Is the GM IPO a Buy?

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It seemed like more Detroit delusions when General Motors CEO Ed Whitacre predicted in March that the government would eventually make money on its bailout of the beleaguered auto maker. But just three months later, General Motors increasingly looks like it is ready to exit the chop shop. Things have actually been turning around for the nation’s largest auto company in the past few months. Sales are up 40% this year. What’s more, the company made money in the first quarter nearly $900 million. That’s a huge turnaround from the $6 billion the company lost in the first quarter of 2009 alone. Last week, news surfaced that the auto company was moving closer to its IPO. That has some analysts and Wall Street watchers wondering the GM IPO will be a worthy investment. Fortune jumps into the debate today.

By extrapolating from current pricing on existing GM bonds, Eric Selle, a debt analyst at JPMorgan, has calculated that investors might support a GM market capitalization of somewhere between $70 billion and $90 billion, potentially providing the US government with a tidy profit.

Such a valuation would be a significant premium to its more profitable rival Ford, which is worth about $40 billion today. But analysts say GM can justify a higher multiple to cash flow due to the company’s much lighter debt load and its recent operational improvements.

There are, of course, many reasons to be cautions. What’s more, IPOs have a history of underperforming in their first year. Afterall, most companies try to sell when the going is good. But given the negative sentiment surrounding GM, I think it is a strong possibility that the restructured GM could end up being a good investment. Here’s why:

First of all, the biggest deathblow for companies is that they are in a business that is going away. Obsolescence is the biggest hidden risk in investing. That’s not the case with GM. We are going to be driving cars for a while. They are not always going to be gas-powered. But GM’s has a prominent electric vehicle, and apparently it’s a pretty good ride. From my editor Bill Saporito:

“It’s pretty good,” I tell Lutz, in answer to his question. Wrong answer. “Whaddya mean, pretty good,” Lutz yells. What I mean is this:  when you drive the electric-powered Volt, you aren’t giving up anything. It accelerates well, unlike some hybrids, because you get immediate torque. It’s nicely styled because the lack of engine noise means that Chevy had to compensate for things like tire noise and wind noise by creating a more aerodynamically efficient body—“keeping the air attached to the car” as Chevy design director Bob Boniface put it. And there’s actually room in the back seat for humans taller than than fire hydrants. Volt goes 40 miles per charge, which is okay for city folk, but it has a gasoline tank that carries enough fuel to power the electric engine another 300-miles, so there’s no worry about running out of juice.

That’s a pretty good car, in my book.

Next, the GM bankruptcy and restructuring has been good to GM.

From any perspective, GM was a sick company before its bankruptcy, racking up more than $86 billion in losses since 2005. It had $53 billion in debt, burdensome labor contracts and a weak lineup of cars at a time when global markets were shifting to smaller vehicles.

Since then, the company has rolled out new vehicles that have sold well, including the Chevrolet Equinox crossover and Buick LaCrosse midsize luxury sedan.

In addition, GM is now using 85 percent of its North American factories to make vehicles. That figure was only 38 percent in the first quarter of last year, when the company had shut down most of its factories to control inventory.

What’s more, the restructuring allowed GM to cut a new deal with auto workers and make its debt more manageable.

But GM also benefitted from its near-death experience in 2009. Following a $6.7 billion U.S. government loan, union concessions and a contentious bankruptcy, GM cut more than $45 billion from its debt noose, brought its multitude of brands down to a manageable four in size and began trimming its sprawling dealer network. It improved its car design and worked to optimize its manufacturing.

“What previous management did and what was accomplished in bankruptcy is one of the most dramatic transformations of any company in American industrial history,” notes William J. Holstein, the author of Why G.M. Matters: Inside the Race to Transform an American Icon.

The hardest part of the equation to know whether GM is a buy is the valuation. The IPO price hasn’t been set yet. So I reserve the right to change my mind if the price is significantly higher than what people are predicting now. My sense is that the government is going to want to say it made money but it is also not going to want GM shares to plummet after the offering.

The government paid $42 billion for a 61% ownership of GM. That means the GM IPO would have to value the company at $69 billion for the government to turn a small profit. At $75 billion, for example, the government would book a profit of $3.75 billion from the GM bailout. That’s something it could brag about. Based on its current run rate, GM could make about $3.6 billion. Let’s say that increases to $5 billion in the next year as the economy improves. That means a $75 billion market cap would give GM a p/e ratio of 15. Not bad. That’s cheaper than many companies in the S&P 500. So GM may not be a screaming buy. But is it not headed for the investment junk heap either.