November 17, 2010

GM’s IPO: Uncle Sam’s Pump and Dump?

Filed under: Business Moves,Economy,Taxes & Government — Tom @ 8:53 am

Note: This post went up at the Washington Examiner’s OpinionZone Blog and was teased here at BizzyBlog on Monday.

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“We aim to increase our vehicle profitability by maintaining competitive incentive levels with our strengthened product portfolio and by actively managing our production levels through monitoring of our dealer inventory levels.”

– From Page 5 of General Motors’ S-1 Prospectus (bold is mine)

The initial public offering (IPO) of Government/General Motors is apparently ready to roll.

Why hasn’t anyone asked the company or its federal minders why they have from all appearances artificially created over $1 billion in U.S.-based EBIT (earnings before interest and taxes) through October by overstuffing its dealers with excessive levels of inventory?

According to the Wall Street Journal’s cheerleading Andrew Bary, the IPO is generating a great deal of fanfare. The Associated Press’s Sharon Silke Carty is decidedly less enthusiastic (“the world’s most charming used car salesman couldn’t cover up major concerns”), identifying four good reasons to for investors to sit the IPO out. One of them is that “Years of fuzzy math (are) still not fixed.”

From here, it seems that the company has created a unique category of fuzzy math: shipped-ahead profit.

The opportunity for manipulation arises in how vehicle manufacturers recognize sales. The related policy is identified in GM’s S-1 prospectus (a very large document accessible at the SEC’s web site), Page F-31:

Revenue Recognition … Vehicle sales are recorded when title and risks and rewards of ownership have passed, which is generally when a vehicle is released to the carrier responsible for transporting it to a dealer and when collectability is reasonably assured.

In other words, once a vehicle is on the truck and leaves the factory, it’s a sale. There’s nothing wrong with this; as noted, it’s common industry practice. But it also gives a company trying to make its books look better than the underlying reality an opportunity to do just that.

As of the end of October, GM dealers in the U.S. were sitting on inventories of almost three months’ worth of sales, up from the low-60s only five months earlier:

GMdealerInvsAndSales

The dealer inventory build-up has occurred despite at least two factors that would normally dictate lower inventory levels. First, after eliminating Saturn, Pontiac, and Hummer, GM is down to four brands (Chevy, GMAC, Buick, and Cadillac). Second, the company has substantially reduced its dealership roster. Yes, the company did offer to reinstate 661 dealers earlier this year. But while the rebound in the number of outlets could explain an increase in absolute inventory levels, it doesn’t explain why vehicles are sitting on dealers’ lots 23-24 days longer than they were in May.

Is 86 days of inventory an abnormally high level? In ordinary circumstances, I would say so. Guidance found at SafeCarGuide.com explains why (bold is mine):

Dealers must pay the manufacturers when they order a vehicle, not when it is sold. To provide adequate numbers of new vehicles whose options satisfy most customers, dealers finance this excess inventory through the financial arm of their manufacturer or through a local bank. This financing procedure is called a floor plan. To help their dealers keep up their inventory, manufacturers return the interest the dealer has to pay on those loans (floor plan) for the first 90 days by issuing them a “holdback” check every 90 days.

If a car has been sitting on the lot for 90 days or more, all of the potential holdback profits have been wasted on interest payments that the dealer makes to floor plan (finance) the vehicle. After 90 days, the dealership has to dip into its own profits to keep the car in inventory. So on vehicles that the dealer has had for over 90 days, holdback won’t help you at all.

Other guidance I have read indicates that dealers ordinarily try to keep their inventory levels at 45 or fewer days.

Thus, you would think that GM’s thousands of dealers would be squawking about holding so much inventory. But the circumstances of the company’s high-pressure, high-stakes IPO are certainly not ordinary.

You might be surprised at how much maximizing product shipped out the door — to heck with the long-term consequences — enhances reported profits. That’s because the variable costs associated with producing a vehicle are fairly low when compared to its selling price.

The only truly direct costs involved in vehicle production are materials, direct labor, and directly-consumed energy. Virtually everything else is at least in the short run essentially fixed, i.e., they are costs that will be incurred anyway regardless of the level of production. For example, you’re going to have a certain level of supervision no matter what; the costs of supervision don’t increase much, if at all, if production increases within a certain range. Pretty much the same number of workers will be involved with maintenance whether you’re producing 60 cars an hour or 80. Many fringe benefits, particularly health care costs, aren’t affected by production levels. You’re going to have to keep your factories’ lights on no matter how many cars they produce. Property taxes don’t change. Depreciation charges are fixed in the short run.

Companies justifiably guard the related cost data carefully, and you ordinarily won’t find information at the level necessary to nail down variable profit in a company’s financial statements or regulatory filings. Thus, specific data relating to variable profit is elusive.

But in 2007, Forbes Magazine carried this interesting tidbit:

Strategy consultant AlixPartners estimates a manufacturer earns $8,000 to $14,000 variable profit on each pickup it sells, but zero to $6,000 on each car.

Thanks to cost reductions achieved in its encounter with bankruptcy, GM’s variable profit is probably near the high end of both ranges; it wouldn’t surprise me if its variable profits are even higher. But to be conservative in the accounting sense, let’s assume that the variable profit numbers are $12,000 each for pickups (light trucks) and $5,000 for cars. If so, here is how GM benefited during the first three quarters of 2010 by putting 93,000 more vehicles onto dealer lots (478,000 minus 385,000 above).

  • Using sales data from the third quarter, GM’s domestic product mix is currently about 36% cars and 64% light trucks.
  • If dealer inventory is similarly proportioned, dealers had about 33,500 more domestic cars on hand on September 30 than they did on January 1, and about 59,500 more trucks.
  • That represents $167 million (33,500 x $5,000) in sent-ahead profits on cars and $714 million (59,500 x $12,000) for light trucks, for a total of $881 million.

That $881 million would represent about 18% of GM’s EBIT from its North American operations of $4.935 billion during the first three quarters of 2010 (from Page 75 of the Notes to Financial Statements in the company’s third-quarter 10-Q filing).

About $663 million of that sent-ahead profit has occurred since May’s trough in dealers’ days sales in inventory (70,000 of the 93,000 total increase x $881 million). Serious talk of the company going public began at about that time. Coincidence?

Early indications are that GM isn’t interested in taking chances on whether or not its closely-watched fourth quarter will be profitable. During October alone, it shipped ahead roughly $350 million in EBIT on a 37,000-unit dealer inventory increase that seems totally devoid of any ordinary business justification. That brings the company’s year-to-date shipped-ahead total to $1.23 billion ($881 mil + $350 mil), and the since-May total to just over $1 billion ($660 mil + $350 mil).

So is GM “actively managing its production levels” as described in the opening quote above by forcing its dealers to in essence give up their holdback profits as described in the name of a “successful” IPO? Or has the company made some kind of a special arrangement with its dealers — perhaps an extraordinarily long interest-free holding period — to make holding excessive inventories more palatable until the IPO is out of the way? Will it embark on a campaign to reduce dealer inventories — and reduce reported sales and profits — in 2011, after the hoopla surrounding the IPO and its immediate aftermath die down?

Has anyone involved in underwriting or promoting GM’s IPO even asked these questions, or about other potential “clever” profit enhancers the company might have employed?

Lucid Links (111710, Morning)

Filed under: Lucid Links — Tom @ 8:13 am

I you think that the $600 billion Ben Bernanke announced in connection with QE2, the second round of “quantitative easing” (otherwise known as “electroinically creating money”) is the upper limit, think again:

Charles Evans, president of the Federal Reserve Bank of Chicago and a strong supporter of the Fed’s easing policy, noted in an interview with The Wall Street Journal that the weak economy and low inflation warranted the Fed’s action and that more such purchases might be needed in months ahead if the economic outlook doesn’t turn. “I would continue to want to apply accommodative monetary policy until I had some confidence that that situation was changing,” Mr. Evans said, noting that $600 billion is a “good place to start” the easing program.

The odds that we’ll have to dust off the wheelbarrows are increasing. Here’s one lesson of history the smarties seem to have forgotten — “In Germany the Weimar republic began printing excess money in 1919, but the hyper-inflation didn’t take hold until a few years later.”

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The Nanny Statists just keep going and going (HT Say Anything via Instapundit) –

Transportation Secretary Ray LaHood said using a cell phone while driving is so dangerous that devices may soon be installed in cars to forcibly stop drivers — and potentially anyone else in the vehicle — from using them.

This proposal represents strike three against LaHood, following these two previous items:

  • He’d like to tax every mile you drive (first item at link), instead of (in the real world that means “in addition to”) every drop of gasoline you consume.
  • He wants to “coerce people out of their cars.” Yes, those were his words (fourth item at link).

Ray LaHood is in his own way every bit as bad as Norma “No Profiling” Mineta, whom Rich Lowry described in 2002 as having “ignorance (that) appears to be nearly invincible,” ever was.

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Item (HT Powerline), based on a deliberate hit by political operatives in the Obama Department of Justice:

According to the DOJ report, Christie — favored by many conservatives to run against President Obama in 2012 — spent a total of about $2,000 more than his budget allowed on 23 trips he took between 2007 and 2009.

… Tom Fitton, the president of DOJ watchdog organization Judicial Watch, agreed with that sentiment, telling TheDC that his first instinct was that the report was nothing more than a hit job from an “ideological and hostile Justice Department that leaked the report.”

The linked Daily Caller item makes it clear that Fitton is correct.

Powerline notes that the actual amount involved is “a whopping $2,176″ (less than $100 per trip, spread over three years), and that “Most of this was because Christie stayed at hotels where he was to deliver a speech the next day.”

The federal government currently spends the annual amount Christie allegedly “wasted” of $725 per year ($2,176 divided by 3) in less than .007 seconds (seriously), and probably spent far more than $10,000 to produce a report about an alleged $10,000 in overspending.

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From Bloomberg via Zero Hedge:

A deal to extend soon-to-expire Bush-era tax cuts won’t be completed until December, and some Democrats in Congress said an accord may not be reached this year.

“I don’t even know what the options are at this moment,” Senator Maria Cantwell, a Democrat from Washington state who serves on the tax-writing Finance Committee, said yesterday.

ZH translation: “nobody even has a clue what is going on.”

As readers here know, what they’re really talking about is whether they’ll let a tax increase on everyone who pays taxes after eight years of having essentially the same tax system in place (2003-2010) just happen automatically.

Increasing taxes on anyone in an economy that is barely recovering after a recession is a big mistake. It’s among many things that Herbert Hoover did to make a bad situation worse while he was still at the helm in the early 1930s.

Specifically relating to taxes:

By 1931, excessive government spending on these programs created a deficit that could only be remedied by higher taxes. So Hoover approved the largest peacetime tax increase up to that time. Taxes were raised on virtually everything, including individuals and businesses. Raising taxes deterred many from private investment, thus stunting economic growth and preventing job creation even further.

The larger historical lesson — one not taught in the FDR-adoring schools (bolds are mine):

Led by President Hoover, the government embarked on what (Dr. Benjamin M.) Anderson has accurately called the “Hoover New Deal.” For if we define “New Deal” as an antidepression program marked by extensive governmental economic planning and intervention-including bolstering of wage rates and prices, expansion of credit, propping up of weak firms, and increased government spending (e.g., subsidies to unemployment and public works)-Herbert Clark Hoover must be considered the founder of the New Deal in America. Hoover, from the very start of the depression, set his course unerringly toward the violation of all the laissez-faire canons. As a consequence, he left office with the economy at the depths of an unprecedented depression, with no recovery in sight after three and a half years, and with unemployment at the terrible and unprecedented rate of 25 percent of the labor force.

Hoover’s role as founder of a revolutionary program of government planning to combat depression has been unjustly neglected by historians. Franklin D. Roosevelt, in large part, merely elaborated the policies laid down by his predecessor. To scoff at Hoover’s tragic failure to cure the depression as a typical example of laissez-faire is drastically to misread the historical record. The Hoover rout must be set down as a failure of government planning and not of the free market.

80 years later, we’re on autopilot to do the same thing.

Positivity: Rescued After 18 Hours At Sea, Man Finally Home

Filed under: Positivity — Tom @ 5:58 am

From Colorado Springs via Clearwater, Florida (video is at link):

Nov 16, 2010 4:14 pm US/Mountain

He didn’t think he’d see his family again, but on Tuesday Ken Harper woke up home in Colorado.

Harper was involved in an accident while fishing in Clearwater, Fla. He and two friends spent 18 hours clinging to the boat after it capsized. On Monday his family was there to greet him when he arrived at Denver International Airport.

“It’s wonderful to be home,” Harper said. “It’s very nice.”

“Just being able to lay my eyes on him and put my arms around him was the best feeling in all of life,” Harper’s wife Marva said.

Harper said all he did was hold on minute to minute, hoping to get rescued.

“I knew if I could do that, as long as I was physically capable of going that, then I’d be okay,” Harper said.

Many of those minutes involved a battle against 5- and 6-foot waves.

“Every time a wave would come over it would shove the life vest up; and just getting banged against the boat. My legs are sore; jellyfish stings and stuff like that; nothing I can’t heal in a few days from,” Harper said.

Thoughts of his family helped him to persevere.

“A situation like this focuses you significantly on what’s important and what’s really not important and you come to the conclusion about the only thing that’s really important is your friends and family.”

The Coast Guard spotted the group Saturday morning. …

Go here for the rest of the story.