Greenlight Capital’s David Einhorn is gunning for General Motors. The investor has turned activist and rolled out an unprecedented proposal to create two classes of GM stock, one driven by growth and the other supported by a permanent dividend.
After studying Einhorn’s proposal for seven months, GM rejected the plan as well as his goal of getting four seats on GM’s board. Thus far both Moody’s and S&P have sided with GM’s argument that Einhorn’s idea would sink the carmaker’s investment-grade credit rating and poses an unnecessary risk.
GM has also insisted that two classes of stock would create management conflicts. Which group of investors would GM put first as it weighed big decisions?
For CEO Mary Barra, this is the second go-round with an activist in just two years. In 2015, GM gave in to Harry Wilson’s much more straightforward demand to increase the speed at which it was buying back its own shares.
Both investors were spurred by the same issue: even as auto sales have surged, and the broader stock market has enjoyed a historic bull run, GM shares have mostly done nothing. Only recently have shares jumped, after Einhorn disclosed his ownership and also as the election of Donald Trump spurred a broad rally in US manufacturers of all kinds.
Still, over the longer term, GM has proven to be a frustrating investment.
US auto sales have boomed, setting records in both 2015 and 2016, and through this expansion, GM has been steadily profitable, as consumers have favoured full-size pickups and SUVs over low-margin passenger cars. The carmaker’s market-share position in the US is also solid: it’s the biggest carmaker, controlling nearly a fifth of the total market.
Again and again, analysts have pointed out that GM is undervalued relative to its earnings. The company has addressed this by taking its free cash flow, above what it requires to keep adequate cash on the balance sheet, and returning it to investors through buybacks and a dividend yield now above 4%.
Buying and not buying
Einhorn’s is buying GM — Greenlight holds about 1% of the available shares, with options to take that 2.5% — but he isn’t buying Barra and her executive team’s financial strategy. He thinks there’s a whopping $US38 billion in additional market cap that could be realised if GM’s accepts his plan (the company’s current valuation is $US54 billion).
GM’s languishing stock price is a mystery to many observers. The typical fear expressed now about getting in is that all the sales growth is in the rearview mirror and a downturn in the US will arrive soon. But that fear has been a constant feature of the auto industry for two years, even as new sales records have been set.
If a cyclical downturn does take hold in 2017, the market is unlikely to fall below 15 million to 16 million in annual sales, and GM is structured to be profitable in a market that plunges to 10-11 million annually. And in any case, GM’s mix of products, especially pickups and SUVs, would enable it to maintain relative profitability even if sales have peaked.
The ultimate conclusion? GM is a victim of its own success. Einhorn sees great fundamentals but a stock price that the markets are getting wrong. He wants to do something about it.
He isn’t the first, and — even if GM manages to shake him off — he probably won’t be the last.