GM Rightfully Dismisses Greenlight's Financial Engineering Scheme

In late March, David Einhorn, the founder and chief of Greenlight Capital, presented a financial engineering scheme for General Motors that he claimed would boost GM’s share price. Einhorn has been in and out of ownership/options in GM on the long side before…and now he’s again long with ownership and reportedly with a very large option position (nearly $1 billion in stock value). It’s a scheme that makes no sense for GM, but it does for Greenlight if, in fact, it resulted in a short-term increase in the stock price.  

Einhorn’s scheme has GM splitting its common stock into two distinct classes of stock. The claim is that GM’s high dividend payout (~4.5%) is not respected by the market. (Yes this is true because the market knows that capital intensive, cyclical companies (almost) always cut their dividends when profits fall to protect their ability to invest and stay competitive or fail to raise dividends as interest rates rise.) Greenlight claims that GM’s investor base is a “suboptimal combination of yield-oriented and value-focused shareholders with divergent investment objectives” although we’re not sure anyone knows the motivations of every single GM shareholder.

To solve the problem of GM’s low valuation despite its high dividend yield (~4.5%), Greenlight proposed that GM spin off “Dividend Shares” to trade separately from the common shares. These Dividend Shares would be entitled to the current dividend. The existing common shares (“Capital Appreciation Shares”) would participate in earnings above the dividend payout and thus in future growth. In doing so, the market will have to recognize the value of the Dividend Shares separately and accord these shares the appropriate value for the high yield and give credit to the Capital Appreciation Shares for future earnings growth. So now dividend investors could buy one set of shares, and value and growth investors the other set if GM adopted Greenlight’s stock scheme.

Let’s look at the results of the first financial engineering scheme to boost GM’s share price since emerging from bankruptcy. In 2015, Harry Wilson, a former investment banker and member of the Treasury’s Auto Task Force (which oversaw the bankruptcies of GM and Chrysler), represented four hedge funds that collectively owned 1.9% of all GM shares at the time. His goal (on behalf of his clients) was to pressure management and GM’s Board of Directors to buy back shares – and he succeeded in getting the Board to acquiesce to his demand in early 2015. (Fewer outstanding common shares result in higher earnings per share which should support a higher share price assuming no change in the multiple.) 

From Q1/2015 through the end of last year, GM has spent $9.5 billion buying back its stock. But GM shares have traded within a price band between $28 and $38 never touching the high price of nearly $39/share reached in late March, 2015 since it authorized the first buyback. So for the nearly $10 billion expended on its own stock in the last two years, the buybacks may have had little impact on the stock price itself. And we might add, that is an amount that might have been invested more productively or better yet held to pay dividends in the rainy days ahead which are sure to come.  

                                 GM Stock Price Chart (Weekly)

                                     January 2015 – April 2017

Financial engineering of the type envisioned by Greenlight really has no benefit for GM or its stockholders. A scheme to “unlock value” is dubious at best due to the nature of the business; it also ignores the fact that the common shares already value the company for both dividend risk and growth potential explained as follows. 

The auto industry is mature and highly competitive in all markets. It demands continuous investment: development of new vehicles; advancing safety, electronic, and emissions technology among others; and improvements in manufacturing. This continual investment has existed since the first vehicle was built – and now will only increase to develop autonomous vehicles. It is also highly cyclical as the prolonged periods of below normal car sales in the US experienced during and after the recessions of 1990-1991 and 2007-2009 demonstrate. Although no one expects a collapse in vehicle demand in the US in the near or medium term, there are warning signs of tougher sales conditions ahead as the economy moves away from the easy credit, low interest rate policies of the previous eight years. All of this uncertainty is the reason why investors are demanding a high current yield on GM and Ford shares; investors have little confidence that GM (or Ford) can boost its dividend over the longer term (and especially in light of rising interest rates ahead).

The market is the ultimate arbiter of stock value. It’s clear that investors are hesitant to ascribe a higher value to the stock price given the historic cyclicality of the industry. Worse, there are new and unprecedented challenges ahead that will redefine profit model of the automakers.

Splitting the stock into two components as described by Greenlight does not in any way change the underlying nature of GM’s business.  All of the risks are still present – and the future growth is somewhat restricted by the very nature of this industry. There will always be swings in earnings ahead – and even years when the dividend will have to be reduced or sacrificed at times.

Written by Maryann Keller and Ken Elias of Maryann Keller & Associates.