The French Solution? Really? (GM)

As I wrote back in March, I spent some time seriously considering purchasing General Motors corporate bonds. The prices were quite low and seemed to assume a high likelihood of bankruptcy, and Martin Whitman at Third Avenue was writing about opening a GM debt position and looking for more.

It turns out, with GM's recent stock recover, that this would have been a good idea at least as a short term play. I didn't buy in at the time and I don't want to now, but I have been paying attention to the General Motors story.

And this latest development about a three way transnational merger of some sort has me a bit confused. I have to say, I'm with the CEO on this one -- I can see why the board is being pressured into investigating this option, since Kirk Kerkorian wields such a heavy hand as a minority shareholder and it's more or less his idea, but I hope they don't go too far with it.

There was a good column in the Washington Post today on this -- and a couple of key points from that article are interesting to note:

1. The only thing Renault, Nissan and GM have in common is that they're all losing market share in their domestic markets.

2. When did merging with a major French company become a good solution for anyone?

I think it's key to note that what we'd be talking about with a Renault/Nissan/GM merger is a merger of companies that are all quite troubled -- and not because they're too small. GM is already doing better overseas than they are in the US, for the most part, so why merge with companies that are losing share in Japan and Europe.

If you want to hire Carlos Ghosn, try to hire him or throw some money at Nissan to get them to give him up -- but why on earth would he be able to solve GM's pension, car design and health benefit problems when other talented executives have so far failed? They're hard problems, they're going to take time and creativity to solve -- Ghosn essentially helped to turn around Nissan by focusing on a few new car models ... which seemed to work pretty well, for a while, for a small company that only had a few models. If it sounds familiar, it's the same thing Iacocca did at Chrysler with the K-car and the minivan.

That's not going to cut it for GM with their multitude of nameplates. They may need outside management, or different management, but I can't imagine there's any kind of quick fix in the cards for them.

No, this looks like the "quick, do something" management strategy at work -- do something to boost the stock price, not something that's going to help a business recover (that, after all, would be hard work, and probably wouldn't earn any extravagant bonuses or friends on Wall Street).

No, thanks.

And on the French front -- after seeing how major French companies, from Alstom to Airbus to Alcatel, have performed, and how much political pressure they face at home to remain employment agencies and French champions above all else, why would you want to sign yourself up for a slice of that pie? And hey, Alcatel's management can't have been feeling great about business if merging with Lucent seemed like a good idea ... is that where Renault's coming from?

GM debt may still be a good deal even at the reduced yield you'd get today, though I expect the share price will decline again once it becomes clear that merging three mediocre car companies is not going to create one great one. I still don't believe GM will go bankrupt, but I'll continue to watch this one from the sidelines.

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Are GM Bonds really cheap?

The number of folks who are writing about their interest (or putting their money where their mouth is) regarding GM bonds seems to be rising over the past few months.

I just read Martin Whitman's latest letter to Third Avenue Value Fund shareholders where he explains his rationale for opening a small position in some senior unsecured GM debt. It's worth reading yourself, as all of his letters are worth reading, but his basic rationale is that the unsecured debt -- trading at less than 60% of face value with about a 15% yield when he first bought in -- has very little downside.

No surprise in that assessment, since "safe and cheap" is the core investing principle of Third Avenue. He goes on to say that the senior unsecured debt has some extra protection because of GMs stable of profitable divisions and investments (to go along with the very unprofitable ones) and what he perceives as a national interest in keeping the GM common stock from becoming completely worthless in whatever kind of reorganization GM has to undergo (either voluntary or chapter 11). If the common stock is to be left with any value in a chapter 11 proceeding, everything higher on the food chain will have to be compensated significantly more ... including the unsecured debt.

Whitman does state that he certainly sees dramatic operating risk in GM -- he thinks any reorganization is likely to be relatively low risk for bondholders, it appears, but also thinks that there will be significant risk for holders of GM common stock coming out of a reorganization (and if GM files for bankruptcy, the bondholders will likely end up with common stock of the reorganized company, not with cash). Reorganization won't fix their product lineup, but it will give them a chance to breathe without their legacy costs hanging over their heads and preventing the company from making a profit. What happens after that is anyone's guess and has a lot more to do with management and the vicissitudes of the marketplace than with balance sheets or cash flow.

Every time I read one of Whitman's letters, I regret that I don't have any money invested in his flagship fund. I do have holdings in two other Third Avene funds that follow the same strategy in particular sectors -- International Value and Real Estate -- and these have been spectaculary successful investments, with excellent managers in their own right. But the Value Fund that Marty runs is, I'd say, the closest thing to a top notch hedge fund (with much lower fees) that most of us small investors have available to us. His letters should be just as much required reading for anyone interested in value investing as Warren Buffett's.

GM debt has come across my radar screen a few other times as well, which is saying something because I'm not generally interested in investing in bonds of any sort at this point in my investing life.

Random Roger wrote about it last month and included a nice table from a January Barron's article listing a few of the widely traded bonds that you can get on the NYSE (GM has a lot of NYSE traded debt, with par values of $25, that are trading between $16 and the low $20s -- I don't know whether Third Avenue is invested in these issues or in others). Older articles from last summer touched on this, too, with a Washington Post article citing another bull on GM debt after a big drop, and lots of discussion on the other side, too -- including this blog post from Controlled Greed.

So is it really worth it to dabble in these junk bonds of a company that may well go through bankruptcy? I don't know, but I'm starting to think that if I want to do so I should make a move soon, given the potentially positive news coming out of GMs labor talks following the Delphi deal today. If GM stock trends higher, the bonds are soon going to stop providing the nice 10-15% yields that most of these issues are getting (and in some cases yields to maturity or call could be dramatically improved on the convertible issues if GM stock does return significantly to favor).

I'll be looking them over as I can over the next couple weeks or so -- this is clearly not an area where a little investor is going to have the leverage that the big houses or even Third Avenue can have in a targeted debt investment, but the large array of available exchange-traded GM bonds makes this, at least, an interesting exercise ... especially if we accept Whitman's argument that a solid return might be achieved on these types of investments even in a Chapter 11 filing.

The NYSE tickers for a few of the big $25 par value issues, for anyone interested in researching these folks, are GMS, GXM, GBM, GKM and GPM, maturities are out anywhere from 25 to nearly 40 years, though some can be called or put or converted at various points.

I still find it hard to look past GMs wounds that are gushing cash everywhere, none of which seem to be all that close to healing, but maybe I'm not seeing the big picture. Let me know if you have any thoughts on these bonds or on GM as a whole -- I definitely wouldn't buy the stock, does that make buying the bonds a dumb idea?

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