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Stay Away from GM IPO... for Now

Written By Brian Hicks

Posted November 15, 2010

Stay away from the Government / General Motors IPO this week… at least until the government is out of the equation. As long as shareholders come second to political priorities, it’s not worth the investment.

But before we share what we’ve found on the GM IPO, let’s look at what else is hitting the IPO trail this week.

Caesars Entertainment (CZR), a casino entertainment provider, is offering a $980 million IPO with a market cap of $5.4 billion. It’s looking to IPO this Friday with a mid-point price of $15. The balance sheet looks weak here with $20 billion of debt. Do not buy.

LPL Investments (LPLA), a brokerage and investment advisory service, is issuing a $450 million IPO with a $3 billion market cap. It’s looking to price around $28.50 on Thursday.

Booz Allen & Hamilton (BAH), a US government consulting service, will start trading on Wednesday with a $252 million IPO and a market cap of $2.1 billion, around $18.

Aeroflex Holdings (ARX), a global provider of radio frequency, will start trading on Friday with a $254 million IPO and a $1.2 billion market cap around $14.50. According to reports, this company has a record of losing money.

Bitauto Holdings Limited (BITA), an Internet content and marking services provider for China’s auto industry will IPO on Thursday with a $113 million IPO, and a market cap of $454 million around $11. According to a report, it “looks like a leader in China’s fast growing Internet-based automobile advertising market sector. With a 64% gross margin, BITA’s bottom line could benefit significantly from (potential) rapid increases in top line revenue.”

As for Government / General Motors, here’s more from NPR:

“General Motors executives are playing up three bright spots in the company’s future as they try to persuade investors to buy GM stock: a better lineup of cars and trucks, potential for global growth and a new cost structure that enables the company to make money even when the economy dips.

But the world’s most charming used car salesman couldn’t cover up major concerns hanging over GM’s initial public offering on Thursday.

GM emerged from a government-organized bankruptcy just 16 months ago, a process the company says has made it stronger and healthier. The reorganization erased debt and lowered labor costs. It also removed $27 billion from the wallets of bondholders and left stockholders with nothing. Taxpayers spent more than $50 billion to save GM from ruin between December 2008 and July 2009 and are not expected to get all their money back.

Critics say GM is speeding into its IPO before it has proved that its structural problems are fixed. Other IPOs often leave the investing public a little slap-happy: Each newly minted stock certificate could turn into the next Walmart or Apple, but it’s rare that one does.

Here are some reasons investors may want to sit this one out:

GM Is Still Government Motors

You might find the nickname clever, but inside the company, it’s an embarrassment and the driving force behind the decision to hold the IPO as early as possible. GM wants the government to sell off its shares.

“We want the government out. Period,” Chairman Ed Whitacre said this summer. But the IPO process will be more like a drawn-out divorce between GM and taxpayers. This stock offering will only reduce the government’s stake in GM from 61 percent to 43 percent. It will take more stock offerings, staggered over the next few years, before the U.S. government is out of the car business.

For shareholders, that means GM may not always put investors first. Political priorities may trump their demands. Some worry GM will spend too much time and use too many resources working on small cars or electric cars and not enough on profitable vehicle lines like trucks and SUVs.

The stock offering “is entirely cosmetic,” says Logan Robinson, a law professor at the University of Detroit Mercy who has worked as legal counsel at Chrysler and automotive supplier Delphi. “The government is absolutely going to call the shots, even if they are below 50 percent.”

Before handing over bailout cash, a task force convened by President Barack Obama wrote in contract provisions forcing GM to use the money in ways the government approved. Some of those provisions, including executive compensation and U.S. production levels, are locked in until 2014.

Even if the Treasury were to sell every share it owns in GM, its influence and power would remain.

The top two executives, Whitacre and CEO Dan Akerson, were picked by the government. Three other directors, David Bonderman, Robert Krebs and Patricia Russo, were also chosen by the government to sit on the 13-member board.

“Where do these board members’ and executives’ priorities lie — is it with the administration, or is it with the shareholders?” asks Linda Killian, founder of Renaissance Capital, which analyzes and invests in IPOs. That question is “sitting there like an 800-pound gorilla, holding stock.”

Years Of Fuzzy Math Still Not Fixed

GM admits it doesn’t have great control over its finances. It said so in a long list of potential risk factors spelled out in its stock registration statement with the Securities and Exchange Commission.

That should be troubling to investors, who need reliable financial disclosures to figure out how much a stock is worth.

In its recent IPO filing, GM said it’s been working on improving its accounting procedures, but as of June 30, “our disclosure controls and procedures were not effective at a reasonable assurance level.” In other words, it’s not there yet. Although many risk factors listed in an IPO filing are standard, only companies that have a track record of financial mismanagement tend to confess that more problems could pop up.

GM’s most recent admission is not the first time the company has said its finances are sloppy. GM has a history of financial irregularities: The company admitted major mistakes five times from 2005 to 2009 and had to restate earnings for a variety of reasons, like misstating pension accounting and booking questionable transactions with its supplier, Delphi.

Since 2006, GM has promised three times that it would fix its accounting irregularities. The impact of those restatements was minimal, but eventually the company slid into bankruptcy because of a host of other problems. Once they began diving into the company’s books, members of the government’s autos task force said they were shocked how little GM knew about its own finances.

GM has a new chief financial officer, former Microsoft executive Chris Liddell, a hard-charging executive who’s known for making changes. But GM may still have a problem.

Questions have arisen over the company’s decision to book $30.2 billion in goodwill as an asset, even though goodwill isn’t something the company can sell, use to invest in new products or help improve its business any other way. It also counts as a bigger asset on the books than all of GM’s property ($18.1 billion) and its cash ($26.8 billion).

Goodwill is usually created when an acquiring company pays more than the book value for the assets of a company it’s buying. It only becomes an issue for investors if the acquisition turns out to be a dud and the acquirer has to take what’s known as an impairment charge to write down the value of the goodwill account. That reduces reported earnings.

In GM’s case, the opposite might happen — it could be forced to reduce its goodwill and take an earnings charge if its financial picture improves. How is that possible? The accounting specifics are arcane, but the short answer is that accounting rules allowed it to pump up the value of potential tax-loss credits it could use to offset future taxable income precisely because its earnings outlook going forward is so cloudy. A similar approach was used in valuing employee benefits it’s on the hook to pay.

The upshot is that if GM is as successful as its executives hope it will be, goodwill-related charges to earnings might be a recurring and unpleasant surprise for shareholders. “It’s another reason why I would not personally think it’s time to invest in GM,” says law professor Robinson.

Meet GM’s New Stepbrother, The UAW

The United Auto Workers union has gone from a drag on the company to a part owner. How the new relationship will play out is still unknown.

The UAW owns 17.5 percent of GM right now, and has the option to buy 2.5 percent more before the end of 2015. It could sell stock during the IPO or hunker down and remain a major player.

But arguments over wages will likely start cropping up, and will become even tougher to deal with as GM talks about how financially secure the company is now.

The biggest grumbling among autoworkers is the new two-tier wage system, under which some workers can earn $29 an hour and new hires get only half that. It’s a system that makes shareholders and executives happy because it brings labor costs in line with non-unionized workers at Toyota and Honda plants in the South. But it could spell trouble for GM if the new wage system creates unrest with workers.

“It’s hard to run a business where some people are making double what others are making for the identical job,” Robinson says.

Besides the wage issue, there is mounting pressure on the UAW from its members and from other unions to demand that benefits lost during the auto crisis be restored.

“The three major US (auto) companies are making profits again . we demand that they do right by the workers who have done right by them,” Richard Trumka, president of the AFL-CIO, said in a speech at the UAW’s major convention last summer. “Because just as there has been shared sacrifice in periods of pain, there must be shared prosperity in periods of gain.”

Electric Vehicles Aren’t A Savior

After a decade of selling Hummers, GM must change its image and become greener. It’s heading in the right direction: The Chevrolet Volt, which can go 40 miles on battery power alone, will debut in showrooms next month.

But there’s no guarantee GM can afford to continue to invest in electric vehicles or other green technologies. And much like the Toyota with its Prius, GM probably won’t make money on the Volt until the third or fourth generation. It was a gamble Toyota was willing to make because the company believed hybrids would catch on eventually, and having the first fully functional hybrid would give Toyota a green image with consumers.

GM is betting the Volt will provide a similar kind of green halo over its cars.

The company is waiting for approval on an application for $14.4 billion from the Energy Department to help renovate older plants to make fuel-efficient vehicles. That money may never come, GM says. Its first application for the funds was made before bankruptcy, and was denied because the Energy Department said GM couldn’t prove it was a viable company.

“If our future operations do not provide us with the liquidity we anticipate, we may be forced to reduce, delay, or cancel our planned investments in new technology,” the company says.

In the days leading up to GM’s New York Stock Exchange debut, investment bankers say they have more orders than stock. Joe Phillippi, president of AutoTrends Consulting, says he expects GM’s IPO will price even higher than current estimates — up from a range of $26 to $29 a share to as high as $32 a share.

But even if the stock pops on the first day of trading, the red flags aren’t going away.

Phillippi expects company will continue improving as time goes on. “It’s going to be a slow and steady march back upward,” Phillippi says.”