Porter Stansberry: Wall Street can be that wrong, it happens all the time…
From Porter Stansberry in the Stansberry Digest:
It might be time to ask ‘The Chairman’ to start writing to us again…
In today’s Friday Digest, I (Porter) would like to show you why I’m convinced nothing has changed about our country’s financial foundation. Yes, our financial markets have recovered from the 2008/2009 crisis. But have we actually learned anything from those mistakes?
No. Not a thing.
As always, I’ll remind you that there’s no such thing as teaching, there’s only learning. If you want to learn about where the big cracks are in our economy and in our markets, I hope you’ll read carefully. And whether you think I’m right or completely wrong about these concerns, please don’t forget to drop me a note at firstname.lastname@example.org.
Back in the spring of 2007, I began writing ‘Letters From the Chairman of General Motors‘…
The premise was simple: General Motors (GM) was in big trouble. At the time, GM required about $6 billion per year simply to cover its interest payments. Meanwhile, it wasn’t earning anywhere close to that amount of money, nor could it. For nearly 20 years, GM had been borrowing to cover the gap between what it owed (to its pension funds, among other creditors) and what it was capable of earning.
Given these facts, I believed that the chairman of General Motors at the time, Rick Wagoner, had a legal and ethical responsibility to tell GM’s shareholders, bondholders, and pensioners that he couldn’t do anything to prevent the firm’s bankruptcy.
So I wrote these letters from the “The Chairman of GM” to highlight the enormous gulf between what GM’s leaders should have been explaining to GM’s stakeholders and what they were saying. At the time, GM faced near-term debt and pension of obligations of about $70 billion, had virtually zero earnings, and had no ability to borrow the capital it needed on reasonable terms, thanks to a credit rating that had fallen into “junk” status in 2005.
GM’s bankruptcy wasn’t merely predictable. It was 100% inevitable. As the “Chairman” explained to our subscribers in the November 7, 2007 Digest…
The simple fact is, we’re going bankrupt. It’s only a matter of time before our accountants force us to insert “going concern” language into our filings. That means they won’t approve our audit unless we admit publicly that we know we’re heading for a bankruptcy filing. That won’t be a good day to be a shareholder.
Within 12 months, GM did in fact have to insert such language into its securities filings…
Then, it did go bankrupt. And it wasn’t a good day to be a shareholder in GM. Following the publication of these letters, General Motors shareholders didn’t enjoy any more good days. The stock fell from around $30 per share to zero, wiping out billions of dollars’ worth of equity value from the business.
I was shocked by the response these letters provoked…
First, believe it not, a substantial number of our subscribers thought the chairman of General Motors actually wrote these letters! I admit, that made me laugh a bit… and then worry a great deal.
But the other response was far more worrisome. Almost all of the professional investors who read these letters assumed that something must have been wrong with my analysis.
Why? Because they didn’t believe “the market” could be that wrong. Professional investors believe the market is relatively efficient. If the situation at GM was really that bad, their thinking goes, surely the stock would already be lower, and more people would be talking about these problems. Time after time, major investors would tell me, “Porter, the market just can’t be that wrong.” As a result, investor complacency with GM was widespread and nearly unanimous.
Let’s fast-forward to today…
As you probably know, GM escaped from the financial crisis without being liquidated. The company was saved for political reasons, not rational economic reasons. Not a single private investor would provide GM with any of the cash it needed to operate during its bankruptcy. No one would even partner with the government on its efforts to bail out the company.
Why not? Because owning 100% of the company post-bankruptcy (without any surviving debts) wasn’t worth the funding required to operate the business through the downturn. That’s unusual, and shows you just how much trouble GM was in.
The private investors were right, by the way. The government lost roughly $50 billion bailing out GM, mostly because it insisted on allowing the pension funds and the unions to recoup about 90% of their losses. Again, these were political decisions, not economic ones. No private investor could have shouldered those obligations.
What has changed at GM today?
Over the past four years, GM has burned through more than $40 billion in cash when accounting for capital expenditures and the net cost of repurchasing leased vehicles. That means it’s not producing enough cash from operations to fund its capital investments (which are necessary to operate the business). As a result, GM’s debt load has exploded. It has jumped from virtually zero long-term debt post-bankruptcy to more than $60 billion today, including the addition of almost $40 billion in new long-term debt over the last four years.
Even more ominous, the company is again relying on huge amounts of short-term funding to pay for its inventories. Short-term debts (loans due in 12 months or less) have almost doubled over the past four years, from $15 billion to $27 billion. Putting all of these obligations together with its unfunded pension liabilities gets you to a total debt for GM worth more than $100 billion. More than half of these debts mature before the end of 2020.
At the moment, none of these potential problems matter…
GM’s credit rating was upgraded in early 2017 to investment-grade. That means it has access to capital at extremely low borrowing costs. Currently, GM spends less than $1 billion a year on interest.
The company is firmly back in the good graces of Wall Street’s wishful thinking. But… what if interest rates rise? What if GM’s debt gets downgraded? That will never happen?
Wall Street couldn’t possibly be that wrong… could it?
Over the past four years, GM has seen its revenues decline…
Demand for cars is highly correlated to the availability of consumer credit. As credit has become less available for subprime car buyers, GM’s sales have gotten weaker. Likewise, all of GM’s most important business metrics have declined. The company’s return on assets, which has always been weak, has fallen from 2% to negative. The same trend is apparent in all of the other, similar metrics like return on equity (now negative), return on invested capital, etc.
Its largest American competitor, Ford (F), is leaving the passenger-car business because it can’t make a profit selling cars. Maybe that’s a sign that GM’s business prospects aren’t nearly as rosy as Wall Street seems to believe. Surely, the guys at Ford know more about the car business than Wall Street’s bond salesmen, right?
Here’s another piece of evidence that GM is making all of the same mistakes again…
Its financial reporting is just as misleading and opaque as ever.
I challenge you to read any one of the company’s quarterly earnings press releases. There’s no way anyone can possibly make sense of any of the figures GM highlights about its business. Here’s the most recent headline, from April 26:
GM Reports Income from Continuing Operations of $1.1 Billion and EBIT-adjusted of $2.6 billion.
There’s no such thing as “EBIT-adjusted income.” It means whatever GM says it means. And good luck figuring that out. Its most recent quarterly press release was 16 pages long and featured an entire page filled with nothing but explanations of what its custom financial terms mean. It’s completely useless to actual investors. That’s why all of the numbers I’ve written here come from real, audited, generally accepted accounting principle (“GAAP”) financial statements filed with the Securities and Exchange Commission.
Why would the company want to use phony numbers? Why would the company desire to mislead investors? Why would the company be managed in a way that’s destined to lead to yet another bankruptcy filing?
That’s the mystery, isn’t it?
I can prove that GM is doing a “Groundhog Day” – making all of the same mistakes, just like it did before. And if you think I’ve got it all wrong, then just ask yourself this question…
Why in the world would a company – which has to borrow $40 billion in long-term debt in just four years to make up for huge cash operating short falls – spend $23 billion over the same period buying back shares and paying out dividends? If you owned 100% of this business, would you borrow money (and pay interest expenses and big fees to bankers) while at the same time distributing capital that triggers additional taxes?
No. Absolutely not. So why would GM management behave this way? Why would intelligent, rational, well-compensated people be willing to risk their reputations pursuing a business strategy that’s bound to fail?
What else can they do?
Major investors own huge amounts of GM’s stock…
Warren Buffett’s Berkshire Hathaway (BRK) owns 50 million shares. David Einhorn’s Greenlight Capital hedge fund owns 23 million shares – a huge investment relative to his fund, representing 20% of the entire capital pool.
These investors haven’t seen great returns. GM’s stock has gone basically nowhere since 2011, despite the major share buybacks. Trust me, these investors don’t want to be embarrassed. They’re going to press GM’s management to do whatever it takes to move the share price higher… even if that means destroying the equity value in the long run.
Here’s one of the hardest and most disappointing lessons I’ve had to learn as a professional investor…
Most publicly traded companies are not run in a way that’s designed to produce wealth over the long term for shareholders. In fact, almost none are well-managed by that measure.
I urge you to read again what I’ve written here about GM. It’s all true. And you can check all of the numbers for yourself. You’re invited to share this week’s Digest with your close friends or financial advisers. And then I want you to ask yourself this question…
If Wall Street didn’t see GM’s first bankruptcy coming… and if Wall Street didn’t see General Electric’s (GE) problems coming… what right do I have to expect the market to be rational?
These were two of America’s (and the world’s) biggest and most important companies. Dozens of Wall Street’s smartest analysts “thoroughly” cover these companies. And that’s why almost every professional investor reading today’s Digest will say, “Surely the market can’t be that wrong.”
Just remember: That’s what they always say.
Take a minute today and go through your portfolio…
Look for companies whose debt loads have increased while their revenues fell. Look for companies whose debts have skyrocketed while their payouts (dividends and buybacks) did, too. Look for companies whose returns (on assets, on invested capital, etc.) have decreased while their debts have soared.
Ask yourself the most basic, obvious question: If I owned 100% of this business, would I manage the company this way? Should I really be investing lots of additional capital in a business that’s clearly not performing well? Trust your instincts. And believe me, the market can be that wrong. It happens all the time.
Soon – no, I can’t know exactly when – the problems I’m warning about will capture the market’s attention…
Soon, these debt-related issues are all that will matter. Trust me, you won’t want to be a shareholder when that happens. And that’s the nice thing about publicly traded stocks. You don’t have to own everything. You can avoid traps like these. But you have to look for them. And you have to be guided by your own rational thinking, not the nonsense people who believe that Wall Street can’t be that wrong.