GM's Cash Guzzlers

Profits are up, but pension and health-care liabilities are staggering

A hot new Cadillac. Booming sport-utility vehicle sales. A higher profit forecast--the fourth upward revision this year. A stock price up more than 20% since January 1. General Motors Corp.'s (GM ) June 3 analysts' teleconference was brimming with good news. Although U.S. sales fell 12% in May, GM said net profits would more than double, to $3.4 billion, in 2002. After years of restructuring, retiring Chairman John F. "Jack" Smith Jr. and CEO G. Richard Wagoner Jr. are entitled to some feeling of satisfaction.

The trouble is, the turnaround of GM's car business is only half the story. Two creeping problems plague the world's largest auto maker--each with the potential to gobble up a fat chunk of cash. It has the largest pension fund and the highest health-care costs of any U.S. company, with obligations to 452,600 retirees. GM is scrambling to fill a $9 billion hole--as of yearend 2001--in its $67 billion pension plan. It also has a $47 billion potential chasm in its retiree health-care trust.

Certainly not all is due now. GM can meet its current payments. But at the present size and rate of return on investments, the funds can't cover projected costs. And until the market picks up sharply, they'll keep falling behind. To get the funds back on track, GM will have to inject billions in the coming years. Says Sanford C. Bernstein & Co. analyst Scott Hill: "If GM didn't have these huge health-care and pension costs, this would be an awesome recovery."

Unfortunately, that's not all. There is also GM's 20% stake in Italy's troubled Fiat Auto. It came with an ill-timed commitment--a put option-- to buy the rest from the parent company as early as 2004. If Fiat's woes worsen, GM may be compelled to make an offer before its value deteriorates much more. Says Deutsche Bank analyst Rod Lache: "That's money they don't need to spend right now."

Indeed. Cash is GM's Achilles' heel--even without Fiat. In the cyclical car business, a key measure of ability to weather big hits--say a recession or pension shortfalls--is cash net of debt. GM says it has $17.3 billion in cash and equivalents and $15 billion in debt. But the cash number includes $3 billion from the $4.9 billion health-care fund, which many analysts say GM shouldn't count. Excluding that, GM has no cushion of uncommitted cash.

Meanwhile, just to keep the retiree-cost shortfalls from getting bigger, GM is likely to have to spend at least $2 billion for the pension fund and $4 billion for health care next year. But that is based on very optimistic assumptions of investment fund returns of 7%. Just to stay where it is and avoid an additional payment, GM says it needs to make 10% on its investments and insists that's feasible.

To keep from eating into cash further, GM must sell assets. It has some $8 billion up its sleeve. The sale of Hughes Electronics Corp. satellite business to EchoStar Communications could yield $6 billion. Defense contracting and locomotive operations may fetch $2 billion.

GM's so-called legacy costs are bills for failures past. "Everyone has their challenges," says CEO Wagoner. "At this moment, legacy costs is a big one for us." GM once was the auto industry king. In 1962, it had half the U.S. market. It now has less than a third. But union contracts all but blocked layoffs, so it retired workers instead. That mortgaged the company to its future retirees.

Things have been worse. In 1993, when GM was nearly broke, its pension fund was underfunded by $18.5 billion. GM plowed almost $32 billion into it until the late 1990s when market returns of at least 20% a year put the fund into the black.

GM is mobilizing, but it must contend with a bear market. Says Wagoner: "Against a base of $80 billion, if you have an off year, you're in the hole again." GM's unfunded $47 billion health-care liability represents the long-term costs as people retire. GM currently pays those benefits from cash flow and the health-care fund. The company, says GM treasurer Eric A. Feldstein, plans to put in "a meaningful amount" to build up the fund for the future, but that diverts cash from such priorities as new models, GM insiders say. "It's a competitive disadvantage for us," acknowledges Feldstein.

GM execs say the black holes don't daunt them. Wagoner and Vice-Chairman and CFO John M. Devine are on a crusade to generate cash and boost the balance sheet. They recently raised $4.6 billion, mostly in convertible debt, and put half in the pension fund. They've delayed or nixed less profitable models and fast-tracked the $49,000 Hummer H2 SUV. A big SUV makes about $10,000 in profits.

The maneuvers to date haven't assuaged some GM watchers' fears. Scott Sprinzen, analyst with Standard & Poor's Corporate Rating service, says that funding pension liabilities with convertible debt swaps one liability for another. Sprinzen rates GM debt BBB+, the same as money-losing Ford Motor Co. "We're taking a guarded look at their credit," says Sprinzen. "The pension portfolio will continue to be a big concern."

Bernstein analyst Hill estimates that GM's average costs per car are $1,350 more than Toyota's just from retiree expenses. That means that GM will struggle to make headway for years to come. Even for Wagoner's motivated team, that's a heavy legacy to bear.

By David Welch in Detroit

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