Thursday, May 05, 2005


Apocolypse Right Now

GM and Ford got cut to junk-bond status by Standard & Poor's today. This, my friends, will someday be viewed as the Beginning Of The End. I'm not sure what that "end" looks like just yet (if I knew that, I wouldn't have an engineering day job and a crappy little blog on the side), but my guess is that there's perhaps 2 or 3 automakers too many in the market right now.

The markets felt the impact, of course, but not as much as I figured - the Dow dropped just a bit less than half a percent. Either the significance of this event went unnoticed, the markets already expected such an event, or I'm blowing this whole mess out of proportion. You're welcome to draw your own conclusions, 'cause I'm a bit mystified. Just keep in mind this fact:

Between them, the two auto giants have some $453 billion of debt outstanding, which analysts estimate includes some $220 billion to $290 billion of unsecured corporate bonds that will become junk after the cuts.

All I can say is that GM had damn well be thankful for Kirk Kerkorvian and his offer of $31/share, because without that established price floor, I personally think the stock would be establishing a new 52-month low.

Since I'm all about airing opposing viewpoints, Richard Lehmann at Forbes is actually recommending GM bonds and "preferreds". He bases his recommendation on the following theory:

GM doesn't have to generate a profit; it merely needs free cash flow greater than zero. Free cash flow is, roughly speaking, net income plus depreciation minus capital expenditures. This figure is net of interest (because net income is net of interest), so if it's a positive number, then interest has been covered. You need look no further than the airline industry to see that a company can operate for years upon years without profitability and can avoid bankruptcy so long as cash flow stays positive. GM, still the world's largest automaker, should be able to manage this feat despite its manifold weaknesses.

The fear of a junk rating for GM has sparked massive dumping of GM bonds and preferreds. This has led to yields exceeding 9%. When you look at comparable yields in the junk market, you're talking about bonds rated below single-B, not ones in danger of falling from BBB- to BB+.

This state of affairs is not due to fears that GM is in jeopardy. The yields are so high because the debt markets are temporarily out of balance between the number of GM sellers (too many) and the number of willing buyers (too few). In other words, this is a great time to buy a GM debt security with a fat yield.

Interesting, but not a risk I'd want to take on at this point. GM's ability to maintain cash flow depends on vehicle sales, and those numbers are not heading in the right direction.

Hang on tight, folks - I'm thinking that not long from now, we might be looking back upon the past few years as the good times.

And before anyone goes and gets the idea that I somehow want GM or Ford to fail, please consider this - my livelihood is probably on the line right now, so let's not go assuming that I somehow want to see the US auto industry go away. That doesn't mean I'm going to turn a blind eye towards the problems or become a domestic-make cheerleader, either.

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