Unlocking The Secrets Of GM's Golden China Share
Having been asked by a certain newspaper to review the new book “American Wheels, Chinese Roads: The Story of General Motors in China [more info on that review coming soon], I’ve been spending my quiet moments over the last week or so looking into GM’s Chinese operations. The book’s author, Michael Dunne, documents GM’s rise in the Middle Kingdom from the perspective of a well-informed outsider, revealing just how delicate one of GM’s best-performing global maneuvers really was. But after following the rise of GM in China, Dunne notes the December 2009 announcement that GM was selling a 1% stake in its Shanghai-GM (SGM) joint venture to its Chinese partner SAIC (for the paltry sum of $85m no less), arguing that GM had made a dangerous leap of necessity. This sale, implies Dunne, could well have been the tipping point that leads to GM being surpassed by its erstwhile junior (in size, technology and global reach) partner, SAIC. And, in the words of “one GM executive who used to work in China,” GM would need
good luck getting that back.
But, back in June, GM CEO Dan Akerson told GM’s shareholder meeting that he wants to do just that, saying
We have an option to buy that 1 percent. It’s our intention to exercise that.
With Akerson’s announcement, the mystery of GM’s “golden share” sale deepened. At first the question was simply “why would GM sell its 1%?” but now there’s another mystery: why would GM want it back? After some digging, it seems that we are now able to resolve the first mystery, and report why GM sold its one percent. But the whole deal is still surrounded by several layers of mystery which conceal whether GM will in fact be able to regain its 50-50 partnership in SGM, why it would want to and whether its gambit was ultimately worthwhile. And given how important China has been (and continues to be) to GM’s global business, this is definitely an issue that GM- and industry-watchers will want to better understand.
First of all, it’s important that we understand how the deal was announced, as it caused a good deal of head-scratching here at TTAC and around the auto industry. As the WSJ [sub] reported at the time, GM played down any major implications of its apparent surrender of an equal partnership in one of its most important markets:
“In actual fact we operate that way already, so that’s not a significant change,” said Nick Reilly, who stepped aside as head of GM’s international operations Friday to run its European business.
GM said the transfer was necessary to help SAIC consolidate earnings from the Shanghai GM joint venture, having been previously barred from doing so as a 50:50 partner under local financial regulations.
The NYT added
the 51 percent stake would give S.A.I.C. the right to approve the venture’s budget, future plans and senior management.
But, as Dunne and others have pointed out, no other Chinese joint ventures have made this move, suggesting that SAIC’s desire to consolidate earnings were not the only reason for the deal. Further confusing the situation was the tiny purchase price: by selling its controlling 1% for a mere $85m, it seemed as if GM were giving away the keys to the Middle Kingdom for chump change. And Akerson’s revelation that GM has an option to reclaim the 1% confused all of this even further: after all, with SAIC insisting that it retain its consolidated earnings in the case of a return to the 50-50 partnership, it would seem that the sale part was unnecessary to that goal, which could have been accomplished with a (relatively) simple contract. What, I’ve been wondering for days now, was really going on with this deal? How to square all of this seemingly contradictory information? Did GM make a worthwhile gamble, or did it foolishly fumble away a key market?
After much digging and many emails to GM, the situation is finally starting to make a little sense. And in the process we got our hands on some information that has yet to be published in the mainstream media (to the best of my knowledge). GM confirms that it does in fact have a call option for the controlling 1% stake, but refuses to give any details about how it might be exercised or what its terms are. The only specific information about the deal comes 196 pages into a 534-page 10-K filing [ PDF here] covering calendar year 2010. That filing reveals that, although GM does have the option to buy back the 1% stake, it’s not in the driver’s seat to make that happen…
We also received a call option to repurchase the 1% which is contingently exercisable based on events which we do not unilaterally control.
Of course GM won’t disclose what these events are (although Akerson does hint that SAIC’s restructuring is somehow an issue), but the admission that the company doesn’t “unilaterally control” the events required to buy it back keeps the shadow of doubt over Akerson’s stated “intention” to return to a 50-50 partnership. Still, with it’s back against the wall, it’s still possible that GM could have signed a deal that might still keep it a junior partner in SGM… had there been enough cash on the table. $85m was clearly not enough to make such a deal worthwhile, but according to the 10-K filing we’ve obtained, there was more in the deal for GM than that.
In February 2010 we sold a 1% ownership interest in SGM to SAIC-HK, reducing our ownership interest to 49%. The sale of the 1% ownership interest to SAIC was predicated on our ability to work with SAIC to obtain a $400 million line of credit from a commercial bank to us… As part of the loan arrangement SAIC provided a commitment whereby, in the event of default, SAIC will purchase the ownership interest in SGM that we pledged as collateral for the loan. We recorded an insignificant gain on this transaction in the year ended December 31, 2010.
So, the truth comes out! This arrangement has been hinted at before, but until we obtained the relevant 10-K, the exact amount had never before been reported. So, between the $85m price and the $400m loan, that 1% stake was worth closer to half a billion dollars than the $85m initially reported. That means that, on the one hand GM got a reasonably fair price for the controlling stake in SGM, but on the other hand, as Bertel noted
If Akerson wants it back for whatever unfathomable reason, then it will cost him.
Without knowing exactly what GM got for its 1%, Dunne argues that the deal was “the end of the beginning” for GM’s successful Chinese efforts. And though GM’s ability to regain a 50-50 partnership is still very much in question based on what little we know about the call option’s details, at least GM got significant short-term help for the gambit. And it’s probably no coincidence that GM was able to keep GM-Daewoo (GM-DAT) in the corporate fold when, just weeks before the SAIC share sale was announced, it injected$413m into its Korean subsidiary. At the time, the Korean Development Bank was trying to wrest control of GM-DAT, which would have left GM without its main source of low-cost, fuel-efficient car development. Presumably keeping Daewoo was worth whatever risk now stands between GM and its call option… just as keeping Opel’s development capacity was worth billions in restructuring costs (probably not coincidentally, GM insisted that the Daewoo bailout cash “came from overseas operations”).
In short, GM’s gambit was a far better business move than we initially thought… although it’s also clear that the reasoning it gave at the time was disingenuous at best. But, thanks to Akerson’s “intention” to exercise the option, we also know that GM is not as comfortable as the junior partner in SGM as it initially made it seem, and the RenCen is obviously anxious to reel the decision back in. But what will the buyback end up costing? What “events” need to happen to make the buyback possible? And, since reclaiming the 1% would neither help GM financially or give it more functional control over its JV (as far as we can tell), why is it so intent on buying back that one (presumably) extremely expensive share? As with so many examples in China-US business relations, solving one mystery tends to lead only to more mysteries…
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That 1% is not worth $485 million. They have underwritten a loan that in the case of a default of GM they will buy a part of SGM for a price that will make the lender whole. It is a bit hard to calculate the cost to them but an upper limit can be calculated by assuming that SGM is worthless at that point in time and it that case it is just the price of a credit default swap for $400 million for GM at that time.
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