GM's $8 Billion Problem

For all of the ranting I do over the ridiculousness of the "decrease in earnings" arguments regarding expensing employee stock options, it would be disingenuous of me not to start out this article by noting the following: What we're talking about here are accounting, not economic, changes. General Motors (NYSE:GM) is not going to lose money based on an accounting change. Its cash flow will still be similar, if not identical, regardless of this issue.

But GM isn't all that excited about having to wipe away 14% of its reported earnings per share, either. So the company has come up with a plan to counteract the impact to its reported earnings should a proposed accounting rule go into effect as expected.

Here's the deal. When you read a company's earnings per share, that share count contains a number of different things: Actual shares, options that are in the money, and potential dilution from warrants and bonds with a stock conversion element, known as "convertible bonds." What has not been included to date is dilution due to what are actually stock-bond hybrids, so-called "contingent convertible bonds." Unlike convertibles, which have an embedded option to convert at a preset strike on the price of the bonds, contingent convertibles can be converted only when the company's stock price exceeds the conversion price of the bond for a predetermined period of time.

One of the attractive things about "CoCo" debt is the very fact that it avoids impacting diluted-share counts. But this seems very likely to change, and for a company struggling in a market beset by overcapacity and economic losses, even the appearance of a decrease to the bottom line is tough to swallow. So GM announced yesterday that it had come up with a plan to dull the impact of an accounting change for CoCos: GM will waive the right to convert to stock (the conversion is at GM's option) on at least the principal amount and use cash instead of stock as the instrument of conversion. This would apply to its nearly $8 billion of CoCos.

Other companies that have large amounts of CoCos include Merrill Lynch (NYSE:MER) and Lear Corporation (NYSE:LEA).

GM relied heavily on CoCos this past year when it raised money to fund its cratering pension fund. At the time, I noted that GM's pension liabilities far exceeded the implied value of the company and that the debt GM raised wasn't going to capital projects but to fund its obligations to retiring and retired workers. Which it absolutely should do, of course -- they are obligations. But in an environment where the Big Three -- GM, Ford (NYSE:F), and DaimlerChrysler (NYSE:DCX) -- are offering thousands of dollars of incentives to bleed down their massive inventories, real economic profits continue to be scarce. Of the list of things that GM is facing, this CoCo issue should barely be considered. But because of its outsized impact on earnings, unfortunately it is front and center.

Hey, two takes on GM in one day! Take a look at Rick Munarriz's Car Buyer's Market. Also, Brian Gorman looks across the pond in Toyota Stays Practical.

Bill Mann owns none of the companies mentioned in this report.