GM's money machine

For the longest time, the conventional wisdom in analyst circles was that auto manufacturers were "banks with a manufacturing subsidiary". Detroit didn't make its profits on the cars--they were sort of like loss leaders for the juicy auto loan business.

That's why it's been so surprising watching GM's travails with the spinoff of GMAC. Two years ago, GM sold 51% of the business to private equity firm Cerberus, the same folks who bought Chrysler. The deal was not only supposed to give GM some much-needed cash, but also boost GMAC's credit rating by severing it from the auto giant's woes.

This has not quite worked out as planned. GMAC's debt dipped into junk territory thanks to its residential mortgage unit. Meanwhile, it is still hoovering money out of GM's balance sheet. Last March, the company had to transfer $1 billion to the ailing finance company to shore up its financials, as per the terms of its deal with Cerberus.

This morning GM announced a $3.3 billion dollar loss. (To put this in perspective, they lost basically the entire annual GDP of Rwanda in a single quarter.) Hundreds of millions of it stems from losses at GMAC; hundreds of millions more are related to ongoing problems at Delphi, the auto parts supplier that GM spun off a few years ago.

Perhaps the most frightening part is that this is actually better than many analysts were expecting--the massive hemorrhage has brought forth cautious optimism. Now if only they could make a car someone wanted to drive . . .

Update Only GM could get a boost to their stock price from a $3.3 billion dollar loss.

Comments

GM was rather smart to spin off GMAC. GMAC was deep into sub-prime loans. They own Ditech, whose commercials you may have seen. GMAC was actually one of the few revenue generating arms of GM in North America. GM sold off 51% of it at just the right time.

GM is in the same quandary it was in during the 80s. People's tastes have shifted to smaller cars. GM's profits depended largely on the margins from large trucks and SUVs. The long running Chevy Cavalier lost money on every unit sold. GM only built those things to meet CAFE standards. But now with SUV and truck sales in the dump they have nothing left to sell but unprofitable small cars. I blame incompetent upper management for not seeing this coming.

Posted by freddiemac | April 30, 2008 11:14 AM

The death knell for them is likely going to be that they also no longer make a full size pick-up that a lot of people want to drive, or at least significantly fewer people want to drive, given gas prices, and the entry of the Japanese manufacturers into that segment of the market. Once you no longer make ANY vehicles which can be sold at a profit, what's the point?

Posted by Will Allen | April 30, 2008 11:14 AM

Couldn't the billions invested in this awesome money-losing machine be better invested somewhere else? I think it's time for some creative destruction.

Posted by Mike | April 30, 2008 11:33 AM

I blame incompetent upper management for not seeing this coming.

What would you have done?

Keep in mind you can't lay anyone off so in order to make payroll you have to keep all your factories running. If you divert your engineering talent to small cars, your customers will start buying Nissan Armadas and Toyota Sequoias. You need to build what people want to buy not what they should be buying.

The only solution I would see would be to advocate for high gas taxes so that US taxes and European taxes are similar. I would think that $10 a gallon US gas prices would tend to harmonize car buying patters between the US and the rest of the world.

As I see it, you can sell a European or Japanese car to an American, but you can't sell an American car to either. This is in large part due to the difference in gas prices.

Posted by jmo | April 30, 2008 11:45 AM

GM could make great cars if they could just default on all those legacy costs...

"Please, your Bankruptcy Honor ... if we just didn't have to pay those nasty costs our corporation agreed to, so many years ago ... we could, like, totally pay off our bondholders!"

Posted by Person | April 30, 2008 11:48 AM

jmo,

GM sells a lot of cars in Europe. The Opel division sells small fuel efficient cars. But in America the profits are derived from large vehicles. The assumption was that gas prices would stay low and people would continue to purchase large vehicles at the rate they did in the 90s. This assumption was false, and many thought at the time that it was folly to not hedge their bets on this.

If I were running the show at GM I would have invested in the small car market. GM has wasted a lot of money on pie in the sky fixes like hydrogen fuel cells in order to sell more large vehicles. GM had a prototype hybrid diesel in Europe years ago, but never did anything with it. If they would have rolled that out instead of a hybrid Tahoe, they could have cornered a market that is new and has potential to grow. Instead of working on technology and vehicle platforms that will get new markets like young people, they have a rather myopic plan that involves retaining large vehicles at all costs.

As Megan snarked, the problem is that GM doesn't build cars that people want. They haven't in 30 years. They build trucks that people want and some cars they give away to maximize truck sales. Is that any way to run a business? To give up on large segements of the market you are in? Heck, the Saturn division has never once made a profit. Instead of wasting money with Saturn they could have worked on cross-division platforms - bringing potentially profitable small cars from Europe over to the Americas. They tried bringing their newest division, the recently purchased Daewoo, into the US market. The Chevy Aveo is a Daewoo car rebranded. It was actually a market innovator, leading to Toyota bringing out the Yaris. However, GM invested nothing in trying to corner this market.

So I stand my by statement: I blame incompetent upper management for not seeing this coming.

Posted by freddiemac | April 30, 2008 11:56 AM

The assumption was that gas prices would stay low and people would continue to purchase large vehicles at the rate they did in the 90s.

And it's not like the suggestion that they build smaller, more fuel efficient cars is new since gas was at $3/gal. People have been saying it forever. The suggestion (not by you, natch) that this is all 20/20 hindsight is ignoring the actual foresight everyone outside of Detroit has had for decades.

Posted by Mike | April 30, 2008 12:13 PM

I'm not so sure GM's biggest problem with their cars is that no one wants to drive them. They have some pretty cool cars now - Chevy SST, Cadillac CTS.

The problem is no matter how much I like a GM car, I'm not going to buy it because of reliability issues. I'm 34 and none of my friends will buy American cars either, for the same reason. GM has improved reliability, markedly on some models, but they lost at least my generation of purchasers.

GM has to make a car that is SIGNIFICANTLY cooler and more fun to drive than anything Honda or Toyota makes for me and my friends to even consider purchasing it, even though the quality gap is closing.

Posted by Kineslaw | April 30, 2008 12:15 PM

"Now if only they could make a car someone wanted to drive . . ."

"I'm not going to buy it because of reliability issues. I'm 34 and none of my friends will buy American cars either, for the same reason"

The company damaged itself in the late 70's to late 80's. As said above, they put out crap and raised a generation on it and that soured their mouths. Now, I understand it will take time to erase this but I do get tired hearing about current quality issues. They upped their quality some time ago and are on par with the foreign manufacturers. All GM vehicles come with the 5yr/100,000 mile warranty (except heavy duty trucks I think).

Megan, there is not one single GM vehicle you would consider? (or Ford or Chrysler?).

Posted by markm | April 30, 2008 12:52 PM

The quality gap has supposedly been closing for 15 years now...

Just cause Ford paid J.D. Powers enough to get them to say they are as reliable as Toyota doesn't make it so (whats funny is Toyota has had a reliability slump lately because of quality control problems resulting from their speedy expansion, so even if it is true, all it means is that Ford at its best is Toyota at its worst).

Posted by Toxi | April 30, 2008 12:52 PM

If I were running the show at GM I would have invested in the small car market.

But by investing in small cars rather than large SUV's you would have gone bankrupt as your customers went for Armadas and Sequoias during the 90's and early 2000's.

If you invest in small cars you go bankrupt while waiting for gas prices to rise. If you invest in large SUV's you go bankrupt after gas prices rise. I guess better to err on the side of going bankrupt later.

Also keep in mind that any number of geopolitical events: economic troubles in China, that huge new Brazilian oil field, progress in Iraq, a liberal revolution in Iran, that could cause cause oil prices to do what they did in the early 80's... plumet after everyone was convinced they would go up forever.

It is certainly possible that we are in the midst of a commodity bubble. Just like internet stocks couldn't go down in 1999 and housing couldn't go down in 2006, everyone is now convinced oil will hit $200 a barrel.

Well, Mr. GM executive, what do you do now: Invest in small cars and then by the time you can roll them out in 2011 oil is $20 a barrel.

Posted by jmo | April 30, 2008 12:53 PM

jmo,

Did Honda or Toyota go bankrupt by investing in small cars? No. Has GM gone bankrupt in Europe by investing in small cars? No. But GM lost the small car market and hasn't tried to regain it. Just read Kineslaw's comments. GM made some really crappy small cars and people didn't want them, whereas Toyota and Honda made quality small cars. GM was raking in the money in the 90s, when gas was at record lows. As gas prices went up from 1.00 a gallon to 2.00 a gallon, where were the small cars? No, instead GM invested billions into hydrogen fuel cells.

GM should have invested in small cars in 1999 or 2000 at the latest. GM really should have invested in the mid 90s when profits were high and they could afford it. They wouldn't have to put all their eggs in the small car basket. They could have kept some money in large vehicles.

Sure, maybe Iraq will come online. Maybe there will be huge new reserves found. But how likely is that? Iran is estimated to consume all the oil it produces in less than 20 years. Think about that for a moment, large exporters will start to use all their oil domestically. Does that suggest that, in the long term, gas prices will be low again? Sure, this commodity bubble can break and gas prices will dive again. But that is short term. I don't see much evidence that they will stay low if they go low. With China and India gobbling up oil, and US demand ever increasing, GM still has the same problem: cars no one wants to buy.

Posted by freddiemac | April 30, 2008 1:05 PM

Sure, this commodity bubble can break and gas prices will dive again. But that is short term.

Yes, and in that short term , if GM has invested in small cars, and all Americans want is large SUV's, GM can go bankrupt.

That's why I think GM and Ford should push for high gas taxes so they can be assured that Americans will never again be in a position to buy fleets of Suburbans.

By insuring that gas prices remain high, the big 3 can mitigate the risk of comming to market with the wrong car at the wrong time.

Posted by Jmo | April 30, 2008 1:44 PM

"Just cause Ford paid J.D. Powers enough to get them to say they are as reliable as Toyota doesn't make it so"

I'm not basing my comment on a TV commercial. I base it on conversations with GM engineers that work at the GM proving grounds. They'll be the first to tell you what is junk and what is good no matter the manufacturer even if it's their own (they do a lot of bench marking so they do test other vehicles than their own).

"GM still has the same problem: cars no one wants to buy."

Granted, my perception is skewed as I don't drive far to work so I could drive a tank and I wouldn't care what mileage it got...but from looks alone, there are some high end foreign based cars I could see myself driving but not the other 85% of them.

Posted by markm | April 30, 2008 1:46 PM

Jmo,

I still fail to see how a commitment to small cars will cause GM to go bankrupt? It didn't cause Toyota and Honda to go bankrupt.

GM has a large presence in gas tax heavy Europe. Their slowness in bringing their Opels to market in the US reflects their ineptitude. Wouldn't it make sense to bring the Astra to the States back in 2003?

It seems we are arguing in circles as I have seen no evidence by you that GM's strategy of relying on large vehicles for profits was a wise way to avoid bankruptcy. Additionally, all evidence I have presented to suggest both the folly of that logic and the myopia of their strategy in the 90s and early 00s has been ignored by you. Why do you support GM's corporate incompetence so much?

Posted by freddiemac | April 30, 2008 1:49 PM

frediemac,

The other issue is GM didn't have the capital or the engineering bandwidth to invest both in small cars and in large SUVs, it was one or the other.

There was no possiblity of them doing both.

Posted by jmo | April 30, 2008 1:53 PM

I still fail to see how a commitment to small cars will cause GM to go bankrupt? It didn't cause Toyota and Honda to go bankrupt.

Because the money that Honda and Toyota spent on R&D, GM spent on lavish pay and benifits for executives and the rank and file.

Posted by Jmo | April 30, 2008 1:59 PM

Megan: (To put this in perspective, they lost basically the entire annual GDP of Rwanda in a single quarter.)

I'm not sure this is a useful perspective; when I hear "Rwanda", 'African tiger' isn't what comes to mind. Converting GM's loss to an annualized figure at least gets you up to the magnitude of Bolivia's economy.

Posted by Bill Woods | April 30, 2008 2:24 PM

jmo,

You say that GM didn't have the resources to invest in both large vehicles and small vehicles. But they did:
http://www.washingtonpost.com/wp-dyn/content/article/2006/05/19/AR2006051900550.html

http://www.gm.com/europe/brands/opel/

They were simply incompetent in bringing them to the US market. Of course you state that "Because the money that Honda and Toyota spent on R&D, GM spent on lavish pay and benifits for executives and the rank and file." Isn't that incompetence on their part for squandering resources needed to grow the company? Doesn't that support my assertion that this is the fault of upper management?

Of course GM has spent plenty of small car money on pie in the sky ideas like the EV1, the Volt, and hydrogen fuel cells. In the meantime Toyota and Honda are locking in their dominance over the new hybrid market. I saw that one coming, why couldn't they?

Posted by freddiemac | April 30, 2008 2:29 PM

freddiemac,

So you're the CEO of GM circa 1999 - what would you have done to get the unions, the executives, and the engineers to work harder for less?

You can't call someone incompatent if they fail to do the impossible.

Posted by Jmo | April 30, 2008 3:24 PM

Jmo,

If I had the reigns of GM in 1999, I would have worked on a transition in several ways:

1. kill off Saturn. It hasn't made any money, it probably will never be very profitable.
2. introduce the Honda system of model upgrade. Methodically upgrade the car design bit by bit rather than a total system refresh every 8-10 years. It is why the Civic has such good overall ratings, it has been tinkered to perfection for 20 years.
3. reduce redundancy. There are a lot of GM cars that are redundant. There were a lot more back in 1999 (the Bravada and the Blazer, Alero and Grand Am, etc.).
4. reduce "big idea" research in favor of practical research. GM wasted a lot of money on so called big ideas. One was Saturn, the company within a company that was supposed to fight off the Japanese imports. Didn't work. And all the money wasted on an electric car? What a waste, that is now just bad PR. I'm sure the Volt will end up the same. I have similar disdain for the hydrogen cars they are working on.
5. overseas cross platforms. The unions didn't want Opels sold here because they weren't union cars. However, they could be brought in line with cross platform guarantees. IE the components could be shipped here and assembeled union. Or, platforms could be exchanged. For example the Astra could be shipped here in exchange that a union built car be shipped out to another GM market overseas.

Back in 1999 GM was still making profits, but they knew their legacy costs were too high and the margins on their cars too low. GM and Ford used to dump their excess car inventories on the rental companies, which worked out great for Hertz and the like. But it didn't make the mid-three any money. Thus any big downturn would leave GM and the rest with huge inventories that can't be sold. Their response to this in 2001 was to whore their cars out with giant rebates. This was a stupid, short sighted idea that was panned as brilliant by the Detroit press. Again, bad news. GM should have been able to respond to the Prius with a competitive hybrid within a year or 2. They didn't. It was bad marketing. They haven't learned from their bad marketing mistakes. This is because the upper management (Rick Wagoner on down) is stupid.

Posted by freddiemac | April 30, 2008 4:26 PM

freddiemac,

1-5 are all spot on.

The other question I wanted your opinion relates back to someone John Smith CEO of GM from 1992 to 2000 once said. A GM executive was pushing GM to invest in 5 and 6 speed automatic transmission and overhead cam engines. Smith was reported to have responded "The American people won't buy what they can't see."

As current example of this thinking: Lexus offers an 8-speed automatic and Mercedes has a 7-speed - while a 2008 Cadillac Deville still has a 4-speed . Keep in mind that Caddy is the devision that GM has invested the most in.

Now, we can say that John Smith was stupid, but would you really have bet that he was wrong. I fear that in his position, given the facts on the ground at the time, we all might have made the same decision.

Posted by jmo | April 30, 2008 7:04 PM

Now, we can say that John Smith was stupid, but would you really have bet that he was wrong.

I would say he was preferring to scapegoat the potential customers who would have rightfullly seen that Detroit had no skill to build such a thing. Ask anyone who changed out one, two, or even three automatic transmissions on an American make between 1980 and the late 1990s -- Chrysler being one of the worst during this time frame, but GM didn't have a rosy reputation for its car and light truck transaxles, either. What good are six or seven forward gears if you can't get half that many right?

Posted by aMouseforallSeasons | April 30, 2008 7:24 PM

Corvettes have an option for a 6 speed automatic. Though I don't know that improved transmission technology really is a selling factor for many cars. The Civic had a 6 speed manual, and I considered getting one. But I don't think I'm a typical car consumer. At any rate Smith probably had a point. Many feel that GM's car designs are too boxy and lack any vibrancy. This was a big critique of the last incarnation of the GTO. While GM responds that Hondas are boxy and boring, Hondas sell to a market that want reliability and efficiency. If GM can't break into that market, what is left is the "pizzazz" market, ie people that were buying up Chryslers ten years ago, and buying the edgier Nissans and Mazdas today.

I used to follow GM back in the day. I recall reading the shareholder material for the EV1, which is why I find the "who killed the electric car" stuff amusing. GM is really bad at marketing. They don't really understand the American consumer anymore. I think they are entrenched in their Detroit towers. I also think that a lot of upper management isn't exactly the most talented, ie they didn't go to the best schools and probably weren't high achievers. Even now GM has more hybrid big vehichles on the line than small cars. That's really bad marketing, even if the "green" market is transient. So it really goes back to Megster's original snark: if only they could make a car that people wanted to drive. They have really high quality cars (the Buick line are right behind Lexus in terms of quality). But they also sell some junk, and they don't really seem to have a game plan going forward. Ford is part of the same sinking ship, but at least the upper management has been changing in order to find someone who can come up with a plan to make cars people like (Nasser, Ford, and now the new kid -all during Ricky's tenure).

Posted by freddiemac | April 30, 2008 8:14 PM

Now, we can say that John Smith was stupid, but would you really have bet that he was wrong. I fear that in his position, given the facts on the ground at the time, we all might have made the same decision.

Posted by jmo

The problem with this is that he's being paid the big bucks, supposedly for being able to make these sorts of decisions, and I'm not. One can't justify an extremely generous remuneration package on the grounds that the recipient brings certain highly valuable decision-making skills to the table, and then turn around and excuse poor decisions with the throwaway line that 'anyone could have made that mistake'

Posted by ScentOfViolets | April 30, 2008 9:39 PM

Though I don't know that improved transmission technology really is a selling factor for many cars.

Ah, but 5,6 or even 8 speeds are going to get you better gas milage and better acceleration. People might not know that but they will notice on a test drive and when they live with the car long term.

I think you've hit on one of GM's biggest problems: the bean counter mentality.

Question from GM Finace Guy: Who is going to by this car because it has a 5 speed automatic?

A: Nobody, people don't car about that stuff.

Question from GM Finace Guy: Who's going to not by this car because we went with laser welding rather than spot welds?

A: Nobody, people don't car about that stuff.

But, when you drive the car over the long term, all that cost cutting comes back to haunt you and you relise that you bought a piece of crap.

Posted by jmo | April 30, 2008 9:49 PM

Megan

AFAIK a loss from a partly owned subsidiary is *not* a cash cost.

That's Accounting 101.

It will only be a cash cost if there is recourse on the debt of the subsidiary back to GM.

So losses which are not cash costs, are essentially irrelevant to GM's Free Cash Flow, and hence to its valuation.

That's Finance 101 as taught in business school.

Posted by Valuethinker | May 1, 2008 6:53 AM