The S&A Digest: A Letter from GM's Chairman

A letter from GM's chairman and CEO... Starting pay for a Wall Street MBA: $169,000... Iowa's corn racket... Icahn's beach condo... Goldman moves into subprime... S&A wants you...

GM posted its first quarterly "adjusted profit" in two years. For the full year, GM lost $2 billion. GM's "chairman" sent us a letter with the details. More on this below...

Signs of a market top: MBA graduates are receiving first-year pay packages that are larger than ever. The business school whose alumni command the highest first-year-out salaries? Columbia with $169,194. The next time you're considering doing business with one of the major investment banks, think about how they can afford to pay so much to people who know so little.

Unmentioned in the furor over global warming and declining oil production in the United States: Tariffs that prevent importing ethanol. Sen. Chuck Grassley (R-Iowa) is even working on a new tariff that would block ethanol imports from Trinidad (currently exempt) because entrepreneurs are building sugar-based ethanol refineries there. Even though it's far more energy efficient (and thus cheaper) to make ethanol from sugar instead of corn, our lawmakers want us to have less access to cheap, imported, sugar-based ethanol. Why? Because voters in Iowa grow corn for a living. That's democracy in action. That's your tax dollars at work.

Shares of Inside Strategist pick WCI Communities (WCI) surged 15% yesterday on a $22-per-share tender offer from activist investor Carl Icahn. A man after our own hearts, Icahn stated the reason for his interest in beaten-down Florida real estate, "If you look at long-term trends and don't think about short-term turmoil, that is where the risk returns can be greatly in your favor."

Time to speculate in subprime? While everyone has been feverishly selling their subprime-mortgage stocks, Goldman Sachs has been waiting patiently to scoop them up. CFO David Viniar said that the bank is looking to delve deeper into the subprime-mortgage sector by ramping up its own operations and searching out a possible acquisition.

Pardon this intrusion... In these pages, we seek to inform, entertain, and cross-sell our services with friendly persuasion. Very rarely do we permit ourselves the indulgence of asking you for a favor. But... we are looking for a very special new employee to help us launch an important new business. You will see the ad below running in our publications for the next several weeks... or months. It will probably take us a long time to find the right person... unless you are that person and contact us quickly.

WANTED: INVESTMENT JUNKIE

Stansberry & Associates Investment Research is seeking the best read, most eloquent financial-information junkie in the world. This person will lead our new effort to build a world-class financial media "aggregation" website.

Our candidate will be an experienced investor, having owned and traded in hundreds of stocks over the last dozen years. He or she will be familiar with all of the major sources of financial news, analysis, and data. He or she will have dozens of personal contacts in the financial industry. And, most importantly, our candidate will have a knack for finding financial insight in the world's haystack of financial information.

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If you're interested – or know someone who would be – please send a cover letter, a resume, salary expectations, and a list of favored financial media to: samediadigest@gmail.com.

A study conducted by Bloomberg shows that the more money you make, the happier you are with the direction of the country and our president. A 15-year-low 23% of all Americans said that America is on the right track, versus 43% of Americans with incomes higher than $100,000 per household.

Today, March 14, or 3/14, is a day mathematicians and fanatics get together to talk about the number pi. The world record for reciting pi goes to a Chinese chemistry student, who recited 67,890 decimals over a 24-hour period. It took 26 videotapes to submit to Guinness.

A sign of the times: There were no new highs across our recommended portfolios yesterday.

And now... the mailbag. We finally discovered a way to avoid your accusations, denouncement, reproach, proscriptions, and blame. The secret? Publish an incorrect feedback link! Yesterday, we mistakenly left out an "s" in our e-mail address. Anything you sent us probably got "bounced" back to you. The correct address is: feedback@stansberryresearch.com. Try to muster the anger you felt yesterday and resend your note.

"I've seen several comments in S&A were (sic) your newsletter writers are rubber-necking the sub-prime train wreck. Talk about missed trades, this train was headed for derailment for months and everyone should have seen it coming. Sad part is that this was (sic) biggest train wreck in recent history and we had no position. Where was the S&A short positions, puts, etc? Porter shorts GM (which isn't going BK - Uncle Sam will step in) while the sub-primes drop over 80% or go BK. Is it possible you folks are losing your touch? Stop rubber-necking and get out there and find the next train wreck!" – Paid-up subscriber Herb Morris

Porter comment: Herb is right, mainly. GM did write-off $1 billion in subprime losses. And it is down about 10% from where I recommended subscribers sell it short. But that's nothing compared to the losses in the real subprime sector. Why did we blow it? Two reasons. First, it is very difficult to short sell high-yielding stocks successfully. You've got to act at precisely the right time, because while you're short, you have to pay the dividends on the stock you've borrowed. Second, as I think we'll see proven in time, almost all of the subprime accounting for the last two years was fraudulent. I first recommended shorting mortgage companies in the spring of 2005 (in the now defunct S&A Trader), targeting Countrywide Financial. But the entire sector kept recording good earnings and low loss provisions. You can't stay short when the numbers are all going against you – even if you believe they're bogus.

"I am a brand new subscriber who has just opened positions based on the 'Buys' in the current portfolio in late February, and it seems like my timing could not have been worse. I know that you are advising people who have been in positions of the current portfolio to 'stay the course,' but those individuals are already significantly ahead (thanks to you and the other Stansberry & Associates 'peeps'). But for a 'timing challenged' new subscriber, such as myself, would you recommend pulling out and waiting for a better entry time?" – Paid-up subscriber Jerry

Porter comment: Jerry, we don't give any personal advice here. We're not licensed to do so... and frankly nobody pays us enough to take on that responsibility and that liability. If you look on our homepage, you'll find a link to the Digest archives. You can read what we've published recently about the general level of the stock market – that we expect emerging markets to fall 30%-50% and that we expect U.S. indexes to fall 10%-20%. Additionally, we establish trailing stop losses on most of our recommendations. Hopefully, this gives you enough information to make a decision about your positions that's sensible for you.

"I am new to this investing game, having spent most of my life working and spending, not investing. But, I find your service refreshing and lively in a discipline known for its stuffed shirts and reserve. Investors need to learn not to treat any investment service as the 'Delphi Oracle,' but simply another source of information about investing and specific companies. I could never do the detailed research that your group does, so I appreciate your hard work, colorful newsgrams, and your recommendations. At the end of the day, the investor, not the investment service, is responsible for his decisions. You guys make it easier and more fun for me to make mine." – Paid-up subscriber Mike Van Vleck

A Letter from GM's Chairman

You can tell far more about a company's prospects by the language in its earnings announcement than you'll ever learn from the numbers. The numbers are easily manipulated... obfuscated... confused... and, eventually, restated.

Compare these two brief passages from recent annual reports, filed with the SEC by two very different large American corporations.

No. 1: "Let's look at a summary balance sheet and earnings statement for the entire group. This motley group, which sells products ranging from lollipops to motor homes, earned a pleasing 25% on average tangible net worth last year. It's noteworthy also that these operations used only minor financial leverage in achieving that return. Clearly we own some terrific businesses. We purchased many of them, however, at large premiums to net worth – a point reflected in the goodwill item shown on the balance sheet – and that fact reduces the earnings on our average carrying value to 10.8%."

No. 2: "Net income for 2006, excluding special items, of $2.2 billion, or $3.88 per share fully diluted, compared with a net loss of $3.2 billion, or $5.67 per share, in 2005, marking a $5.4 billion improvement. Including special items, [the company] had a net loss of $2.0 billion, or $3.50 per share for 2006, compared with a net loss of $10.4 billion, or $18.42 per share in the year-ago period."

I make my living as a financial analyst. I've read thousands of earnings releases and looked at thousands of financial statements. Try to read that second example and explain to anyone else what it means. You can't.

The second example – as you probably have guessed – comes from General Motors' annual results press release. The report is utter gibberish. The summary press release alone is 32 pages long – and there's not a single sentence in the whole thing that makes any sense.

GM's inscrutable reporting tells me far more about the business and its management than any of the company's numbers. Either the men in charge of GM don't want you to know how the business is doing, or they themselves don't know. Regardless, the result is a disaster in the making.

Quote No. 1 comes from Berkshire Hathaway's annual report, written eloquently by Warren Buffett, the largest shareholder and the chairman of the board. Berkshire is a far more complicated business than GM, involving dozens of different industries and huge insurance holdings, which are some of the most complicated businesses in the world. Nevertheless, Buffett is able to describe the history of the businesses, the current operations, and all of the key financial metrics in less than 20 pages – all of which are a pleasure to read.

After studying the GM report for several hours, here is what I would have written to my shareholders, were I the chairman of General Motors:

Dear Shareholders:

We own one of America's proudest companies, whose heritage and reputation far exceeds its operational capabilities today. We have infrastructure and employee obligations that outpace what we can afford given our greatly reduced profit margins and debt load. Our ongoing results reflect these important structural problems, which may be beyond our best efforts to fix.

Last year, we did our best to cut costs, terminate extraneous employees, and retire our debt load. A key to this process was selling a controlling stake in our finance company, GMAC, to a Wall Street hedge fund, Cerberus Capital Management. However, these Wall Street guys are no dummies. First, they only offered us about five times net income for our most profitable division. And they forced us to guarantee GMAC's estimated $14.4 billion book value. Thus, every single bad subprime loan we made over the years will have to be paid for out of your equity. So far, in the last few months of 2006, that bill came to around $1 billion. Our CFO tells me GMAC is "leaning away" from subprime loans now, but we have no ability to quantify what that means.

The good news about the deal, though, is it removes a lot of debt from our balance sheet. Investors (you guys) won't be able to easily measure the extent of our GMAC risk, which, as a result, means our share price probably won't tank in line with the other subprime lenders.

So, here's where things stand now – officially.

Like the crew on a sinking ship, we've shoved overboard as many hard assets and employees as we possibly could over the last year. We sold our investment in Suzuki ($2 billion). We sold our desert proving grounds in Arizona. We sold our investment in Fuji Heavy Industry. We liquidated a joint venture with Fiat. And we've spent $5 billion-$7 billion (we don't know the real number) on paying off union employees to retire, so we can close down money-losing production lines. We even cut our dividend in half – and, honestly, we can't afford even that diminished amount.

We've done a great job cutting costs. Our total operating expenses declined last year by 17%. Even so, our ongoing operations (leaving out all of the special charges) in the fourth quarter lost $132 million. All of our fourth-quarter "profit" came from nonoperating income (asset sales) and tax benefits, which will not recur. For the whole year, things look a lot worse because most of our cost cutting didn't benefit the company until the end of the year. Our operating loss for all of 2006 was $7.6 billion. I don't have to tell you that losses like that, if they continue, will surely bankrupt us.

Now, let's talk about the balance sheet.

There has been a lot of talk in the press about the size of our cash balances. Unfortunately, that's a lot of smoke and mirrors designed to fool the credit-rating agencies. The truth is pretty ugly. We've got about $64 billion in cash and cash-like holdings. But we also have $67 billion (that's $3 billion more) in current debts. You can imagine our cash position as being a lot like what your checkbook probably looked like in college: You weren't bouncing checks, but only because they took three days to clear.

I've saved the really bad news for last. The truth of the matter is we've been operating at a capital loss for a long, long time. Simply put, it's been a while since we made enough money to pay interest, invest in our business, and pay dividends. As a result, we've racked up a stupendous amount of debt. Even after selling our finance operations, we still have $33 billion of long-term debt, $50 billion of post-retirement benefits other than pension benefits, and $15 billion of deferred income taxes. (Take another look at our post-retirement obligations. Any wonder why Detroit has more pharmacies per-capita than anywhere else in the world?)

Even if you assume that our post-retirement benefit obligations don't grow faster than interest rates (and that's not a safe bet) and even if you assume future losses will offset all of our tax obligations, we're still staring down the barrel of more debt than we can afford to service. You can probably do the math in your head: $83 billion of long-term obligations multiplied by steadily rising interest rates, thanks to our deteriorating credit ratings. If you estimate a 7% rate for 2007, you'll see that we need to make at least $5.81 billion from operations just to pay interest. There's also a very good chance that interest on our debt will increase more than I expect. In the last year alone, the average interest we pay, globally, on our entire debt portfolio increased from 5.25% to 6.01%. In the last two years, we've gone from being one of the best credit risks in the world to being a junk-bond debtor. This fact, more than any other, makes it very unlikely that we'll escape bankruptcy.

The simple fact is, we can't afford our debts. We haven't made more than $5 billion from our car operations in a long, long time. Probably not since 1992. It's very, very unlikely that we'll ever make that kind of money again because we're facing never-ending declines in our global market share. Back in 1992, we controlled about 30% of the world's car business. Last year, despite the progress we made in launching some great new trucks, our global market share fell to 13.5%. And that's down from 14.1% in 2005.

As I hope you can understand, unless something radical happens to free us from our employee obligations, there is no way I can honestly tell you that GM will not go bankrupt.

Please invest accordingly.

Your Chairman.

Regards,

Porter Stansberry

Baltimore, Maryland

March 14, 2007

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