Petro-Politics, Releif for the US Economy, and General Motors 10-24-2008

Relief for the US Consumer and Petro-Politics

Oil dipped below $70 per barrel in trading late Thursday for the first time in over 12 months. Aided by a stronger US dollar and weaker global demand, the price of light sweet crude has been in steady decline. Much to the delight of US consumers and the chagrin of OPEC and other oil rich dictatorships around the globe, an enormous tax on the US marketplace is finally being trimmed, and it couldn’t have come at more critical time.

The US consumer faces tough challenges as we head into the all-important holiday buying season. Recession fears have brought real economic slow down; and though the US consumer has always led us out of such difficulties, it hasn’t appeared likely that retail purchases would lead us towards economic strength again. Fortunately, declining fuel prices may leave $20-$25 more per week in consumer pockets than only a few short months ago; and this, coupled with renewed talks of another economic stimulus package, just may save the retail season, while at the same time provide much deserved economic pressure to unfriendly oil producing nations rarely sympathetic to US concerns.

This is a good news, good news story, with a bad news chaser. The decrease in demand that has driven some of oil’s price decline represents a domestic and global economic slowdown that won’t retreat for at least two or three calendar quarters. It is also indicative of a shift in our country from being net spenders to net savers as many have realized that their lifestyle demands simply grew beyond their resources. This shift will be uncomfortable as families adjust spending patterns, but will ultimately yield benefits as savings levels ultimately support capital investment and a more secure financial foothold for consumers.

With the dramatic retreat in the oil markets, the likes of Venezuela, Russia, Iran, and Saudi Arabia, currently awash in US dollars due to oil prices well over $100 per barrel, exporters of tremendous pressure on the US’s political and military establishments, will now have to face their own problems at home, without the aide of hundreds of billions of excess US dollars. As their corrupt leadership attempts to deal with the domestic unrest already being felt as a result of sharp declines in oil revenues, their citizenry may finally call for action and accountability where there has simply been rhetoric and excuses for years.

Over the past several years, these nations have exported fear, terrorism, and excessive anti-American sentiment alongside the enormous quantities of high-priced oil. Today, not only are oil prices down, but the volumes are in decline as well, making it more difficult for these countries as the value of their currency is declining against the US dollar. The convergence of these three important financial events equates to a tremendous loss of political, social, and economic strength for some of the US’s least cooperative foreign leaders.


General Motors and the three ‘C’s: Corvette, Cadillac, and Camaro

The upheaval in the American automotive industry took a sharp turn for the worse with the dramatic increase fuel prices this last year. As oil made its historic run to eventually top out at over $147 per barrel, the US transportation market was left bleeding in its wake. Airline, railroad, transports, and SUV manufacturers were devastated. The loneliest road in America, formerly the section of US Highway 50 running through central Nevada, all of a sudden became the approach road to any Hummer dealership in the country. Just as oil prices turned back towards $90, $80 and then $70 per barrel and fuel prices began a sharp decline, the credit crisis surged to strike yet another blow to automobile sales. For some, the blow may have been fatal.

US auto sales have fallen sharply in recent months. Overshadowed by the decline in housing prices, the credit crisis, and the turmoil on Wall Street, the US automotive industry has been fighting for its life, or at least its asset value. Successful auto dealers reported having difficulties making payrolls a few weeks ago and stock values plummeted. Ford Motor Corporation bottomed out today at $2 per share, down from a 52 week high of $8.75. And General Motors looks like a multi-car wreck taking place before our eyes.

Over the past few years we’ve commented several times that some form of reorganization must be part of General Motor’s (GM) long term business plan. The enormous legacy costs they carry from millions of former employees, many of whom are current retirees, is crippling, especially in light of continued upward revisions in their underfunded pension and medical benefit costs. When GM ruled the domestic market and proudly supported a major national labor force, they were better able to compete with other US auto manufacturers and appease the ever-hungry labor unions. But today, with only a fraction of the weakening US auto market, a labor force that bears little resemblance to the army of technicians formerly on GM’s payroll, and extraordinary pressure from foreign automobile brands, many with US manufacturing operations, GM is in serious trouble.

Two weeks ago GM’s corporate credit rating was downgraded by Standard and Poors, and the stock went into a tail spin to close at $4.00 per share, down from a 52 week high of $39.45. Without the appropriate credit rating, GM may barely be able to hang on through the end of the year without some sort of intervention, whether from a bankruptcy filing, takeover bid, or sale to a private equity firm.

Analysts project that GM’s current cash position will only support operations through 2009, after which the unthinkable could possibly occur. But GM has tremendous value if it can be stripped of its legacy costs. Several of GM’s domestic brands still rate extraordinary loyalty from enthusiasts: Corvette, Cadillac, Camaro, the three ‘C’s of the automotive world are alive and racing, literally. GMAC, though tainted through association with the sub-prime mortgage disaster, remains a powerful, and profitable, financing arm. GM’s dealer portfolio is impressive and includes some of the wealthiest and most successful auto dealers in the country. And GM’s manufacturing operations control vast pools of real estate, technology, and skilled labor world-wide.

Some of GM’s future strength may rest in emerging markets and green technology, but other manufacturers are developing those same markets and technologies in what may ultimately be a fast-paced, high-stakes game of musical chairs. The likes of Toyota, Nissan, Honda, Ford, Chrysler and others have invested billions towards the same end, and it’s likely that only one or two companies will be able to capture the right technologies, in the right markets, at the right time to win big. Though most of the others will be able to ride some of the same wave, some brands won’t survive, and the others will spend years playing catch-up.

The GM brand will almost certainly survive, but without some of the baggage that currently holds it down. If a corporate reorganization was part of GM’s long-term business plan before, it’s likely to be part of its short-term strategy today. A bankruptcy would rid GM of its excess pension and medical liabilities, give it room to breathe as it restructures debt, and allow it to remake itself as a leaner, greener domestic and international manufacturing powerhouse once more.

Unthinkable only a few short months ago, GM is now inexpensive enough for a private equity firm to make a credible run at the company. Cerberus Capital Management, LP, the private equity firm that owns Chrysler, Air Canada, and the half of GMAC that GM no longer owns, is reportedly in talks with GM executive leadership to acquire the auto manufacturer. Cerberus has made no secret of its interest in owning the entirety of GMAC, and if it has to purchase the auto manufacturer to gain control of its lucrative financing arm, then so be it. This was Cerberus’s strategy in acquiring Chrysler, but it quickly realized that the manufacturing concern took more of the luster off of Chrysler Credit than it had bargained for. An acquisition of GM would allow Cerberus to merge the two automobile manufacturers, gain enormous economies of scale, perhaps shed some the legacy cost liabilities in the process and reintroduce GM/Chrysler to the public markets. Cerberus could possibly be left with the financing arms they’ve long sought after, and end up saving two automotive legends at the same time. The logistics of such a transition would be enormous, and the painful red ink that might be written at the dealer level could take years to erase, but the Corvette would still be an American icon, Cadillac could continue to reign as an American luxury brand, and Camaro could once again steal the hearts of teen-agers (young and old) throughout the heartland.