Rebirth: General Motors and Capital Structure Movements

Earl A. Poyser

Kaplan University

Unit 5

Professor Ana Machuca

October 9, 2012

Introduction

From the brink of absolute dissolving and dilapidation, General Motors has made impressive yearly strides that have come to symbolize a strong sense of perseverance, urgency, renewed purpose, and spirited fervor to restore capital structure to its original luster. GM Corporation is an American multinational automotive firm headquartered in Detroit, MI, and the world's largest automaker in 2011 by vehicle sales. It is basically the lifeblood and operational core of America's automobile manufacturing endeavors as well as a formidable ambassador fit enough to stand next to the elite entities of this crowded industry. Unfortunately, GM's standing as the perennial package of successful capital structure, business acumen, and profitability had taken a serious blow when the executives were compelled to request a government bailout in December 2008. GM, along with Chrysler and Ford, made the claim that without the financial aid from the government, the adverse effects on the already fragile economy would be exasperated beyond foreseeable recovery. GM had twice as many brands as needed, and twice as many dealerships, thanks to state franchise regulations. For them, the bailout was needed to restore the U.S. auto industry to international relevance.

"In order to fund its activities a firm typically needs some kind of funding. In financial language, the firm’s chosen set of financing sources is called its capital structure" (Byström, 2007). General Motors was, unfortunately, operating within the grips of financial distress. GM officially filed for bankruptcy protection on June 1, 2009, which gave the U.S. government 60% of it in return for $50 billion in funding to keep the company afloat while it was being revamped. Jobs, dealerships, and production were drastically cut in order to reconcile and justify the funneled in money. It was to also demonstrate to the taxpayers and government beneficiaries that the willingness to restructure a failed corporate structure was top priority in the bigger scheme of things. However, there are many naysayers who strongly believe that General Motors had brought this financial misfortune on themselves and should not have been thrown a lifesaver. "Many opposed the bailout, saying U.S. automakers brought their near-bankruptcy on themselves by not retooling for an energy efficient era, reducing their competitiveness in the global market" (Amadeo, 2012).

This concept explains the amount of risk General Motors would incur if not for the debt. It is basically the risk that is an intrinsic part of its operations, and this comes from the uncertainty about future operating profits and capital requirements. This held especially true for GM due to the fickle nature of the economy and lack of confidence in the vehicle performance when compared to outside competitors, which was evidenced in their declining sales. Lately, overall global sales volume ascended "7.6% to 9 million for the year, enough to allow it to recapture the global sales title it held for 77 years before it fell behind Toyota Motor in 2008. Revenue rose 10.8% to $150.8 billion" (Isidore, 2012). However, their bloated cost structure, including unaffordable U.S. labor contracts, and a drawn out decline in market share soon sent the company to utter demise. Economic downturn throughout the nation contributed greatly to the struggles of this company because demand variability is more directly affected in the auto industry than many of the nation's businesses. People will be more willing to forego purchasing a car, minivan, van, or truck than food or home utilities. But to truly understand the mismanagement of business risk for General Motors prior to their bankruptcy filing, one has to be made aware of the five major reasons for this, which were: (1) bad financial policies; (2) uncompetitive vehicles; (3) ignoring competition; (4) failure to innovate, and (5) managing in the bubble.

There is a great amount of financial experts who are not quite sold on the dispersing effect of the government bailout as it relates to GM's stockholders. There is a strong belief that the money now owed to the government will put a constraining burden on the funds subsequently meant for shareholders. This illustrates the concern: "The Government bailout of General Motors has not, and likely will not benefit past common shareholders because the old General Motors Company no longer exists and trading of shares in the old General Motors was halted on July 10, 2009. This is because common shareholders are among the last beneficiaries in the bankruptcy process and compensating them would have required liquidation of the company that was ruled against in the July 5th bankruptcy court proceeding.

One of the important factors in a company like General Motors moving toward an optimal capital structure is to uncover the amount of debt financing that maximizes the value of operations. This is the capital structure that also escalates shareholder wealth and intrinsic stock price. The $80 billion borrowed from the government has been reported to not only being fully paid back, but GM has also been said to have actually made profit. Some of the money was repaid in cash, while the remaining interest was tied up in equity shares held by the government. “Both Chrysler and GM slashed costs and unloaded debt in the process, and the US treasury has thus far recouped about 50 percent of the loans and grants made to the two companies as well as suppliers and finance institutions.  The loans were either repaid in cash, or through equity shares Uncle Sam negotiated beforehand. The U.S. government holds a little more than 500 million shares of General Motors stock” (Max, 2012). Such figures ultimately encourage shareholders to invest in the dually responsible and profitable General Motors. The managers have seemingly wised up from their troubled past due in large part to pressures from disgruntled American consumers and the competition that had surpassed them in inventory sales.

In their restructuring plan for long-term viability dispatched to the U.S. government, General Motors acknowledged the errors that led them to their temporary misfortune. The Chapter 11 intervention has allowed GM to pursue a major overhaul of its business model and capital structuring as well as expediting the production of fuel-efficient vehicles. They have also engaged in manufacturing consolidation by making the agonizing yet necessary decision to downsize their workforce and discontinuing nameplates like Saturn, Pontiac, Hummer, and Oldsmobile, which has ultimately freed up their operative abilities toward an effective global initiative. Obviously, the return to past glory is still being engaged while still trying to appease weary shareholders and potential consumers. The signs of recovery can be seen in DBRS, Canada's largest credit rating agency, upgrading GM to BBB (low) from BB (high) and the much improved profit margins, "with $27 billion in net cash, and strong cash flow" (Muller, 2012). GM continues to uphold its balance sheet and pay back its debt (5 years ahead of schedule), which by all accounts demonstrates a harmonious accord of capital structure decision making.

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