Prospective GM investors have U.S. over a barrel

October 12, 2010

Prospective investors in General Motors’ upcoming initial public offering have the automaker and its majority investor, the U.S. Treasury, over a barrel. Sure, GM is pottering along nicely and no longer burning cash. But the early hard sell about the size and timing of the deal has backfired, leaving Treasury looking like a distressed seller.

For months, the message leaking from Detroit was that GM’s share sale would raise up to $20 billion, which would make it the largest ever U.S. IPO. On top of that, insiders, from top executives like Ed Whitacre to Treasury Secretary Timothy Geithner, fanned expectations the deal would launch in the fourth quarter.

Now, though, the target GM will raise has been halved amid word the Treasury is now more interested in getting a higher price than exiting swiftly. That’s smart, but after all the hype it’s hard not to interpret it as a reaction to poor demand. That, in turn, puts even more pressure on timing. Absent a stock market crash, any attempt to postpone the deal would leave GM, the Treasury and their bankers looking even weaker.

That’s just the kind of advantage institutional investors love to pounce on. They already have reason enough to be skeptical about GM. It has only two profitable quarters under its belt; its European arm is still losing money; executives are untested and spanking new to their roles; its pension plans, untouched in bankruptcy, are underfunded by $27 billion and its remaining healthcare and other retirement obligations are $9 billion underwater.

GM won’t be worth enough any time soon to repay taxpayers’ money anyway. Generously assume it deserves the same multiple as Ford <F.N>, around seven times next year’s earnings. That means churning out some $9.5 billion of profit, double what it’s likely to make this year. Absent an astronomical improvement in GM’s margins that would require a surge in auto sales. Yet experts reckon U.S. industry sales will rise just a few percentage points next year, according to a Credit Suisse poll, and take a couple more years to hit the new assumed normal of around 15 million units a year.

Investors don’t need to pay for that now. Given GM’s challenges, they’re right to demand a discount to whatever they do think the automaker’s currently worth. Considering their grasp of the whip hand ahead of the IPO, there’s a good chance they’ll get it.

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