About Me 0105: Making Money Marketing

As
General Motors has shrunk, its pool of U.S. retirees has swelled.
Today there are almost 700,000 GM retirees and just 70,000 active
workers, a 10-1 ratio. The company’s $100 billion pension fund is twice
the market capitalization of the automaker itself, and keeping up with
funding obligations acts like a ball and chain on GM’s core car-making
business. Small swings in the value of the pension plan can have
massive effects on the value of the company. “That’s no way to run a
company,” said GM’s chief financial officer Christopher Liddell.

I
met with Liddell during the Detroit auto show this week, and he talked
extensively about GM’s more conservative financial philosophy since
emerging from bankruptcy in July 2009. GM’s objective is to carry no
debt, fully fund its pension plan, and pay for its day-to-day
operations using cash generated from the sale of cars and trucks. It
sounds so simple, but that’s not the way GM has been run in many years.

GM
took a big step in that direction Friday, announcing it had
contributed $2 billion in newly minted GM stock to its U.S. pension
plan, on top of $4 billion in cash it had contributed a couple of months
back to try to bring that pension fund closer to fully funded status.
As of the end of 2009, the portfolio was $17.1 billion short of what it
should have, under government rules, to cover its current and future
pension obligations.

The gap likely
closed some in 2010, thanks to strong market returns, but the gains
could be offset by further swelling in the retiree ranks. GM plans to
give an annual update on the health of its pension plan next month when
it announces its fourth-quarter financial results.

Three
factors determine the health of any pension fund: asset returns,
company contributions and the discount rate, which is used to calculate
the present value of pension liabilities and is tied to interest
rates. In the past, market swings and interest rates would cause GM’s
pension fund to fluctuate wildly between being overfunded and
underfunded. In the 1990s, GM borrowed heavily to pay off its pension
plan, saddling itself with hefty interest payments. As long as the stock
market remained high, the value of the assets in GM’s portfolio
exceeded its liabilities. But even a change in the discount rate could
cause big swings in the plan’s funding status.

Between 2005 and
2007, GM’s pension plan was in great shape, and the company didn’t need
to make any contributions. But then the equity and credit markets
collapsed, coupled with declines in the discount rate (which made the
present value of GM’s pension liabilities rise significantly) and more
early retirements at GM, increasing the number of beneficiaries.
Suddenly, the pension plan was $17.1 billion in the hole.

“We’ve
got to get this company to where the economics, everything, is driven
around designing, selling and producing cars,” Liddell said. “Things
like the pension plan don’t enter into the equation.”

Liddell
said he believes GM can fully fund the pension plan within three years
at which point, he plans to “de-risk” the portfolio by investing less
in equities and real estate, and more in fixed income assets, which
generally provide a lower rate of return. “Perfection to me would be
where the assets exactly equal the liabilities in both their maturity
and their risk profile,” he said.

He’s not expecting perfection,
but he is expecting GM to operate debt-free in the future. It seems
like forever that GM has been up to its neck in debt, including its
pension and health care obligations to retirees. But it’s only in the
past 15 years or so that GM has been highly leveraged. Before that, it
was a AAA-rated company.

Now it’s working to get back there. It
off-loaded retiree health care to a union trust fund in 2009, is
working on the pension problem, and restructured the rest of its debt
during its government-controlled bankruptcy. In 2010, GM lowered its
debt from $14.2 billion to $5 billion, and reduced its $9 billion
preferred share obligation to $7 billion. It obtained a $5 billion
revolving credit loan, but Liddell said he doesn’t think GM will have
to tap into it.

Perfection? No. But progress, yes.

I
agree, it's not perfect but it's progress. GM is doing the right thing
by topping up its pension plan now that times are good. If they can
reach fully funded status in three years, so much the better. Of course
that entirely depends on where markets are heading. In the
meantime, GM can focus on its core business and hope that car sales pick
up steadily in the next few years.

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Monday, January 24, 2011

Making Money Marketing

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