Breaking up GM and Ford

By admin_45 in Blog

Regular readers will know that I (Nick) spent the 1990s as the senior auto analyst at First Boston/Credit Suisse. This was long before analysts were prohibited from pitching investment banking business, as they are now. I therefore spent a lot of time – probably 20-30 percent of my day for 9 years straight – working with bankers on various deal pitches.

Putting on that old hat for today’s note: if I were banking Ford or GM right now, I would be pushing hard for them to spin off their electric vehicle operations. The valuation differentials are straightforward enough to at least get a meeting with the CFO:

• Tesla: $1.1 trillion
• Rivian: $148 billion
• Lucid Group: $88 bn

• General Motors: $91 bn
• Ford: $79 bn

The basic idea would be this:

• Create an EV “newco”. This would include all the parts of the business relevant to winning in an all-electric vehicle future: R&D, product design, parts sourcing, and assembly.
• Get an outside CEO and CFO – people from the tech world, but with experience in design and manufacturing. Staff the rest of the organization from the top-performing ranks of existing management.
• Recruit a strong, independent board and name an outside Chairperson. The individuals here should come from venture capital and technology, with preference given to people who have built disruptive businesses.
• Sell 19.9 percent of this company in an initial public offering for, say $10 billion. That’s a good-enough discount to the current comps and will assure strong aftermarket price action. Newco gets the $10 bn for general corporate purposes.

Now, since I’ve dealt with auto industry managements, I also know why they would say “No” – at least at first. Here is what I imagine them saying (or at least thinking) and how I might respond:

1: “Those are just fad stocks. We’re a real company.” Yes, GM and Ford are real companies with an equally real problem. Their cost of equity capital is tied to the internal combustion engine (ICE), a technology in its sunset years. If GM wanted to raise $10 billion for electric vehicle development, it would dilute current equity owners by 11 percent. If Tesla issued $10 bn of new stock, the dilution would be 0.9 percent. Big difference, and the auto world is nothing if not profoundly capital intensive so this is far from an academic problem.

The point here is that traditional automakers are at a huge competitive disadvantage relative to EV pure plays when it comes to accessing capital markets. That may not be an issue today, because GM and Ford are generating cash flow from their ICE operations. But what happens in the next recession? Or if there is a technological breakthrough in batteries that requires a lot more capital? In those scenarios, “old” GM and Ford – with a mix of ICE and EV products and a stock valuation to match – are stuck. As in possibly dead …

2: “We can’t split up our business that way.” This is, to some degree, a legitimate problem:

• R&D and assembly plants would be fairly easy to allocate to an EV “newco”. You’d have to leave union worker headcount the same at production plants, of course, to get UAW buy-in for a spinoff. Not a great answer, but manageable.
• But what do you do with marketing and dealer relations, for example? It makes no sense to have an independent Chevy EV brand away from the one that still applies to internal combustion engine vehicles. And GM has legal agreements with dealers that require the company to deliver product, EV or ICE, so you’d need to respect those even though we’re talking about two different companies.

So, the reply is “yes, it’s hard, but do you honestly have a choice?” Remember what Clayton Christensen said about why incumbent companies fail when upstarts arrive: they do all the “right” things, and that only accelerates their decline. Instead of fighting newcomers at the beachhead, they retreat to their most defensible core markets. Their return on capital rises as a result. But… Their addressable market shrinks. And over time, the incumbent either disappears or becomes a small shadow of its former self.

#3: What’s the point here, aside from shuffling paper around? My answer: to build a cash buffer for the EV business and to have a public market currency for acquisitions. We’ve covered why the first bit is important. The public market currency is just as critical, however. Electric vehicles will eventually morph into autonomous vehicles and reshape how people around the world consider transportation. Leading that disruption – or at least not losing out – will require a high-value equity currency for M&A and strategic investments. With where GM and Ford’s stock prices currently sit, they will be bringing a penknife to a gunfight.

Now, here’s the punchline: GM and Ford will almost certainly NOT spin off their electric vehicle operations even though there is a compelling case to do so. Maybe we’re wrong on that. Maybe managements will rise to the challenge or be pushed to action by activist shareholders. It’s never happened before (remember Ross Perot and Kirk Kerkorian?), but you never know.

And that, in a nutshell, is why current equity valuations for Tesla, Rivian, et al are so amazingly high right now. The market is betting that GM and Ford will not break off their EV operations. This will leave them at such a disadvantage that they will eventually fail. Yes, this is a big leap of logic and yes, GM and Ford still have time left on the clock. But as for a dramatic corporate remake that reflects the existential challenges they face … We’re not holding our breath.