GM's Big Assumptions
GM is banking on a return to years of 16 million sales, but those
numbers were as inflated as the housing bubble
By David Welch
If there's one thing that investors should have learned as a result of
the recent credit crisis, it's the danger of accepting inflated
numbers—whether they be home prices or advertising pages—as the norm.
Newspapers have to accept that they won't be able to return to the day
of fat print budgets, and carmakers will have to adapt to a world where
only people who can truly afford a new car will buy one.
But there's a lot of disagreement about what that world will look like.
And just how big the future car market will be plays a major role in
General Motors' (GM) survival. In fact, as its annual filing with the
Securities & Exchange Commission made clear on Mar. 4, GM's auditors
have "substantial doubt" about the carmaker's ability to continue as a
That statement may have been routine business for GM's auditors, but the
company's plans to return to viability seem to be based on two pretty
big assumptions. The first assumption is that there is a bonanza of
pent-up demand on the other side of this downturn. The second is that
the rebound will be big enough to service the debt that the company will
have as it borrows more from the government.
Betting on a Recovery
For the last decade, "all the tools were there to let the market
overheat," says Gary Dilts, senior vice-president for J.D. Power's
Global Automotive group. "Everything was geared to do that. Now it's
geared to not do that."
Just look at the car market. GM and most other automakers think that the
current rate of sales—a dismal 9.1 million annualized selling rate in
February—will add up to a flurry of car purchases once the economy
recovers. By 2012, GM thinks carmakers will once again start selling 16
million cars a year and that could go as high as 18 million.
Maybe pent-up demand will spring loose a bonanza. But analysts are
increasingly thinking that even selling 16 million cars and trucks may
be a great year, not the norm. J.D. Power thinks consumers will buy
between 14 million and 15 million vehicles a year, Dilts says. Ford
Motor (F) market analyst George Pipas says 16 million may "be the high
watermark." He could well be right.
A Boom Fueled by Cheap Credit
Let's consider a few facts. For the past 10 years, auto sales soared
well over 16 million cars and trucks every year. In 2000, at the height
of the dot-com boom and when real estate was surging and credit was
easy, Americans bought a record 17.8 million vehicles. That was pretty
astonishing growth back then when you consider that annual auto sales
only crossed 16 million vehicles in the U.S. in 1999 when stock markets
were booming. Other than that, car sales were between 12.3 million and
15.5 million for the entire decade of the 1990s.
At the start of the decade, auto executives figured the car market was
around 15 million. That was the rule of thumb. With a strong economy or
a pitched sales war that led to price cuts, it could go higher. But 15
million vehicles was the benchmark.
Since 1999, Americans have bought a lot more than 15 million every year.
They used home equity loans, easy credit from auto finance firms, cheap
lease deals, and huge rebates to buy cars even when the one they had was
just a few years old. Some people who once could only afford a used car
were buying new rides. All of that inflated the car market by about 1
million vehicles a year, says J.D. Power.
Leases and Rental-Car Sales Fall
Many banks won't even do lease deals anymore. GMAC Financial Services
does little if any leasing and GM owns a stake in that lender. The banks
that are leasing are using tougher terms, so the monthly payments are
higher. And home equity? Let's all bow our heads to the passing of home
Rental-car sales also played a big role in the boom. Before GM, Ford,
and Chrysler started to take downsizing their factories seriously, they
just sold off their excess production to rental companies. Often, they
would lease the car to a rental agency for three months and then take it
back. It didn't make them any money, but it propped up sales. J.D. Power
says that's another 1 million vehicles a year.
If J.D. Power is right, then the industry sold 2 million cars a year
more than it should have over almost an entire decade. That may be
right. If 15 million vehicles is the real size of the market, then the
extra sales on top of that since 1999 adds up to almost 17 million.
That's almost 2 million vehicles a year.
Long Wait for a Bonanza
So what does that mean for pent-up demand? The industry may have to wade
through some portion of those extra millions of vehicles that were sold
before it starts to see a bonanza. In fact, J.D. Power dropped its
near-term forecast by about 1 million cars a year. Dilts says that by
2011, annual sales may only grow to 13 million vehicles. GM has the
market at 14 million vehicles and much higher than J.D. Power's forecast
going beyond that. If it doesn't hit 16 million in 2012, GM will owe
more than $20 billion by then to the government.
Not surprisingly, GM executives and other industry insiders aren't ready
to concede that the car market is smaller than we've seen in a decade.
Population growth will create more buyers, they say. Every year, 2
million more drivers get a license. And about 12 million cars are
scrapped every year. With sales so low, the median age of cars on the
road is now almost 10 years old, says Michael DiGiovanni, GM's chief
market analyst. "Cars were a bubble like housing," DiGiovanni says. "But
that doesn't mean it won't rebound to 16 million cars."
It will have to for GM's sake. The company's recovery plan says that it
will renegotiate $27.5 billion in bond debt down to $9 billion. The
company also will likely cut a deal to slash $20 billion in cash owed to
a union-led retiree health-care fund to $10 billion.
Big Interest Payments
To get there, GM will reduce its current nongovernment debt load of $63
billion down to roughly $35 billion. Then, it will add almost $30
billion in government debt on top, replacing those liabilities with
government borrowings almost dollar for dollar.
That means big interest payments siphoning cash and profits. The good
news is, GM says all of its cutbacks mean it can make money if consumers
buy just 12 million cars a year. The bad news is, they may not buy
enough cars for GM to pay back its loans in a reasonable time.