Make A Bet on General Motors

Marilyn Cohen, Forbes Magazine, 09.04.06

Bond's in GM's finance arm offer nice yields and, lately, a lot less risk. Much rides on a buyout firm.

The domestic automakers are in a stew, with General Motors in the deepest. Nevertheless, GM, the largest company in what seems to be a dying U.S. industry, may get a new life. At least that's the possibility held out should dealmeister Kirk Kerkorian be successful in midwifing an alliance between GM's chief, Richard Wagoner, and Renault/Nissan Motor's, Carlos Ghosn.

If the alliance goes through, GM may gain a cash infusion and cost savings from combining production with the French-Japanese partners. Then long-suffering GM bondholders won't be exposed to a Chapter 11 filing, which is the fate many investors mentally assigned the company not long ago. So now, on that basis, an investment in General Motors debt obligations might make sense.

But the better bet is in bonds of the company's relatively robust finance unit, General Motors Acceptance Corp., which, unlike the parent, turns a profit. While both credits are below investment grade, GM's rating is junkier, B from Standard & Poor's; GMAC's rating is BB.

Small wonder. GM's future rises or falls on whether it can sell vehicles. GMAC's rests on loan payments for cars and trucks already sold. Yes, the finance arm would suffer if GM fell into bankruptcy, but GMAC is diversified, with operations in home mortgages and insurance. GMAC is also eyeing used-car financing and loans for non-GM cars. Recently, the Pension Benefit Guaranty Corp., the federal agency overseeing corporate pensions, has agreed that GMAC has no liability for GM's billions of dollars in unfunded pension liabilities.

And GMAC's financial strength is likely to improve because a group of hotshot investors, led by the investment fund Cerberus Capital Management and including Citigroup, is buying a 51% stake in the company. The $14 billion purchase price should give parent GM some breathing room, which in turn should benefit GMAC.

The Cerberus agreement could fall apart. Federal banking regulators have slapped a moratorium until next Jan. 31 on new applications for nonbank lenders, and the new Cerberus-GMAC entity will have to apply. The deal can be called off if it is not completed by the end of March 2007.

Cerberus also can nullify the purchase if parent GM's credit rating falls below CCC. S&P has GM on negative credit watch, meaning that a downgrade may well occur, but a drop all the way to CCC is unlikely to happen in the next seven months.

Some solace here: Should the deal encounter one of these pitfalls, I believe that Cerberus won't walk away; rather, it will renegotiate a better price. Cerberus Chief Stephen Feinberg's ego is involved. The financier wrested GMAC away from buyout kingpin Henry Kravis.

Since GMAC bonds enjoy better ratings and hence are not as risky as GM paper, they yield 2.7 percentage points less, giving roughly a 7.5% yield to maturity. Some GMACs that are now only a couple of pennies below par were trading a year ago at 85 cents on the dollar. To be frank, most investors didn't have the stomach for GMAC bonds back then. I'll pay the smaller discount for the greater peace of mind it brings; the yields still are handsome.

That said, not all GMAC bonds are worthy. Do not under any circumstances buy what are called GMAC Smart Notes. These bonds are part of a large program created specifically for small retail investors when GMAC bonds had investment-grade credit quality.

Smart Notes are the ultimate Roach Motel; you can get in, but exiting is a bit sticky. Smart Notes are issued in small batches and lack liquidity. The difference between bid and ask can be five points. That's $50 for every $1,000 face value.

The best GMAC bonds to buy are the large issues, such as the 6.875s of Sept. 15, 2011 or the 6.875s of Aug. 28, 2012. The first is a $5.5 billion issue; the second, $2 billion. Both bonds are noncallable and actively traded. The 2011 issue changes hands at 97.6 cents on the dollar for a 7.45% yield to maturity. The 2012 at a price of 97 cents gives you 7.5%.

Compare those two issues with the unsecured GM 7.2s of Jan. 15, 2011. This junkier $1.5 billion issue is also noncallable yet yields 10.2% to maturity.

If you are a big risk taker and can trade in a volatile market, then by all means fasten your seat belt and buy paper in the parent company. I'll stick with the safer GMACs.

Marilyn Cohen is president of Envision Capital Management®, Inc., a Los Angeles fixed-income money manager and author of The Bond Bible. Find past columns at www.forbes.com/cohen.

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