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GM's best offense could be defense
Without big changes, the outlook for auto giant General Motors is downright bleak. But a move into the defense sector could help.
By Robert Walberg
Back in the 1950s, Harlow Curtice, then president of General Motors (GM, news, msgs), said the automaker "has no bad years. Only good years and better years."
Well, Harlow, times have changed. It looks very much like 2005 will be a difficult, if not bad, year for GM.
A few weeks ago, General Motors reported a disappointing 37% drop in fourth-quarter earnings. If that weren't bad enough, management drastically reduced its first-quarter earnings guidance. The company now expects to roughly break even. Thirty days ago, Wall Street's consensus estimate was for first-quarter earnings of $1.08 a share. In the first quarter of 2004, GM earned $2.25.
Sluggish car sales here and abroad, combined with rising raw material and health-care costs, are largely to blame for the miserable results. About the only thing going well for GM is its finance business. There are concerns, however, that poor overall results could trigger the credit-rating agencies to cut GM's debt rating to junk status, a move that would hurt the finance unit.
Toss in mounting pension obligations, and the near-term outlook for General Motors is downright bleak. Wall Street concurs, with only three out of the 15 analysts following the stock rating it a "buy." The rest rate it "neutral" or "sell." The stock has lost nearly 8% so far this year. It's trading at its lowest levels since early 2003.
What does management need to do to regain investors' confidence? Some of the more common answers to that question involve cutting costs further (and trimming headcount), introducing several newly designed vehicles that resonate with consumers, and possibly hacking its dividend. The company pays an annual dividend of $2 per share. Right now, GM produces a 5.4% yield.
A no-win position
While any or all of these steps would likely win applause on Wall Street, none is bold enough to return General Motors to the elite of Corporate America. Tinkering with its business won't change the fact that the automaker is in a no-win position against foreign competition. Relatively high labor costs mean it can't produce cars as cheaply as Japanese or Korean auto manufacturers.
And history argues against acquiring other carmakers in Europe or Asia to gain share and bolster competitiveness. The company's current problems with the Italian automaker Fiat could force GM to buy out its partner or pay Fiat to go away. And the industry is filled with mergers that didn't bear the fruit originally expected. One of the best examples is the 1998 combination of Daimler-Benz and Chrysler.
Nope, buying another carmaker won't put GM back on the road to success. If the company wants to again live up to the quote, "What's good for our country is good for General Motors and vice versa," then management needs to think outside the box. In fact, it might want to take a cue from the man who uttered the quote. It came from then-president Charles Wilson during his 1953 confirmation hearing to be secretary of Defense under Dwight D. Eisenhower.
GM might want to follow in "Engine Charlie" Wilson's footsteps and get into defense contracting. Though not an obvious move, it could be a good one for the automaker, just as it was for jet maker Boeing (BA, news, msgs) nearly a decade ago. Admittedly, Boeing was already in the aerospace/defense business when it acquired McDonnell Douglas in 1997, and the two companies shared some obvious synergies. However, by expanding its foothold in the defense industry, Boeing insulated itself from the ups and downs of the volatile airline sector.
Seeking shelter
A similar move by General Motors to greatly expand its presence in the defense industry would shelter the company from the cyclicality of the auto sector and move it into a higher margin business with more promising and stable growth prospects.
Those of you familiar with the auto giant's history might be thinking that GM tried such a move about 20 years ago when it acquired Hughes Aircraft, which later became Hughes Electronics. While Hughes was tied to the aerospace/defense industry, its focus was in the electronics/communications side of the business. It evolved into principally a consumer-electronics company by the time GM sold the unit.
I'm talking about looking further back into the company's past, say to the 1940s, when GM delivered more than $12 billion worth of war material. That included the 6x6 Army truck that carried both troops and supplies, and the DUKW, or "duck," which was designed to carry troops on land or water.
Diversifying into the defense industry might seem a far-fetched notion, but when you consider the company's past, its expertise in designing and manufacturing vehicles and its recent acquisition of the Hummer brand from defense expert AM General, the possibility seems less improbable and more intriguing.
With GM's nearly $23 billion in cash and prodigious annual cash flow, a major defense industry acquisition doesn't need to add to the company's sizable debt burden. Such a move might even help the debt outlook because it would bolster and stabilize earnings.
Though there are no matches as obvious as McDonnell Douglas was for Boeing, General Motors could enjoy numerous benefits from the purchase of an outfit like, dare I say it, General Dynamics (GD, news, msgs). In addition to the obvious similarity in names, General Dynamics derives significant revenues by making armored vehicles, ships, subs, business jets, etc. It might not be automobiles, but at least its products are related to transportation.
With a market capitalization of nearly $21 billion, such a merger would be one of equals and one that might stretch the boundaries of GM's balance sheet. But the combination would be a potential earnings powerhouse that generates annual cash flow of nearly $4 billion.
If GM wanted to set its sights a little lower, United Defense Industries (UDI, news, msgs) might be another option. It makes combat vehicles, artillery systems, naval guns and missile launchers, and it services naval ships. With a market cap of $2.3 billion, it would also be much easier to swallow than General Dynamics. But with the investment firm Carlyle Group owning almost 50% of the company, it might also prove a more difficult acquisition.
Not exactly in the works
Now I'm not saying that General Motors is considering such a bold move as acquiring a defense contractor. In fact, it's probably not even on the radar screen. But it should be, or at least let's hope management is thinking of something more original to fix its problems than cutting labor costs and redesigning a few cars and trucks.
Why? GM's problems aren't temporary. They are structural in nature.
Hopefully, CEO Rick Wagoner shares some of the innovative and creative tendencies of Robert Lutz, the company's vice chairman and design czar. If not, the nation's largest auto company could find itself headed for a nasty crash.
As it stands now, earnings this year are likely to fall short of management's projection of $4 to $5 per share. Additional earnings disappointments are likely to push the stock down even more, as well as heighten fears of a debt-rating downgrade.
Clearly, this isn't the time for pat answers and conservative thinking. It's the time for management to act dynamically, perhaps even General Dynamically.
At the time of publication, Robert Walberg neither owned nor controlled shares in any equities mentioned in this column.
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