In the latest string of events surrounding General Motors' (NYSE:GM) massive recall debacle, America's largest automaker was slapped with a new lawsuit that could cost the company more than $10 billion. The lawsuit seeks compensation for as many as 15 million car and truck owners who stand to lose roughly $500-$2,600 in resale value due to the negative publicity surrounding GM's vehicles. Let's take a look at this lawsuit, assess the big picture, and find out what effect it could have on the once, and perhaps still, troubled automaker.
First things first
Right off the bat investors need to understand that General Motors may not have to pay a single dime because of this lawsuit. When General Motors emerged from bankruptcy in 2009, it essentially became a different business entity. One of the stipulations provides protection for "New" GM, from accidents cause during "Old" GM's era, its pre-bankruptcy days.
It's unclear exactly how this lawsuit will shake out, but you can guarantee General Motors will be using this defense to claim zero responsibility for owners demanding compensation for their vehicle's lost value. With that in mind, let's look at the big picture and see how it all relates to General Motors as an investment.
What else is there to consider?
What we know for sure is that General Motors will take at least a $2 billion charge, split between the first and second quarters, for costs associated with repairing the recalled vehicles. We also know that General Motors agreed to pay a maximum possible fine, from the U.S. Transportation Department's investigation, of $35 million.
While that $35 million fine is chump change for General Motors, a more significant charge could be imposed by the U.S. government -- though, GM might be able to avoid it entirely.
Several years after Toyota's recall of roughly 10 million vehicles, due to unintended acceleration problems, the Japanese automaker recently agreed to pay a $1.2 billion settlement with the U.S. government. The settlement was a result of an investigation that proved the Japanese automaker purposely misled U.S. consumers and regulators about the acceleration defects in its vehicles.
Currently, it's unclear whether the Justice Department can or would attempt to impose a similar charge on General Motors. Gross incompetence, which is so far all that has been proven, is different than criminal intent to mislead consumers about defects, or a cover-up of the situation altogether.
Just to be thorough, let's examine what it would look like for General Motors if it lost some of these major legal battles.
How bad could it possibly get?
Even in terms of a potential worst-case scenario, which would have General Motors hypothetically paying $10 billion to the lost resale value lawsuit, as well as a charge from the Justice Department -- take Toyota's recent settlement for $1.2 billion as an example -- the once-troubled automaker still wouldn't be brought to its knees because of its massive cash hoard -- although it would suffer a huge blow.
Consider that General Motors ended the first quarter with a staggering $27 billion in automotive cash and marketable securities. In addition to its huge cash pile, General Motors also has a very strong total automotive liquidity of $37.4 billion. On top of those factors, GM was categorized as investment grade by Moody's Investors Service last year and would be able to borrow large sums of money at lower interest rates if it needed spare cash to further fund its operations.
Ultimately, looking at GM's charge associated with the cost of repairs of $2 billion so far, it's realistic to think that General Motors could end up paying the same grand total for its massive recall debacle as Toyota did: roughly $3 billion. Investors and consumers alike will know more when General Motors begins to process victims' claims regarding the faulty ignition switches in early August. More details are likely to come from Kenneth Feinberg, who is behind the creation of a GM compensation fund and has the full authority to establish compensation levels.
What investors should watch
Surprisingly, car buyers and the American public have seemingly brushed off the bad headlines about the company's recall woes. Consider that even during these past five months, when the most negative attention arguably would've been focused on the automaker, General Motors' sales are up 13%. Furthermore, last month was the company's best May sales result in seven years, and it was GM's best total monthly performance since August 2008.
If a consumer backlash hasn't negatively affected GM's sales thus far, it's difficult to imagine a scenario that would send them plunging now. That said, it would still be wise for investors to keep an eye on sales over the next quarter as victims' claims are processed.
Unfortunately, recalls of autos for various defects are a part of business in the automotive industry. As long as you're a long-term shareholder willing to hold while all the dust settles, and believes in General Motors' ability to remain a global powerhouse automaker, the costs associated with this recall shouldn't be a reason to sell. But investors should keep abreast of new information that may be damaging to the automaker further. Toyota went through a similar recall saga in 2009 and 2010 and bounced back strongly -- there's no reason General Motors can't do the same.