Tale of Two IPOs: GM in With a Bang; Harrah's Out With a Whimper - Barron's - November 2010
General Motors roared back into the stock market last week just 16 months after emerging from bankruptcy, but the $15.8 billion initial public offering proved less popular with investors than many had expected. Still, that was far better than another IPO did; Harrah's Entertainment pulled its scheduled offering.
GM offered 478 million common shares at $33 and sold a companion issue of $4.35 billion of mandatory convertible preferred stock. Both deals could be increased in size by 15%, which would bring the total size of the offering to $23.1 billion.
The lukewarm market response to both the common and preferred offerings may have created a buying opportunity because the No. 1 U.S. car maker (ticker: GM) is valued at a sizable discount to Ford (F) and has a stronger presence in the developing world.
GM shares opened above $35 and then sank, trading most of Friday below $34 before finishing at $34.26. Based on the trading of its debt, we had figured that GM would be trading closer to $37. Barron's has written several times on the company this year, including a bullish cover story on March 1 ("GM is Back!"), in which we predicted that it could go public this year with a market value of $50 billion or more. GM's market value is now $58 billion, using 1.7 billion outstanding shares, including in-the-money warrants. We wrote two weeks ago that the initial price talk of $26 to $29 a share looked too low.
While GM's deal got done, Harrah's pulled its IPO Friday, citing "market conditions." The highly leveraged casino operator was the subject of a skeptical Barron's article last week ("Harrah's IPO: A Big Gamble for Investors," Nov. 15), in which we argued that the deal looked unappealing and might be scrapped.
General Motors now is valued at about three times projected 2011 pretax cash flow, a discount to Ford, which trades near five times estimated '11 cash flow. GM bulls argue that the stock could approach 40 by year end. CRT Capital Group analyst Kirk Ludtke put a Buy rating on GM's common and preferred Friday and set a price target of $45 on the common, saying GM ought to trade on a par with Ford based on cash flow.
There was some investor grousing Friday that the Wall Street underwriters of the IPO might have increased the deal size by too much–the offering was originally set at 365 million shares–and placed the stock with too many institutions that planned to sell, or "flip," it, rather than hold it. Once the GM offering is better digested and in the hands of investors who want to own it, the stock could move higher.
Reflecting the underwhelming initial reaction to the deal, debt of old bankrupt GM debt fell in price last week to about 31 cents on the dollar from 35 cents. The debt is a proxy for the stock since bondholders will get a mix of stock and equity warrants, with the actual distribution likely to begin in 2011. Some longtime bondholders might want to consider swapping into the stock to establish a tax loss this year.
The GM preferred offers an alternative to the common with less upside and better downside protection. It was priced at $50 and listed on the New York Stock Exchange as GM Pr B. It ended Friday at 50.50.
Here's how the structure works. The GM preferred has a dividend yield of 4.75% and a conversion premium of 20%. This means that at the mandatory equity conversion in three years, investors will get back $50 a share if the common is between $33 and $39.60. If it's above $39.60, preferred holders will receive more than $50. If the stock is under $33, preferred holders will get back less than $50.
Convertible fans liked the structure. "The mandatory convertible is hands-down a superior instrument to the GM common," says Barry Nelson, a senior vice president and portfolio manager at Advent Capital Management in New York, a convertibles specialist.
He says the convertible should offer about 80% of the appreciation in GM common above $39.60. If the stock doubles, to $66, in three years, from the IPO price, holders should receive about $90 for their preferred, including dividends, an 80% gain. If the stock remains steady or falls, convertible holders will do better than common holders because of the 4.75% dividend on the preferred.
Both General Motors common and preferred look like good bets on the big auto maker's revival.
—Andrew Bary