Letter From the Chairman of GM: 'Don't Say I Didn't Warn You...'

Why Ukraine is 'in a very sweet spot'...

Yesterday, S&A Global Contrarian editor Kim Iskyan shed some light on the recent uproar of protests in Ukraine.

Today, he explains why these events are setting up a profitable opportunity for investors...

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Editor's note: Our favorite corporate suit is back… The "Chairman of GM" has penned another in the series of satiric letters we've published over the years. We hope you enjoy it...

Dear shareholder,

I knew it wouldn't last. And I tried to warn you.

In my last letter to you, I explained that our third-quarter "adjusted" financial results – which were being used by Wall Street to sell our bond issue and hype our stock – weren't representative of our operating reality.

As I said at the time…

"These numbers are presented on an 'operating" basis... our real earnings... the earnings attributable to common-stock holders... fell by about 50%. Even worse, our market share in North America fell, too – even in trucks... The truth is, we're barely hanging on to the market share we've got. Yes, trucks bolstered our results. And yes, we sold a lot of trucks. But we didn't sell nearly as much as our competition. We actually lost market share in the U.S. truck market."

And as I knew it would, reality soon intervened.

Our company's fourth-quarter results, which we reported to the public two weeks ago, showed a far different picture of our business. To save both of us a lot of time and useless study, I'll simply summarize the key figures below. (Our financial reporting continues to be as opaque and useless as ever. Our fourth-quarter financial "highlights" summary press release was 14 pages.)

Here are the important numbers for the fourth quarter:

Revenues: Up marginally – by around $1 billion, or 3%. Selling new model trucks at a higher price generated all of this increase. Unfortunately, a record number of those same new trucks are on our dealers' lots, where they will have to be heavily discounted/rebated. (More about that below).

Net Income: Flat.

Automotive Free Cash Flow: In my view, this is the crucial statistic: Are we making money selling cars? For the quarter, we booked $2.75 billion in cash from selling cars. (Again... as I'll explain... a lot of that revenue came from "channel stuffing.") We invested another $1.7 billion in our car business, resulting in free cash flow from automotive operations of $1.12 billion in the quarter. That's down from 2012's fourth-quarter free cash flow of $1.13 billion.

We accomplished these fourth-quarter results by shipping huge volumes of our new Silverado pick-up truck out the door before the end of the year. Our dealer lots are now bulging. Our dealers are sitting on a record level of cars and trucks – more than 110 days of inventory. Normal inventory is 60 days.

Meanwhile, for accounting purposes, we counted as "sold" any car or truck we shipped last year. So when you're looking at our fourth-quarter numbers, you should be aware that even though we missed Wall Street's profit forecast by nearly 25%, we did so using sales volumes and prices that weren't real.

For example, we claimed profit margins of 7.5% in the quarter. Meanwhile, to move the vehicles off the dealer lots, we had to discount by about $7,000 per vehicle over Presidents' Weekend. Those rebates will hurt our results going forward and will make it nearly impossible for us to maintain the higher prices we were asking for last year.

Or said in a more colloquial way, all of those "adjusted results" we bragged about last year were just a bunch of bull. Meanwhile, we used those numbers to sell billions of dollars in new bonds to investors.

Plus, the global auto industry in general faces major problems.

For example, Australian production has completely ceased because the government refused to continue paying billions in subsidies. Production has moved to cheaper markets, like Indonesia. These economic pressures, along with generally high levels of overcapacity (promulgated by politicians who will do anything to prevent plant closures) continue to make it difficult for anyone to grow profit margins.

And as I've continued to warn you, GM is particularly ill-suited to compete in this kind of market.

Last year, Fiat-Chrysler saw profits grow by 118% (coming off a low base). Daimler grew profits by 6%. And Ford, our closest rival, saw profits grow by 26%. Our company, even with a huge new truck launch and the re-launch of the Stingray Corvette, saw profits decline 14%.

The problem we face as a company is easy to see... if you're willing to look.

It's not just overcapacity. As I've told you several times, our core problem is that we're no longer being run by capitalists on behalf of shareholders. Instead, the UAW union holds the real control of our company.

Consider this. Our results attributed to common shareholders declined materially over the last year. But by stuffing our dealers' lots full of trucks, we were able to report that GM North America produced record "earnings." That entitles our 48,500 hourly workers (read "union members") to a $7,500 cash bonus.

Just so we're clear about the size of that bonus, that's a check for $363,750,000. What are the odds that extra compensation of that magnitude might have influenced our managers' decision to stuff the channel?

Our most urgent problem is that to compete with Ford and others, we've drastically lowered our credit standards. Since 2011, we've been offering subprime credit to buyers in massive amounts – more than $10 billion in total. Pushing this much credit onto uncreditworthy borrowers pulls demand forward and will reduce demand in later quarters. This is the main reason I expect we'll see a major sales slump in 2014.

The other issue is that our brand – already tainted by the government bailout – is increasingly associated with the poorest buyers. This will make it hard to raise our prices in the future.

Given the amount of overcapacity globally in the car business, the size of our legacy obligation to the union's pension program, and the union-focused management of our company, I believe GM will at some point be forced to file for bankruptcy again. A filing is not imminent. These problems will surely take a long time to reach maturity. But they are now becoming apparent for the first time, even to outside investors.

In 2013, several famous investors – including Berkshire Hathaway and Kyle Bass of Hayman Capital – became investors in our company. This excited the general public and surely led many to purchase our shares. As the problems in our company become more widely known outside of senior management circles, you should expect these investors to sell. Knowledge that they've done so will probably send our share prices back down again.

If you're asked about my view, please remember the warning I've given you for a long time: What's happening with us is a microcosm of what's happening with the rest of our society. Where once GM's employees sought only a fair opportunity for greatness, now they seek the false security of collectivism.

Just imagine paying more than $300 million in bonuses on the back of near-fraudulent business practices, during a year when profits declined substantially and more than all cash flows were sent directly into the union's coffers. This isn't capitalism.

I continue to believe that all of our profits... and more... will end up in the hands of the unions and retired workers.

For example, we produced $3.7 billion last year in automotive free cash flow. From these profits, roughly $1 billion was spent paying dividends to the union via its preferred stock and another $3 billion was spent buying back these preferred shares. So we spent more on the union than we earned.

This is what prompted our return to the bond market for capital. At some point in the future, we will also have to pay into the legacy pension fund, which remains underfunded by $20 billion. Yes, $20 billion.

We might have gone bankrupt in 2008. But judging by our legacy union obligations, you'd never know it.

I believe that overcapacity will continue to drive profit margins lower and result in declining market share for GM.

I was surprised last year to see profit margins increase (market share continued to decline). But as we know now, those higher prices and higher margins created a huge glut on dealer lots. Those weren't real. Our first-quarter 2014 results will offer a much more honest picture of our business. And trust me, we won't see 7.5% profit margins.

I continue to believe that we will be forced to borrow massively from Wall Street to finance the buyers of our cars and contributions to our pension fund.

This process has begun. Last year, we borrowed $6 billion from bondholders. And these debt issues will accelerate. Soon – within five to 10 quarters – Wall Street will begin wondering if we are a reliable credit. Please keep in mind: If we cannot service these new debts (and they will grow very large), our common stock is almost certain to be rendered worthless.

A great example of the real, tangible, long-term risks we face because of our capital weakness and the influence of politics in our management was the announcement by Ford that it will launch all-aluminum pick-up trucks later this year (2015 model year). We will not be able to match this product until 2018 – at the soonest. That's because we cannot afford to match Ford's research and development spending, which has been among the largest in the world for decades.

It's also because we spent so much time and energy on the Volt – an electric car nobody (except the Obama administration) wanted and that we lost billions on.

Anyone want to buy a used Volt?

No?

Well, it's probably a better investment than our stock.

Regards,

Your Chairman

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In today's mailbag, a couple of subscribers comment on their new services. Send your e-mail to feedback@stansberryresearch.com.

"Jeff Clark is putting out some great stuff. I am attempting to start options. With his recommendations I feel confident." – Paid-up subscriber Charles McDonald

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Regards,

Porter Stansberry
Baltimore, Maryland
February 21, 2014

Editor's note: In yesterday's Digest Premium, Kim Iskyan, editor of the S&A Global Contrarian, shed some light on the recent uproar of protests in Ukraine. Today, he explains what's next... and why Ukrainian stocks are offering a good value today.

The price of Ukraine's sovereign bonds has plummeted.

Yields on $1 billion of Ukraine bonds maturing in June have increased from 6% in early January to 34% today... At one point, yields hit a record-high 42%. Remember... higher yields mean lower prices for bonds.

But I (Kim Iskyan) expect that Russia won't let its would-be client-state default. Ukraine doesn't have cash... but its debt level isn't enormous, and Russia might be holding off on the next bundle of funds in its bailout program for maximum leverage.

I've also read a lot about the scope for civil war in Ukraine. Things look bad now... but I doubt they'll go that far. Russia's hands are tied right now because the world's eyes are focused on the Olympics. Then, Russia might not be as restrained as it has been. As it showed in its short war in Georgia in 2008, Russia isn't afraid of using guns.

Ukraine could still go in the direction of the West. I recently spoke with a well-connected friend who works at a big international lending organization. He told me that contrary to what you read in the press, Ukrainian oligarchs are abandoning Russia and siding toward the European Union.

Ultimately, money calls the shots... and politics follow. So if the country's big money is rejecting the idea of moving closer to Russia, the politicians can fiddle and people can protest, but the country won't be moving toward Russia. But today, that's a very contrarian perspective.

Meanwhile, Ukrainian stocks have collapsed. Ukraine isn't slipping off the map. There is a big "blood in the streets" buying opportunity coming up (if it's not already here). My prediction is a lot more messiness between now and a resolution... But Ukrainian shares will be much higher a year or two from now.

Already, asset managers like Franklin Templeton are adding to their Ukraine positions. Mark Mobius, Franklin Templeton's famed emerging-market investor, told news-service Reuters that Ukraine is "in a very sweet spot" economically... It has the Europeans and Russians who both want to help.

– Kim Iskyan

Why Ukraine is 'in a very sweet spot'...

Yesterday, S&A Global Contrarian editor Kim Iskyan shed some light on the recent uproar of protests in Ukraine.

Today, he explains why these events are setting up a profitable opportunity for investors...

To continue reading, scroll down or click here.

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