General Motors recently announced that it bought back preferred stock from the UAW Retiree Medical Benefits Trust and the Canadian government. The deal closed in December of 2014 and supposedly will result in a reduction to GM’s fourth quarter earnings to the tune of $800 million. GM had the option to redeem the shares at face value after December 31st of 2014. The timing of the deal brings into question the motivation behind the move and also leads us to reexamine a previous preferred share buyback that occurred in late 2013.
The 2013 deal seemed to have been designed to benefit the UAW rather than the shareholders that GM has an obligation to serve. Reuters reported on the deal in September of 2013 with the following:
General Motors Co (GM.N) said on Monday it would buy back just under half of its preferred shares held by the United Auto Workers healthcare trust for about $3.2 billion, essentially cutting company costs by financing the deal with lower-cost debt.
To finance the purchase of 120 million of the Series A preferred stock from the UAW Retiree Medical Benefits Trust at $27 a share, GM said it would raise funds with a debt offering.
The UAW trust, which manages retiree health benefits for blue-collar auto workers, received an 8 percent premium on what it would have received at the end of next year. The deal also gives it the money now, so it can invest earlier in hopes of raising more funds to pay retiree medical care costs that are set to rise further in the future.
GM did not specify how much it would raise but said the debt would be five-, 10- and 30-year senior unsecured notes, which would be offered on or before September 30.
GM took on more debt to finance the deal, borrowing $4.5 billion at an average annual rate of close to 5%. So, now let’s do the math to expose how the motivation for the 2013 deal could not have been to save money for shareholders.
GM would have had to pay an additional 1.25 years of the 9% dividend on the 120 million / $25 face value preferred shares owned by the UAW if they had not repurchased the shares. That equals about $338 million. GM would have then had the option to redeem the shares at $25 per share after December 31st of 2014.
GM instead chose to pay $27 per share, an 8% premium to the UAW for the shares that would have matured in just over a year. That premium equals $240 million. Add the interest expense on the notes that were issued by GM to pay for the deal. About 5% on $3.2 billion for 1.25 years comes to about $200 million. Here’s the bottom line; GM paid a total of approximately $440 million between the premium paid on the purchase and the interest on new debt to save $338 million in future preferred dividends. So, they lost over $100 million on the deal.
Just think about it, why would a company pay an 8% premium and issue new debt at 5% to buy back shares that are paying 9% and mature in little over a year? The answer can be found in the above referenced quote from Reuters regarding the 2013 deal which stated, “The UAW trust, which manages retiree health benefits for blue-collar auto workers, received an 8 percent premium on what it would have received at the end of next year. The deal also gives it the money now, so it can invest earlier in hopes of raising more funds to pay retiree medical care costs that are set to rise further in the future.”
There is also the smoke and mirror accounting style of GM, which relies on one time charges to explain away poor earnings performance. The $800 million charge taken for the 2013 deal seems high considering that the premium paid for redeeming the shares was $240 million; which leads us back to the more recent preferred share buyback.
Why wouldn’t GM wait less than a month til maturity to redeem the preferred shares that it repurchased in December of 2014? Media reports on the latest deal have conflicting statements on whether or not GM is actually paying a premium on the shares. The Detroit News reports that GM “repurchased 156.1 million shares of Series A preferred stock for $3.9 billion, a transaction that will reduce the automaker’s fourth-quarter net income by $800 million.” That comes to about $25 a share, which is face value. Why would that result in the same $800 million charge that GM took in 2013, when it paid a $2 per share premium to repurchase preferred shares?
The article goes on to state, “The preferred shares were expensive because they carried a 9 percent dividend that cost GM about $348 million a year.” What am I missing? How would you consider the deal expensive if GM paid $25 a share, which is face value?
Maybe one of the Wall Street analysts will question the deal when GM has its conference call for fourth quarter earnings. Why buy back shares and take an $800 million charge when you could have waited a month to redeem the shares when they matured? I suspect that the true answer would not be given, even if the question was asked.
I’ll put it bluntly; GM management can not be trusted to keep shareholders best interest in mind. UAW interests always seem to come first. The 2013 preferred share buyback proves that. Shareholders lost out while the UAW, once again, won. The 2014 preferred share buyback is suspect and appears to be driven by underhanded accounting methods.
While smoke and mirror accounting methods may give the appearance of financial strength at GM, the bottom line is that debt is rising much faster than the company’s cash position. GM management shows its government DNA when it rewards the UAW and shows a misguided focus on green, money-losing electric vehicles all the while increasing spending and borrowing more to pay the bill. That is really all you have to examine to see that GM, under current management, will not survive when the cyclical auto industry eventually has its inevitable downturn.
Mark Modica is an NLPC Associate Fellow.