've been wrong about GM so far, I'm still convinced that both its business and stock are fixable sooner rather than later. The company has right-sized its cost structure, ramped up product development, gained market share, and centered itself around the four core brands of Chevrolet, Buick, GMC, and Cadillac.

The trouble
There's more GM's leadership should be doing to unlock and create shareholder value. I'll walk you through those three keys in a moment. But first, let's zero in on the root cause of GM's ills: Car sales in its key U.S. market are still stuck in a ditch.

Sources: Bureau of Economic Analysis and author's calculations.

GM has actually managed to turn a profit for the past seven quarters despite this tough slog, but lackluster demand is a pox on the houses of all automakers. That curse has pushed crosstown rival Ford's (NYSE: F  ) stock down just as hard as GM's over the past year while foreign rivals Toyota (NYSE: TM  ) , Honda (NYSE: HMC  ) , and Nissan (Nasdaq: NSANY.PK  ) have also underperformed the market.

The good news is that new vehicle sales should snap back thanks to an economic recovery and pent-up demand. The average age of cars on U.S. roads is now a record 10.6 years, according to Polk, as a tough economy has forced drivers to grind out just a few more miles on their clunkers. As those vehicles get more and more expensive to fix and used car prices hover near record highs, new vehicle demand will get pushed upward whether the economy comes along for the ride or not.

The fix
And so a rising tide should lift all boats. The bad news is that there is more to be done at GM beyond the great work current management has already done to turn around the business. Here are my three steps for turning around GM's business and stock price.

Step 1: Put the cash to work
GM's bankruptcy taught the company the value of a large cash stockpile. While I appreciate a newfound conservatism, GM needs to put some of its $33 billion war chest to work. Specifically, it should invest about $11 billion with two moves.

The first is the most controversial: buying back half of the U.S. government's stake in the company. Uncle Sam is in a catch-22 when it comes to GM. It doesn't want to dump its stake at a loss, but the stock is stuck in neutral because many investors don't want to buy shares only to have the largest shareholder dump its shares shortly thereafter. An easy and actionable solution would be for GM to spend about $6 billion buying back half of the government's 32% stake in the company.

Buying back part of the government's stake would create value for smaller shareholders because it would be at an attractive price. Plus, it would get the monkey one step closer to being off the backs of GM, its investors, and Uncle Sam, and potentially reverse negative sentiment around the stock. That would allow the government to sell the rest of its stake later at a price that could help it get closer to saving face.

The second step is also important but less flashy: simultaneously announcing a voluntary $5 billion contribution to the underfunded U.S. pension. GM's underfunded retirement obligations, which we'll get more transparency on around at the end of this year, are a favorite bear talking point and drag on the stock. GM can put a dent in that case and, ahem, do the right thing by more actively shoring up the shortfall.

Step 2: Market aggressively
GM has stepped up its marketing over the past year, but there's room for more. The company should aggressively attack consumers with brand-building -- not sales -- campaigns. Specifically, GM should double down on new and improved display and video advertising opportunities to better connect with affluent consumers and young buyers who view GM's brands as tired. Hammering home messaging about GM's improved style and quality will not only drive sales both for the short and long term, it will also help wean GM off its long-standing addiction to discounting, which has crimped margins and hurt the entire industry.

Step 3: Get out of Europe
Here's one GM's management won't want to hear: The company needs to exit Europe by any means necessary. It hasn't been close to consistently profitable there since the Clinton administration, and the efforts to turn things around are a huge suck on cash and management's time. Instead of spinning its wheels trying to cost cut its way to success in fading economies stuck under crushing sovereign debt loads, GM should cut its losses and redeploy its resources toward its key profit center, North America, and emerging economies such as China, where GM is already a leader.

And how can GM exit? As the soundtrack to Rocky IV hammered home, there's no easy way out. Finding a willing buyer for the entire unit isn't realistic and GM won't get much for its assets. Still, even a worst-case exist scenario of liquidating the business and selling brand rights piece by piece beats the alternative of throwing time and money down a bottomless pit. It is a painful decision, but the right one.

The Foolish bottom line
I think any of those three steps would prove a boon for GM, though I'd nudge them to consider all three. The good news is that its strong balance sheet, the tailwind of an eventual recovery in U.S. auto sales, and a stock selling for only around five times earnings mean GM's stock could soar even without making any of these changes. Meantime, I'm content to sit back and wait for this story to play out -- even if it makes for a bumpy, pun-riddled ride.

Joe Magyer owns both GM shares and warrants. The Motley Fool owns shares of Ford. You can kick the tires on his newsletter service, Inside Value, free for 30 days. GM and Ford are recommendations of Motley Fool newsletter services. The Motley Fool's disclosure policy brakes for no one.


Read/Post Comments (23) | Recommend This Article (20)

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  • Report this Comment On November 18, 2011, at 4:43 PM, TMFBreakerRob wrote:

    Overall, a good article, Joe! Some comments:

    * I don't agree with getting rid of Europe. Its the GM global center for small car engineering and I remain convinced it *is* fixable with bold steps in cutting. A first step is brand consolidation. Keep Opel, jettison Vauxhall (and Holden while they're at it), fewer products to develop. There have to be other moves too, GM hasn't been the most bold player out there.

    * Your cash uses: surprising suggestions to me, but very good ideas!

    * Improved marketing. Definitely.

    GM has a lot of potential, but its going to continue to be hampered by the old guard. Yep, they're still there. Hire a better marketing team, give Lutz a free hand to set up the Product Development team he really wants, hire a South American management team that knows what its doing ....and stand back.

    In the meantime, I hope GM stock continues to tank. It just gets to be more and more attractive as they grow stronger and the stock drops. I wouldn't mind buying some after the European crisis peaks.

    It'll be one of the better industrial company buys out there.

  • Report this Comment On November 18, 2011, at 4:45 PM, TMFBreakerRob wrote:

    I should have mentioned: Yeah, I know Holden is Australian, but its yet another GM brand that needs to be buried in the name of reduced complexity for product development, reduced production costs and more efficient marketing.

    They're still too diffused.

  • Report this Comment On November 18, 2011, at 5:35 PM, devoish wrote:

    "The second step is also important but less flashy: simultaneously announcing a voluntary $5 billion contribution to the underfunded U.S. pension''

    They are scheduled to pay 5.9bil in 2013, and 10ish? in 2014 to the pension. I think the are allowed to pay a portion in stock (that might have defrayed the cost of VEBA though). But the whole point of handing the union responsibility for the pensions and healthcare was to get rid of a question mark liability and establish a fixed expense for investors benefit, and shift the ucertainty off of them. I don't see the gain to investors of prepaying, but the 99% might be impressed.

    Best wishes,

    Steven

  • Report this Comment On November 18, 2011, at 5:44 PM, TMFJoeInvestor wrote:

    @TMFBreakerRob. Thanks for the comments. Always appreciated, as usual. You make good points on potential in Europe, but if you step back from the situation and take a cold look at the business unit -- a consistent money loser for virtually the entire past decade -- it is tough to justify its ongoing existence. If nothing else, I'm glad I stirred the pot a bit. ;-) -- Joe

  • Report this Comment On November 18, 2011, at 5:48 PM, xetn wrote:

    The only thing that would have "fixed" GM would have been for the government to have stayed out and let it go bankrupt. Its remaining assets would have quickly been sold off to more innovative companies and would now be generating real value.

    The bailout was nothing more than a bailout of the union at taxpayer expense by the fascists in power.

  • Report this Comment On November 18, 2011, at 5:51 PM, TMFJoeInvestor wrote:

    @devoish: I hear you. But while I'd love to say that GM should manage the business and not the stock price, the reality is that the market cares about the shortfall. For that matter, $33 billion is way more than they need to carry, especially with interest rates effectively at 0%. $5-$6 billion would be enough to make a meaningful dent and signal to the market that GM's leadership was aware of its need to keep its retirement obligations in check without making too painful a draw down on the cash pile.

  • Report this Comment On November 18, 2011, at 5:52 PM, TMFJoeInvestor wrote:

    @xetn: I'm appalled by the bailout as a taxpayer. But that doesn't have anything to do with the current investment opportunity. You can't live in the past as an investor. -- Joe

  • Report this Comment On November 18, 2011, at 6:53 PM, Thuddd wrote:

    How about a relentless quality control program?

    Look at Hyundai. This company was making cut rate Yugo wanabees until, out of nowhere, they placed their cars at the top of the reliability ratings. Now look at this company..it's growing by leaps and bounds and reliable quality has made Hyundai a desirable brand and a force to be reckoned with.

    That might just work. GM is lacking in this area, and must do better if they want repeat business. With their huge legacy burden, they can't compete on price and still bring home a decent margin. Marketing can only go so far.

  • Report this Comment On November 18, 2011, at 8:17 PM, Merton123 wrote:

    GM and Ford lost market share because Toyota provided quality and they didn't. Ford has come back and is providing good quality trucks. GM hasn't improved quality. When the consumer starts buying new vehicles again will GM be left in the cold?

  • Report this Comment On November 18, 2011, at 8:35 PM, skypilot2005 wrote:

    Step 4:

    Get rid of the UAW workers.

  • Report this Comment On November 18, 2011, at 9:11 PM, hoegee wrote:

    Joe,

    Regarding your proposal for stock buyback from the US Treasury---you do understand that current market price ~$22/share is substantially below USG's breakeven point of ~$53/share? On 500MM shares, Treasury's loss would be ~$15.5BB. Do you expect Treasury to take this type of loss on behalf of taypayers, and in election year?

  • Report this Comment On November 18, 2011, at 9:20 PM, FoolishBMW wrote:

    I was born and raised in Flint, MI so I would absolutely love to see GM get it together. GM has a special place in my heart because my dad's GM checks paid for my entire childhood existence. Unfortunately, I don't know of a GM vehicle that I would spend my hard earned dollars on right now. GM needs to design compelling vehicles (the only head turner is the Camaro) and back up their quality claims with a no-brainer warranty.

  • Report this Comment On November 18, 2011, at 11:32 PM, he784 wrote:

    GM should not buy back any of the treasury shares, if Treasury wants to sell they can on the open market. GM should also not but to much money in it US pensions because they may become over funded if the stock market rebounds over the next 4 or 5 years.

    What GM should do is buy its stock back on the open market to reduce the total shares outstanding and to declare a dividend. They should also pay off all long term auto debt, less than 4 billion, which will save interest costs.

    GM should also not waste a ton of money on marketing and should reduce overall marketing expense to help increase margins. GM also must stay in EU as this is a large car market that all global players must swim in. When the XTS rolls of the line next spring in Canada it will be on a EU designed platform Ep2 that will be sold world wide.

  • Report this Comment On November 19, 2011, at 6:35 AM, Kloris wrote:

    I am not sure I disagree with the Europe part. Okay, I strongly disagree with it. Opel is a very strong brand in Europe (and yes I live in Europe). If such a strong brand is not profitable that should be fixed.

    I mean come on, it's not like they first need to build the brand. Or fix the image. I'd like to see some analysis to why Opel is a bleeder. And vauxhall? Those are just English Opels, with the steering wheel on the right. Not much extra effort at building those brands.

    Holden? Come on guys, Toyota builds and designs different cars for the European market and they can make it work, why can't GM?

    The pension fund is a tough one. Looking through European eyes I find it an absolute disgrace that it is underfunded while GM is sitting on $33 billion in cash.

  • Report this Comment On November 19, 2011, at 7:28 AM, TMFJoeInvestor wrote:

    @Thuddd & @Merton123: You make good points on quality. Thuddd, I especially agree with your comments on a total quality framework.

    In a half-hearted defense of GM, though, its brands have made a meaningful improvement in quality scores over the years. Unfortunately, much of quality is perception rather than reality. Hence my push on pushing on brand-focused marketing.

    A quiet move that GM has made to shore up the perception of low quality is backing away from fleet sales. GM's previous leaders chased that bad, high-volume business in order to keep factories running and to prop up sinking market share. That was a terrible strategy, of course, killing margins, keeping the cost structure inflated, and absolutely drubbing resale values.

    It won't happen overnight, but I suspect within the next couple of years you'll start to see a reversal in quality perception because of the actual improvements and the improved resale values from a lack of fleet sales. It may sound fanciful, but remember that it wasn't that long ago that everyone agreed that Home Depot's long famous customer support had deteriorated. By simplifying the business, refocusing on its core, and making customer service a priority again, HD has beaten LOW on same-store-sales 10 quarters running. Again, point being that perception turnarounds are achievable. -- Joe

  • Report this Comment On November 19, 2011, at 7:39 AM, TMFJoeInvestor wrote:

    @hoegee: Yep, I'm aware that the government is pretty far from break even on its investment in GM and that taking a loss is politically unpalatable. That's why I recommend a partial repurchase of stock and not a full one.

    As for it being an election year, well, it actually isn't an election year. Next year is. And Congressional elections happen every other year. My point isn't just to be snarky but to say that there is no convenient take to lock in a loss. GM's stock would need to rise 144% for the government to break even at this point. While I'm bullish on GM's medium-term prospects, there's little chance of this happening between now and the general election next year. Better to rip off part of the band-aid today.

    By doing a partial repurchase today GM can create value for shareholders and reduce the catch-22 problem of the government's stake acting as an overhang. It isn't a great solution, just the least worst.

  • Report this Comment On November 19, 2011, at 7:40 AM, TMFJoeInvestor wrote:

    @skypilot2005: Good luck getting rid of the UAW. :-) I take your broader point, though.

  • Report this Comment On November 19, 2011, at 8:01 AM, TMFJoeInvestor wrote:

    I'm a little surprised at the impassioned defense of the European business here. If GM's brands were actually valuable in Europe and the problem was fixable, why has the unit so consistently piled up losses? And, remember, just because a brand is popular doesn't make it valuable -- ask a Krispy Kreme shareholder. A less extreme example would be Dell, which still hawks laptop after laptop but is shifting resources away from the low-margin consumer PC business towards higher-margin business with better long-term prospects. I'd like to see GM do the same.

    The European business is a massive diversion of cash and talent. Meanwhile, old Europe is drowning in debt and austerity measures are likely to be pressed down across the board. A fundamentally weak economic backdrop in Europe makes the case for sustained investment there even more difficult.

    Is there a middle ground? Sure, and it doesn't need to make any hasty decisions -- though that is exactly the mentality that has led to this discussion today. Still, I think we'd all be deluding ourselves to say that a business unit that has consistently bled cash for more than a decade will somehow turn around in the face of a sovereign debt crisis. GM needs to make some tough choices here and, if nothing else, I'm glad to pour gasoline on the discussion.

  • Report this Comment On November 19, 2011, at 8:25 AM, TMFJoeInvestor wrote:

    @he784: So it sounds like we pretty much disagree on everything save that a buyback of some sort makes sense. :-)

    A few comments: Treasury's selling into the open market wouldn't help the stock price in the short-term, thus exacerbating the government's losses if they only sell partially. I suppose the government could spin a general tender as a positive, using it as a way to highlight that the stock is undervalued and the business is healthy. Though, ironically, if they didn't sell shares back into that their own stake in the company would increase, which would be counterproductive.

    You make a fair point on the dividend, but we're still too early in the ballgame for that. GM should manage its business for the long-haul, not rush to copycat all things Ford, including its dividend reinstatement. I'd still like to see the fiscal house in order before making a long-term commitment to shelling out cash to shareholders. I suppose a nominal dividend reinstatement would be marketable both by the GM and its largest shareholder (the government), though, and could pave the way for a higher exit price for the government. Still, given the pension shortfall and the stock's deeply discounted valuation it would seem that paying out cash isn't especially attractive.

    On pre-paying the bonds, that's an option. The rates (around 7%) aren't too usurious and the bonds will be paid off in due time, though. Speaking of the pension, I'm not sure that banking on a stock market recovery to shore up the pension is prudent and definitely isn't conservative, especially with low interest rates acting like a nail in heel. If GM lowers its return assumptions at the end of this year, which I'd wager it will given the state of both equities and interest rates, that gap will look even wider.

    In terms of marketing, we'll have to agree to disagree. GM is working to reinvigorate its brands, which are tired and have lost religion among consumers. Throttling back marketing spend would be counterproductive. I'm willing to accept a short-term hit to margins for a long-term improvement in brand perception.

    Big picture, we're ironically closer to agreement than not in that GM needs to put its cash to work. Even if we don't agree on everything, you make some great points and definitely added to the discussion! -- Joe

  • Report this Comment On November 19, 2011, at 8:50 AM, Kloris wrote:

    Opel is valuable in Europe. That is not really the subject of debate among Europeans.

    I just do not know why after all these years it is still a bleeder.

  • Report this Comment On November 19, 2011, at 2:52 PM, BobMichigan wrote:

    I love it when I see bright, informed comments like "Give Lutz a free hand", yeah ,there's a guy who knows what he is talking about....

    (PS, he has a free hand on the golf course, he is retired. It's actually been quite a while too.)

    As far as how great he was, pretty much all the styling at Buick is his now. Enough said.

    As far as the GM haters, we get it, quit wasting your time posting on GM articles it is getting old. Pretty much anybody too stupid to understand why the bailout necessary at the time it was done is too stupid to make enough money to be actually paying taxes. We get the UAW thing too. You are a Republican and unions are socialists and blah blah blah. The article is about how GM could improve and that is not going to happen in this place the rest of us call reality.

    As far as marketing, GM has FINALLY come up with campaigns that do not make me cringe, but they could do better. The Chevy ads are great, but do they really think anyone stops and stares at the Buicks?

    Long term, their #1 problem has been and continues to be the dealer network. They learned that lesson with Saturn and then forgot it.

  • Report this Comment On November 20, 2011, at 9:45 PM, skypilot2005 wrote:

    On November 19, 2011, at 2:52 PM, BobMichigan wrote:

    "Long term, their #1 problem has been and continues to be the dealer network. They learned that lesson with Saturn and then forgot it."

    Hey Bob,

    Thanks, for reminding us of Saturn. Another brilliant move by GM. I bet the service for those vehicles is great at your local Buick dealer.

    Hopefully, the bankruptcy court for Government / Generous Motors will set some money aside so you can get them serviced at a FORD dealer.

    Come on.

    Can't wait for your next round of "labels".

    Sky Pilot

    Republican, UAW / Socialist hater, etc. According to Bob

  • Report this Comment On November 22, 2011, at 10:37 AM, mzllrc01 wrote:

    Call me a cynic but why does anyone bother with GM stock?

    This stock has been rock bottom for decades and now after over $100 billion dollars in free bail out money there is still no positive performance. If this stock can’t show anything positive after that it never will.

    What’s the point?

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