Written by Sinclair Noe   

Maybe GM is Just Too Stupid to Exist
by Sinclair Noe
Eatthebankers.com


General Motors' approval this week of a new $5 billion buyback plan will likely delay one of its important goals: achieving a top-tier credit rating. Standard & Poor's and Moody's analysts say the carmaker's next upgrade could be delayed due to its new capital allocation plan. The buyback scheme was pushed by an activist investor, Harry Wilson, and even if it doesn’t make the company stronger, it might make the shareholders more money, or not.

The intentions of a share repurchase plan are simple: to “return capital to shareholders” by spending money in a way that makes the stock go up and shareholders wealthier as a result. The primary idea is that buying back existing shares decreases the supply of outstanding stock, and gives existing shareholders a bigger piece of the company. Each dollar of earnings is spread among fewer shares, meaning that each share should be more valuable. But stock buybacks aren’t all they’re cracked up to be.

For example, ExxonMobil bought back more than $13 billion of its own shares last year. The price of oil went down and ExxonMobil share price dropped about 9% in 2014. Another example is IBM; they bought back more than $13 billion of its own shares last year and the share price underperformed the broader S&P 500 index by about 25%. Not much of an advantage. The problem with IBM is that the one-time tech giant isn’t doing anything very innovative, and a buyback scheme can’t cover that flaw.

General Motors announced today that, beginning with the 2016 model year, they will cut the warranties coverage on Chevrolet and GMC vehicles. The new warranties will be five years or 60,000-miles on the powertrains, including courtesy transportation and roadside assistance, down from five years or 100,000 miles. Free maintenance will drop to two visits within 24 months, from four.

GM issued a statement that said: "We talked to our customers and learned that free scheduled maintenance and warranty coverage do not rank high as a reason to purchase a vehicle among buyers of non-luxury brands. We will reinvest the savings we will realize into other retail programs that our customers have told us they value more than these."

We don’t know what retail programs they intend to reinvest in, but we do know they plan to invest $5 billion into a stock buyback plan. And that goes against the published research on warranty coverage. According to a study published in the Journal of Business Research curtailing warranties is bad for business. The study found that: "Warranty improvements signal improved vehicle quality and lower maintenance costs. Warranty curtailments signal the opposite.'' The authors note that "Korean manufacturers' share of the U.S. market quintupled from 1% in 1996 to 5% in 2006. Much of the credit for this increase has been attributed to restyling, lengthened warranty, and improved quality." And cutting warranties results in a 24% decline in market share growth.

The study finds that if you want to sell more cars, restyling gives you the biggest bang for the buck. In other words, build a better car, give it a strong warranty so people know you are confident that it is indeed a better car, and people are more likely to buy it. Sounds like common sense.

Now, keep in mind that GM is still dealing with claims of defective ignition switches that resulted in crashes that killed 64 people and 1571 other claims are in for injuries. The executives at GM knew for 13 years that their cars had a defective ignition switch that would, well, kill people. But they did a "cost-benefit analysis" and concluded that paying off the deceased's relatives was going to be cheaper than having to install a $10 part per car. They then covered up their findings and continued to let millions drive around with the defective part in their cars.

So, in the real world, GM must now deal with the death and injury claims; they could repair all the defective switches so nobody else dies; they could make sure there are no additional killer design flaws; they could invest in R&D to build a better car, a car that looks great, runs more efficiently, is safer for the drivers, and is so reliable that they could increase the warranty with confidence – or – they can kowtow to one activist corporate raider and gamble $5 billion on a stock buyback scheme that may or may not pay off; and in the process, they are destroying their own credit rating and hamstringing liquidity.

About 7 years ago GM was on the verge of collapse. Back then we had high oil prices and the Big Three US automakers were stuck making big trucks and SUVs and when oil prices jumped, buyers developed an aversion to gas guzzlers. GM was slow to respond and soon they were bleeding cash. They turned to Uncle Sugar for a bailout, to the tune of $49 billion. GM was essentially nationalized. In December 2013, Treasury sold its last GM shares. According to a tally by the US Treasury, taxpayers lost $9 billion on the U.S. government's automotive industry rescue program. According to another study by the Center for Automotive Research, a couple of million jobs were saved and the government "saved or avoided the loss of" $105 billion in lost taxes and social service expenses, such as food stamps, unemployment benefits and medical care. Of course there were some vendors that got stiffed by GM in bankruptcy. And it might have been cheaper to just give every GM worker a check for $250,000 and tell them to make the most of it.

We could debate whether the bailout was good or bad, but the bottom line is that GM is still around and now they are profitable, at least for Harry Wilson. The bad thing is that they didn’t learn from their struggles. They aren’t setting aside money as a cushion for a rainy day; they aren’t taking the $5 billion for stock buybacks and investing in R&D and innovation and better, safer cars. They didn’t learn any lessons about how to serve their customers, how to treat their employees and vendors, or how to show gratitude for the country that saved their bacon. And so, if GM ever finds itself in the same situation as they were in just 6 short years ago, the debate should not be about whether there should be government intervention or not, we could just look back on their decisions of the past week and we could all agree that GM was too damn stupid to exist.