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Why GM is a Buy

Companies / US Auto's Nov 18, 2010 - 06:15 AM GMT

By: Money_Morning


Best Financial Markets Analysis ArticleJack Barnes writes: If you are one of the millions of retail investors who found themselves totally out of luck on the General Motors Co. (NYSE: GM) initial public stock offering, don't fret.

Although the GM IPO is over, the profit opportunity has just begun.

The incredibly oversubscribed GM IPO may well have been the biggest stock offering in global history. But I believe that this stock has plenty of room to run.

In fact, I believe this is a stock that you'll want to buy in the aftermarket - provided that you follow some very strict guidelines for share prices and timing.

Let me explain...

Bullish Fuel
The new GM shares, which are to begin trading today (Thursday), have been priced at $33 per share.

The stock should do well over the coming months, as global sovereign wealth funds mop up shares with some of the U.S. dollars they have generated from selling U.S. Treasuries and agency debt of late.

It's this mopping-up process that will give traders a chance to make a few dollars. Here is how we can join the ride, without being a hostage to holding locked up shares.

When I examined this deal, I discovered eight potential catalysts that, when combined, are all-but-certain to guarantee strong demand for GM in the IPO aftermarket - and for months to come. From my own research and from my own sources, I discovered that:

•SAIC Motor Corp. Ltd., China's largest carmaker, was reportedly in talks to invest $500 million or more for a possible stake in GM. There's strong investment interest from China's government, most likely via some of Beijing's hefty sovereign wealth funds.
•Goldman Sachs Group Inc. (NYSE: GS) closed its books early, meaning investors who didn't get shares in the initial offering will have to seek them out in the aftermarket.
•UBS AG (NYSE: UBS) doomed retail Americans from participating, further ensuring retail demand in the immediate aftermarket - and for months to come.
•U.S. institutional investors want these shares, and will be buyers in the days and months to come.
•The same is true of global sovereign wealth funds - which are with cash from huge trade surpluses and other sources. They, too, will be big buyers in the aftermarket. Once the IPO is finished, investors in China and the Middle East will reportedly control 4% or more of the U.S. carmaker.
•A big boost in demand for preferred shares underscores that the newly public GM will have a stronger-than-expected corporate balance sheet.
•Thanks to the so-called "fresh-start" financial reporting used by companies in Chapter 11 bankruptcy reorganization, GM will have $30 billion in good will to put to use - a development that could have major implications for the carmaker and its finances, depending on how it's taxed in the future.
•And last, at $33 a share, GM would trade at 7.8 times earnings, based on its net income from the first nine months of 2010, compared to Ford Motor Co.'s (NYSE: F) share price of eight times estimates for 2010 profits.
Let's look at several of these more closely.

Heightened Demand
In my opinion, the GM IPO will be a success due to international economics, as well as the ongoing currency wars - the so-called "race to the bottom" that's right now playing out in global exchange markets. General Motors is still an international company, meaning there is a large worldwide base of potential investors out there who are ready and willing to put their cache of U.S. dollars to work.

Through SAIC and through China's sovereign wealth funds, Beijing will end up with a big stake in GM. With its typical long-term view, the Chinese government clearly wants to use GM as a pipeline to export Chinese-made small cars into the U.S. market under the GM nameplate. That will negate the need to overcome anti-China sentiments among U.S. consumers.

This interest from China is representative of the better-than-expected demand that yesterday prompted GM to boost the common-stock portion of the IPO by 31%. The number of common shares to be sold rose from 365 million shares to the new total of 478 million shares. The projected IPO price also increased, from an initial range of $26 to $29 per share to $33 each.

Investor demand also pushed up the number of preferred shares GM planned to offer - to $4.6 billion worth from $3 billion.

With all these adjustments, GM is looking at raising $15.8 billion from common stock sales, and an overallotment and sale of preferred shares could push the total to $22.7 billion - making it the biggest IPO in global history.

These are all signs of real demand for the shares. And there are a number of benefits here, not the least of which is that GM will be able to apply some of the money to its pension obligations.

But thanks to some of the pre-IPO maneuvering, the interest in GM shares will continue into the post-IPO aftermarket - and for months to come after that.

Last week, Goldman Sachs announced that it was closing its portion of the offering three days early due to extra demand for shares. As a former hedge-fund manager, I have to confess that it's been awhile since I remember a book runner closing its book a week before the shares start to trade. This is a key "tell" for the real underlying demand for GM shares.

The latest soap opera event involving the GM IPO came when UBS - a major bank - was thrown off the book-running team. It seems an analyst sent out an e-mail blast to about 150 clients and internal contacts breaking down their view of the internal metrics of "Government Motors." This happened during the quiet period. And it's a major "no no."

Unfortunately, this transgression has resulted in the mainstream retail investor largely being locked out of the IPO. You see, UBS was part of the lineup of banks that were offering shares, which has doomed any investor who wanted shares at The Charles Schwab Corp. (Nasdaq: SCHW), TD Ameritrade Holding Corp. (Nasdaq: AMTD) and E*Trade Financial Corp. (Nasdaq: ETFC). Any retail investors who conducted most of their trading on the Web with these brokers will now have to buy their shares in the open market.

The end result: There will now be a real retail market for GM shares after trading begins.

An Improved Business
Earlier this month, General Motors reported a $2.16 billion profit for its third quarter - the third straight quarterly profit for the carmaker. It remains on track to report its first annual profit since 2004.

The once-bloated GM says that its restructuring will enable it to compete in today's tougher car market. Company executives say it can now turn a profit with a 19% market share of a U.S. car market operating in the narrow window of 10.5 million to 11 million units a year.

Before that, GM needed to have a 25% market share with annual sale of 15.5 million cars, GM Chief Financial Officer Chris Liddell told prospective institutional investors during a video presentation that was part of the IPO "roadshow." GM has slashed U.S. hourly labor costs to an estimated $5 billion this year, from $16 billion in 2005, Liddell said during that road show presentation.

If that's truly the case, then GM could be packing a hidden punch for its new shareholders. According to a forecast by Scotia Economics, U.S. auto sales hit 12 million units on a seasonally adjusted annualized rate last month - up from 11.3 million cars through the end of September.

The rest of the forecast: North American sales could advance to 13 million units in 2013 and rise to 18.5 million units later in the decade.

GM has also established a very nice beachhead in overseas markets - and especially in China, which is now the world's No. 1 vehicle market.

GM recently overtook Volkswagen AG (PINK ADR: VLKAY) as the No. 1 foreign-selling brand in China. What's more, GM will sell more vehicles there this year through its partnership with SAIC than it will in its home U.S. market. recently estimated that the fair value of GM's stock is about $44 a share.

Although the ‘Government Motors' stigma is likely to hang over General Motors - and while the process has been painful, and more than a year in the making - GM comes back to the U.S. stock market a truly changed company. It has dropped billions in liabilities. And its bondholders were given a haircut unseen before in modern case law.

The company that is being brought back to the market is better prepared to be an international manufacturing powerhouse than its pre-bankruptcy predecessor.

Will it be the largest or the best ever again? I don't believe so. However, that does not mean it won't be a successful equity investment for a patient investor.

What happens next is up to management of General Motors. But this is one investment I don't believe that investors should let pass by.

Just make sure to be patient - both in the price you pay, and in the time you give this investment to work out for you.

Action to Take: Unless you have a major account with a full-service broker, you are not going to be holding any of the newly offered GM shares. This should make the trading of the stock a bit interesting, since U.S. retail investors will have to buy the shares in the IPO aftermarket. I believe that this fact alone should be enough to keep the shares rising in the near term. So how should you play it? Let's consider two strategies (**). The first one is fairly basic, with steps taken to manage risk and the potential for a nice return. The second approach is a bit more aggressive, but it also manages risk and offers a higher return and the potential for some income to boot, in return for that extra effort.

With either strategy, the starting point is the same: Based on the size and makeup of your portfolio, determine how big a position you'd like to have in the shares of the new GM.

Strategy A (The All-Stock Strategy): With that determination completed, let's look at the first strategy, which is an all-stock play for GM's shares. We will want to get our whole position in as early as we can. This stock appears to have a profitable buying pressure built into it for a while. Let's look to buy our intended position with a "limit order" of less than $35 per share. The stock is going to be volatile in its early trading. We don't want to let the market makers earn their holiday bonus too soon - and definitely not at our expense. So let's be patient and use limit orders that are 50 cents below current market prices to get our fill.

Strategy B (The Two-Step Strategy): With our second strategy, let's look to buy half of our intended position - again with a "limit order" of less than $35 per share. Again, given the volatility that I expect, let's be patient and use limit orders that are 50 cents below current market prices to get our fill.

Use the other half of our desired position to write "naked put options" (known in Wall Street parlance as "naked puts") on GM shares once a liquid options market has emerged. Write these puts for a price that's about 5% out of the money, and use the case to build up a synthetic dividend yield for this position. Writing naked puts means that we will be paid a small cash payment for providing downside insurance or exposure. If the stock pulls back beyond our strike price, we will have the shares placed in our account. If the stock is above our strike, we will pocket the cash premium.

When GM shares experience a pullback, as they inevitably will, we will use that opportunity to have the shares placed in our account. That's because, having written the naked puts, we are exposed to being required to purchase the shares at any trading price below our strike price. Until that time, GM can generate a cash yield for your portfolio each quarter with a series of naked puts written 5% out of the money. With sovereign wealth funds, U.S. institutional retirement funds and now most U.S. retail investors having been locked out of the IPO itself, GM's newly minted shares will find a steady supply of new buyers in the open market.

Indeed, it is this institutional demand that will help propel GM's stock price to a point where the U.S. government (and the taxpayers) will not only break even on its investment, but could actually turn a handsome profit over the long run.

(**) Special Note of Disclosure: Jack Barnes holds no interest in GM or any of the companies listed in this article.

[Editor's Note: In a two-part investigative series that appeared in June 2009, Money Morning predicted that General Motors would rebound and become a U.S. investment success story. We even correctly predicted many of the catalysts.

If that's the kind of market intelligence you demand, and you wish to receive it on a regular basis, then The Money Map Report is for you.

This monthly advisory service - an affiliate of Money Morning - employs many of the same experts whose columns you read here each day. The difference is that The Money Map Report's straight investment analysis. Our writers use proprietary money-flow indicators to identify and isolate the most timely profit opportunities you'll find anywhere.

For more information about The Money Map Report, please click here.]

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