Lehman analysts say sale of GMAC stake could raise $11 billion to $12 billion

By Rebecca Melvin

Princeton, N.J., Oct. 18 - Sale of a controlling stake in General Motors Acceptance Corp. could help parent General Motors Corp. raise $11 billion to $12 billion, and those proceeds will mostly likely be used on GM's balance sheets to create a "cash cushion" in the event of an industry downturn, among other things, according to Lehman Brothers analysts, who hosted a conference call Tuesday to explore recent developments at GM.

The purchase price estimate was greater than book value, but not at a significant premium, taking into account risk inherent in the automotive sector to which the financing arm of GM is exposed, according to Lehman fixed-income research analyst Jean Lantz.

The size of a controlling stake would have to be greater than 50% to successfully delink GMAC from GM at the three major rating agencies, which is the primary purpose in making the sale, Lantz said.

"This is not something GM wants to do; it's something it has to do if it wants to continue to fund the purchase of cars and have capital to fund that financing," Lantz said.

With the proceeds, GM could pay off some of its debt, of which the average maturity is more than 20 years, with less debt at GM than at GMAC, the analysts said. They could also be used to provide a one-time dividend to shareholders, fund employee buyouts or make VEBA health care cost contributions.

A new, more formal operating agreement between GM and GMAC will have to be in place in order for a successful sale of GMAC and subsequent credit rating improvement, the Lehman analysts said.

Such an agreement would protect both would-be buyers of the stake and from GM's perspective, ensure that the equity participant would continue to focus on the financing of GM vehicles.

GMAC needs the investment-grade rating to ensure access to unsecured markets to which it goes for securitization, Lantz said.

The conference call was scheduled in response to two major announcements by GM on Monday, including its new tentative agreement with the United Auto Workers that will cut health care costs and the possibility that it's looking to sell a controlling interest in its finance arm, GMAC.

The world's largest automaker also posted on Monday a $1.6 billion loss for its third quarter, bringing losses so far this year up to about $3 billion.

GMAC sale seen likely

The probability of a sale of a stake in GMAC is 80%, Lantz said. And the timing of such sale is likely to be within a few months, but not before January, which is a critical period in terms of a potential strike by autoworkers at Delphi Corp.

In addition to the sale and cutting pension and health care costs, the automaker revealed plans for worker cutbacks and plant closures, but there were no indications of selling off product lines.

"This management team has made its bets. The near-term pipeline has precious few examples" of consolidating brands and models, which is something Lehman autos and auto parts analyst Darren Kimball highlights as a problem for GM's fundamental picture.

GM said it will need to close more assembly and component plants, cutting about 25,000 jobs, or 8% of its workforce, by 2008. The moves would reduce GM's costs by $5 billion by the end of 2006. The impact on earnings in 2006 depends on the approval of the health-care changes.

Of fundamental red flags, Kimball also mentioned GM's lag behind Japanese competitors and the fact that gasoline prices are double from when GM had its peak in full-size SUV sales in 2003. He said sales of full-size SUVs are expected to be 450,000 this year, down 15% from 2003 and down 22% from 2003.

Investors are planning that its new SUVs will falter, Kimball said, and "a strong showing could cause a short squeeze."

Kimball said the GMAC transaction will be highly dilutive and isn't good for investors who will get an earnings stream that is even more dependent on autos. But it is necessary, he said.

While there is continued tension between negative fundamentals and prospects for the turnaround story, Lehman Brothers still expects GMAC to outperform Ford Motor Co. and Ford credit in the near term at least until year-end.

The potential buyer of the stake will be a large, well-established financial institution, and preferably a financial institution that already has an auto finance business, but not exclusively. Potential candidates include JP Morgan, Citigroup and GE Capital, Lantz said.

For GMAC to gain a mid triple B rating, the strategic partner of a 51% stake will have to be low single A or above rated, Lantz said.

Convertibles recommendations

Lehman convertibles analyst Venu Krishna recommended three trades involving GM's $8 billion outstanding of convertible debt.

The first recommended trade was to swap out of the common stock into the 6.25% convertible, which allows investors to move up the capital structure and also retain equity upside. The trade is particularly attractive if the company cuts its dividend. If the dividend is cut by 50%, the 4.5% value increases 4.5 points in bond equivalent terms. Such a move adds 127 basis points of incremental income, with 7.9% from the bond and just 6.6% from the equity.

The second recommended trade was to swap out of the 7.125% straight bond due 2013 into the 5.25% convertibles, which are lower priced, due in 2014.

In doing this trade, one loses 44 bps of current yield, but the maturity is extended by eight months and there is a gain of 96 bps in absolute yield, Krishna said.

The final recommended trade was using the liquid 4.5% convertibles as a short dated debt alternative and as an alternative to illiquid credit default swaps. The 4.5s have a 1.4-year maturity and a put in March 2007, so it carries an 8.8% yield to put, or 457 bps.

"By selling the CDS you add liquidity and lock in a higher spread," Krishna said.

The trades were similar to those Lehman suggested in July relating to GM convertibles. But the July trades didn't suggest the 4.5s as an alternative to credit default swaps or swapping from straight debt to the 5.25s.

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