After receiving a massive government bailout and undergoing a bankruptcy restructuring during the 2008-2009 financial crisis, General Motors (NYSE:GM) went public again in late 2010. By the time of its IPO, investors were enthusiastic about the "new GM." Strong demand for GM shares made its IPO the largest ever at the time.
However, it's been a rough ride for GM shareholders. Whereas the S&P 500 has gained more than 75% since the GM IPO, GM stock has barely budged. In fact, just a few weeks ago, GM stock traded for less than the $33 IPO price.
GM's sluggish share price performance has finally attracted the attention of activist investors. Harry Wilson, one of the architects of GM's bailout, recently informed GM that he will nominate himself for the company's board this year with the backing of several hedge funds. This sets the stage for a big fight between GM's management and its critics in 2015.
What went wrong?
To understand the tension between management and investors, it will be helpful to look at the causes of GM's poor share price performance over the past few years.
The first headwind to arise was the European sovereign debt crisis that began in 2011. Going into the year, GM had planned to break even in Europe, excluding restructuring costs. The company abandoned this goal in late 2011 as Europe tilted back into a recession that ultimately lasted for five quarters.
By 2012, GM's pre-tax loss in Europe had swelled to $1.8 billion, becoming a significant drag on overall company profitability. GM is still losing money in Europe today, although it hopes to be profitable there in 2016. (That said, instability in Russia and Greece may be giving investors an uncomfortable sense of deja vu.)
A second pain point for investors was the weak market reception of the redesigned 2014 Chevy Silverado (and its twin, the GMC Sierra). In late 2013 and early 2014, as dealers switched to selling the new models, GM lost share in the lucrative full-size pickup market.
While GM earned higher margins on the new pickups, that didn't mollify investors. One auto analyst called the Silverado/Sierra launch "arguably the least successful large pickup launch over the last 15 years."
Last, GM was rocked last year by a series of recalls that ultimately totaled about 27 million vehicles in the U.S. alone. (The previous one-year record for the entire industry was 30.8 million.) These recalls have already cost billions of dollars, and GM could be on the hook for much more if a federal bankruptcy judge allows owners of defective "old GM" cars to sue the company for injuries and loss of value.
What the activists want
One of Harry Wilson's key complaints is that GM stock is undervalued because management has not provided enough clarity on how it will meet its financial targets. He also asserts that the company has not moved fast enough to improve its profit margin.
But as Mike Colias of Automotive News recently observed, Wilson seems to be saying the same things as GM's top executives on many topics, such as the importance of improving supplier relations and boosting international profitability.
Thus, while Wilson wants GM to move faster and explain its interim goals more clearly, the main point of dispute has been his capital allocation proposal. Wilson and his hedge fund backers want GM to dip into its $25 billion cash pile to buy back $8 billion of stock by mid-2016.
For the moment, GM is pushing back against this proposal. Last week, the company disclosed that it is working with Goldman Sachs and Morgan Stanley to formulate a response to Wilson's big buyback proposal.
GM's performance is already improving
The ironic thing about activist investors' current interest in General Motors is that the company is already on the upswing. For example, the company's North American profit margin is surging, showing that customers are looking past GM's recall woes. Indeed, demand for GM pickups has finally taken off, driven by falling gas prices and a shortage of Ford F-150s.
Strong sales of GM's highly profitable pickups and large SUVs should continue to boost the company's North American profitability in 2015.
GM will still lose money in Europe this year, but it closed an assembly plant in Germany in December, reducing its cost base. GM will also introduce redesigned versions of the Corsa and Astra for its Opel and Vauxhall brands this year. These two models represent about half of GM's European sales volume, and the new models should command higher prices than the outgoing versions.
As a result of these factors, analysts are (on average) expecting GM's EPS to rise nearly 50% in 2015. This suggests that -- at least among the analyst community -- GM still has credibility, despite missing some targets in the last few years.
GM has also already committed to returning capital to shareholders. Earlier this month -- before Wilson proposed the $8 billion share buyback -- GM announced plans to raise its quarterly dividend by 20% to $0.36.
CFO Chuck Stevens also suggested that GM will return more cash to investors once it gets clarity on its recall-related obligations, which could include a hefty government fine and additional legal reserves.
Even if Harry Wilson wins a seat on the GM board, the company isn't likely to cave in to his buyback demands. GM is worried that it will lose its investment-grade credit rating if it commits to a big buyback before knowing how much it will need to pay to settle its recall obligations. That would raise borrowing costs for its financing arm, GM Financial.
But GM won't need to fight off Wilson and his backers for long. By the fall, if GM is on track to exceed its $20 billion to $25 billion automotive cash target, its management and board are likely to consider a buyback. It's important to remember that the company is not "anti-buyback" on principle -- a few years ago it used $5.5 billion to buy back stock from the U.S. government.
As a result, the most likely scenario is that GM will be in a position to make a counteroffer -- perhaps a smaller buyback of $4 billion to $6 billion -- in the not too distant future. The two sides may meet in the middle or GM might decide to unilaterally implement a buyback of its preferred size.
If GM does this, and if it can meet its key 2016 objectives -- a 10% pre-tax margin in North America and a return to profitability in Europe -- investors won't have much left to complain about. As long as GM keeps its business on track for the next two years, activist investors are likely to take their profits and move on to new targets.