Monday, May 23, 2005

Full Throttle: Can Kerkorian Put the Motor Back in GM?

Aging billionaire set to become the third largest holder of GM
On May 5, Billionaire Kirk Kerkorian's investment firm Tracinda Corporation, which has extensive interests in DaimlerChrysler, MGM Mirage and a number of airlines, launched an aggressive effort to purchase 28 million shares of troubled General Motors at $31 per share. This move will double the firm’s stake in the automotive company to 50 million shares, or 8.84 percent, and position it as the third largest shareholder behind State Street Corporation and Capital Research and Management Company. Tracinda already owns 22 million shares that it acquired in April at $26.33 just above the 12 year low.
Tracinda’s surprise offer, 13% above the previous day’s close, reflects Kerkorian’s assumption that GM’s stock price is undervalued. According to Dave Cole, chairman of the Center for Automotive Research, the move focuses more attention on how much GM is undervalued at today's stock prices.
GM shares decreased through March on warnings that the automaker was consistently losing money in its core North American operations and in April, prices fell to a 10-year low following the announcement that the company reported a $1.1 billion loss in the first quarter. Following the news release, GM shares rallied to close at $32.80, up $5.03, and 60 million shares traded hands. This was the largest gain for GM in more than 40 years. Regardless, GM’s status was reduced to “junk”, which will increase borrowing costs.
Industry Analysis
Dismissing similarities to a failed 1995 hostile takeover attempt of Chrysler, Kerkorian insists that this robust acquisition is for investment purposes only and that neither he nor his firm are interested in asserting control over GM’s business. "Tracinda became aware of rumors over the weekend concerning its possible purchase of shares of General Motors stock," said the firm's statement. “Since Tracinda's acquisition of General Motors stock is solely for investment purposes, it decided to go forward with this tender offer to remove any uncertainty in the marketplace as to its investment intent.”
GM, on the other hand could benefit from restructuring and Kerkorian could reap significant benefits by forcing GM to lower bloated health care costs for union employees and retirees, and slashing excess manufacturing capacity. Notably, the reputable investor could sell off GMAC, GM’s finance division that earned $2.9 billion in 2004, which accounted for 80% of the company’s total earnings. "GMAC is worth itself more than the value of the company today," said Cole. "They have a power train operation that could be spun off as an independent company." UBS analyst, Rob Hinchliffe was quoted as saying “Kerkorian's stake can result in more forceful discussions with the union." The board and other shareholders will most likely welcome the increased leverage with unions and cost cutting measures that the acquisition will produce.
GM did not formally comment on Tracinda's provoking offer but insisted that its board and management are committed to enhancing shareholder value for all investors. However Kerkorian may become a thorn in the side of CEO Rick Wagoner, who recently assumed day-to-day oversight of the automaker's troubled North American automotive operations. Contrary to Kerkorian’s promise, he could continue to increase his interest and gradually exert more pressure on GM management to take more aggressive steps to cut cost and cultivate profitability. It is also speculated that other investors could also surface in the coming weeks, whereby igniting a bidding war. Some industry analysts believe that, despite any investor efforts, outside manipulation will only have a limited effect on the ailing automaker because of their depth of fundamental problems; lackluster growth, damaged brands, and mounting commitments to retirees.
Independent Outlook
Recent trends in the underperforming hedge fund industry have evoked fund managers to acquire larger percentages in weaker or mismanaged companies with the intentions of shaking up the leadership. As significant shareholders, these hedge funds can assert the pressure that is required to get the ailing companies back on track. Despite, Kerkorian’s comments, we believe that he has every intention of restructuring GM. Obviously, he will look to spin off GMAC as quickly as possible, but will look much deeper than that. We expect to see rigorous cost cutting in effort to streamline GM’s tumbling North American operations. Kerkorian, renowned for his tenacity, will not sit on the sidelines once the additional shares have been acquired.
The market also believes that a shakeup at GM is on the horizon. GM was downgraded this month on the assumption that bankruptcy was imminent and as a result, the firm was dropped from the Lehman Aggregate Bond Index. Concurrently, money mangers will be obligated to drop GM, because of its junk bond status, from funds pegged to an agg bond index. Interestingly, however, many managers have not started dumping the distressed debt – they believe that GM will be back on track and reinstated in the index by the end of June.
GM will most likely buck outside interference, but it is apparent the premise of third party influence is a primary driver of fruitful forecasts. It is certainly in the best interest of Tracinda to exert pressure and GM, in its own best interest should bow to the wisdom of the aging billionaire.

David H. Smith
Greg Watson
Troy Stalter


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