The purpose of this diary is to detail why any equity infusion into GM will be fruitless in terms of saving the company from bankruptcy through an analysis of its financial position: its income for this year and next, and its balance sheet.
Rather, instead of spending billions on trying to save what is a dysfunctional and uneconomic enterprise, the money should be reallocated to a job replacement/retraining/assistance program for the estimated 2.5 million workers potentially affected in the fallout. With auto sales declining with no recovery expected until beyond 2009--if we're lucky--a bailout of GM would not be beneficial, but only sinking more money into a losing proposition. Given that the US is under threat of losing it's esteemed status as the most credit worthy entity, throwing money at GM would be a mistake.
General Motors lost $21 billion dollars alone for this year, and they still have three months left to go. Let's take a look at the anatomy of GM's loss. In economics, we break down losses into two main categories. Losses as a result of fixed costs, and losses as a result of variable costs. Variable costs are the "cost of goods sold," or COGS. In GM's case, this would be hourly wages, materials and other costs directly associated to producing a car or truck. Fixed costs are those which the company would pay regardless of how many trucks or cars it sold. In this category, it would include rent, property costs, employees on a long term salaried contract, etc. If a firm takes in more money from selling trucks then the variable costs, that is called a gross profit. Net profit takes out the costs of selling, general and administrative expenses (fixed costs).
Let's review:
Revenue - COGS = Gross Profit
Gross Profit - Fixed Costs, Taxes = Net Income
If a company can't make a gross profit, then it is the logical decision to simply stop the company's operations unless future profitability justifies the loss. If a company can make a gross profit, but can't pay off all of its fixed costs, then it is still worthwhile in the short run to continue operations so that the company can pay off some of the fixed costs.
GM is in a very bad situation. For the first nine months of this year, ending September 30th, 2008, in billions:
Revenue: 118,586
COGS: 116,219
Gross Profit: 2,367
SG&A: 16,200
Net Loss: (21,264)
[As a note, there were other losses in esoteric accounting terms not useful for discussion--that's why these numbers don't add up exactly, but they are all correct]
This information is from their latest 10-Q filing with the SEC, available at sec.gov. As you can see from above, the company is barely making enough revenue to cover the cost of revenue. For simplicity, this is like setting up a lemonade stand, spending all afternoon manning it, selling 500 dollars worth of lemonade and then, after the cost of the cups and mix, pocketing 10 dollars--but for GM, this is in the scale of billions.
Interestingly, over those nine months, GM could have frozen its factories and invested the 116 billion in government bonds and have gotten the same result.
So, now we get to the point about the government giving GM money. It is a safe assumption to assume that GM's revenues will fall next year. With falling revenues comes falling economies of scale, so you will likely see a negative gross profit. In fact, analysts expect GM to make 13 billion less in revenue next year, though these same analysts underestimated GM's loss in this quarter alone by 50%. Analysts now estimate that GM's loss for the last three months of this year will be 4-6 Billion.
$25 billion would be enough at this point to fund GM's losses without any additional improvements or investments for this year. And the fact is that is exactly where the money would have to go, because GM only has 16 billion in cash to work with.
Let's take a look at the balance sheet. Current means that the assets can be used as cash now, long term means they can't be. Current liabilities have to be paid this year, long term not the case):
ASSETS (current)
Cash and Equivalents: 15.8
Inventory: 16.9
Other: 7.8
Long Term Assets: 53.0
Total Assets: 110.4 (some assets irrelevant to situation are included in this total)
LIABILITIES (current)
Current: 69.0
Long Term: 97.8
Total: 169.5
Okay, so here we have the general picture of GM, and it is not good at all. GM needs to come up with 69 billion in cash to pay off its current debt due within 12 months, and it's not coming from selling cars, because they are losing 25 billion this year from doing that, and that will likely get worse next year. They only have 40.5 billion in current assets to do that, but they can't use all of that money to pay off the debt since they have to float accounts receivables and other accounting/balance sheet goodies.
So let's summarize: for GM to make it through the next year as is without additional green manufacturing initiatives, it needs to do two things.
- Pay off 69 billion in current liabilities, or refinance it (not possible with their credit rating and the financial markets now)
- Fund greater than or equal to 25 billion in operating losses
The problem is that, as I said earlier, GM only has 16 billion in cash to do it. The government needs to find close to 95 billion to keep GM where it is now for the next 12 months. (Why not deduct the 16 from that? Companies need to keep cash positions for various reasons, such as delays in payments and covenant agreements, etc).
Of course, the government won't just give GM 95 billion; that will come in the form of a loan, so GM's issue only gets worse and will make it's failure 12 months, 18 months or 24 months from now much more painful for the taxpayers.
"But AIG got 150 billion, why not GM...."
Here's a good question. The difference between GM's problem and the banks and insurers problems is nuanced. GM's losses come from it's operations...the business itself is not healthy, and there is no operating profit--they lose 25 billion making cars. AIG, Morgan Stanley, etc all have profitable operations, but they have lost money from the assets on their balance sheets, not from selling insurance or buying stocks for clients.
Going back to the lemonade stand example, its as if you paid 100 dollars for your table and took out a 100 loan from a friend. You make plenty of money with your stand, say 40 dollars in profit. You wake up the next day to a table market panic, and your table is now worth 25 dollars. Your assets have shrunk to 25 dollars and your 40 dollar profit while still owing 100 to your friend. In accounting, you have to "write off" that 75 dollar loss on the table, so despite making 40 dollars from the lemonade, you lost 40-75=35 dollars, despite the healthy sales of lemonade. However, you expect the market for tables to improve once panic goes away, so it would be worthwhile for another friend to give you 35 dollars in exchange for ownership and profit once the market stabilizes and the table returns to its original value. In GM's lemonade stand, you don't even make money on the lemonade.
In short, that is what happened to AIG, Merrill and the others who had investments in mortgages and corporate debt. The prices collapsed under pressure of hedge fund liquidations and the Lehman liquidation, while still making operating profits in their businesses. Once they wrote down losses on assets, they showed losses in net income.
So what's the main point? Saving GM is not possible or worthwhile at this point, especially since we have so little money to work with at the moment. What happens to the workers, to the rust belt? Nothing good, but it's come to a point where the government has nothing in its disposal to really fix GM, let alone Ford and Chrysler. So we would be better off taking this money and using it on public transportation improvements, worker retraining and retooling, and education.