Commentary: Has GM Outrun Its Pension Problems?

Massive borrowing refilled the plan. But interest and retiree health-care costs loom

Investors were euphoric when General Motors Corp. (GM ) announced on Dec. 12 that its pension plan -- underfunded by a staggering $18 billion a year ago -- would be flush by New Year's Day. Even before the announcement, GM shares climbed as analysts predicted that the company would erase a pension gap that had absorbed billions of dollars in profits since 2001.

Using much of the proceeds of an enormous bond sale and proceeds from the sale of its Hughes Electronics (GMH ) subsidiary to News Corp. (NWS ), GM poured money into the plan. A 19% return on the pension plan's assets in 2003 came in handy, too. The pension-fund news has helped push GM's stock to around $55 a share, a 26% rise since Dec. 1.

But is the market overreacting? GM's financial weak spots certainly have not disappeared. Big interest payments on the bond issue -- reaching $1 billion a year -- will hit profits hard. And GM has yet to tackle the problem of its retiree health benefits, a massive unfunded obligation totaling more than $50 billion -- or almost two-thirds of its $80 billion pension liability. GM has set aside only $10 billion in a trust fund to pay for retiree health care, so it must pay out-of-pocket costs of more than $3 billion a year for that benefit.

Nor does fully funding the pension plan eliminate its drag on GM earnings. Last year, GM reported $2.6 billion in pension expenses, plus $500 million paid in interest on the bonds. The pension expense should fall this year, to $1.5 billion, but add in the $1 billion in interest on the bonds, and that's still a big tab. "The good news is that our pension expense is lower," says GM Chairman and Chief Executive G. Richard Wagoner Jr. "The bad news is that it didn't go to zero."

Another red flag for investors: GM could end up shoveling even more money into the pension fund if its key assumption doesn't pan out -- that the fund will steadily earn about 9% a year. To pull that off, GM is shifting some of its pension-plan investments into real estate, junk bonds, and emerging-market stocks. CFO John M. Devine says those investments have been historically less volatile than the big stock holdings that dragged down the plan during the equity market's wrenching boom and bust. GM also notes that they act as a nice hedge against those equity investments. "Relying on historical returns is always risky," says Standard & Poor's analyst Scott Sprinzen. "Whether it leads to lower volatility, time will tell."

It's not that GM made a mistake in borrowing to fund the plan. By shifting its pension obligations over to bond debt, GM has bought itself time to pay the pensions of its legions of retirees, 450,000 and counting. And GM is paying 7% on the bonds, while figuring that its pension-fund assets will earn 9% in the years ahead. Plus, the bulk of the new debt doesn't come due until 2023 and 2033, well after the ranks of GM's retirees peak in 2008. Without the funding, the pension plan would have sucked $15 billion in cash from GM's businesses over the next five years, says Devine. Instead, the company will be free to devote more cash now to designing the new cars it needs to ensure that the auto maker is still competitive in 2023. In fact, Wagoner says GM will probably boost this year's capital-spending budget above $7 billion for the first time in three years.

This, in essence, is the bet that GM -- and investors -- are making. By pushing much of its pension costs 20 years and more into the future, the world's largest automotive company gets some breathing space. If GM invests that money well, it will generate the car sales and profits to make paying down the debt a snap. But if GM squanders this opportunity and develops new products that disappoint -- and along the way gets hit by another bear market that causes a pension-fund surprise or two -- the gleeful investors piling into the stock will be in for a bumpy ride.

By David Welch

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