Will US lose Money On GM IPO?

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The US probably won’t get as good a deal on its GM investment(Carlos Barria/REUTERS)

A lot has been made of the fact that much of the US bailout of the banks actually turned a profit for Uncle Sam, or close to it. The auto industry bailout: Not so much.

On Wednesday, GM said it hopes to sell 365 million shares to the public at around $27.50 each in a $10 billion IPO. The share sale would value all of GM at about $41 billion. And that’s the problem. The car company currently owes the government $40 billion from the bailout of the auto maker at the height of the financial crisis. It is possible that the US could still break even on GM, but it’s looking less and less likely. Here’s why:

First of all, the IPO will actually raise the eventual price GM shares have to climb to before the government breaks even on the car maker’s bailout. How’s that? Here’s the math: Right now, the government owns about 60% of GM. The US is selling around 280 million shares in the GM IPO. Based on the government’s current stake in GM, the company would have to sell shares at just less than $44 for Uncle Sam to make a profit. But it isn’t. Instead, GM is selling its first batch of shares at $27.50. So the government will take a loss of about $16.50 on every share it sells. That means the government will have to sell its remaining shares at an even higher price than before to make its money back on the GM bailout.

How much higher? All told, the deal is expected to net the government $7.6 billion. That would leave the US still in the red to the tune of $32.4 billion on GM. That means the government will have to sell its remain 650 million shares at around $50 to get its money back, or about 60% higher than the current proposed IPO price.

How likely is it that GM’s stock would climb to $50 a share? Not very, at least in the near future. As I said above, the GM IPO will give the company a market value of $41 billion. In its most recent quarter, the car company earned just over $2 billion. Given that pace, GM could earn $8 billion in the next 12 months. So the IPO values the company at about 5 times earnings. Sounds cheap, but maybe not for a still troubled car manufacturer that is highly tied to the still weak economy. If GM’s stock was to jump 80% from its offering price to $50 a share, which is the government’s break-even price, GM would then be trading at a market cap of around $70 billion, or roughly 9 times earnings. It’s possible. But that’s the same valuation that Ford gets and pretty much everyone agrees that Ford is in a much better position to grow its earnings that GM.

So let’s assume that GM deserves a 30% discount to Ford’s valuation, which is more than what the bankers setting up the company’s IPO think GM can get. So it seems fair. Based on that valuation, of 6, the company would have to increase its earnings to $11.7 billion a year or 46% more than the company is making a year now to warrant a $70 billion valuation.

GM may eventually turn in that much in annual profits but will take a while. Analysts believe Ford can increase its earnings just under 14% a year over the next 5 years. GM still has a lot of investment to make in its fleet, including rolling out the much-anticipated Volt. So it’s probably fair to say that GM’s earnings, even under the best case, will rise at a slower pace of say 10% a year. Based on that growth rate it will take nearly 5 years for the government to hit its break even point on GM’s shares.

So the question of whether the government will end up making money on GM, or at least breaking even, comes down to how long Uncle Sam is willing to hold onto its stake. 2015? My guess is political pressure will force the government to cash out long before that. If so, it will most likely be at a loss.

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