An Easy Guide to Shareholder Letters: Look for These 3 Things

An Easy Guide to Shareholder Letters: Look for These 3 Things By Dan Ferris, editor, The 12% Letter Wednesday, November 27, 2013

It was an unusual research project… Not one in 1,000 investment advisors or newsletter writers would ever consider it. Over the last month, my research partner and I read every shareholder letter issued by companies in the S&P 500 index. I got the idea from billionaire super investor Warren Buffett. A couple years ago, Buffett talked about a one-page fax he got from the CEO of a potential acquisition: The quality of the business, he said, "jumped off the page." During our project, we found a few shareholder letters that were that good… And if you study what I'm about to teach you, you, too, will be able to identify companies that "jump off the page" as wonderful investments you'd like to own one day. You won't have to pick stocks anymore. They'll pick you! And it's easier than you think… I found three valuable types of insight in the best shareholder letters…  1.   How the company spends the excess cash it earns.   2.   How to keep the company accountable and measure its success.   3.   How the CEO describes the company and what makes its approach to the industry different and better than other competitors. The first and most important insight a great shareholder letter will give you is about the company's approach to cash…  It's great to own a piece of a profitable company… but if the management team squanders the profits, they'll destroy shareholder value instead of preserving and growing it.  Take Wall Street mega-bank JPMorgan Chase (JPM), for example. It is the only S&P 500 company that says growing its dividend is the most important thing it does with excess cash… even more important than growing the business!  Here's the relevant passage from the 2012 annual shareholder letter by CEO Jamie Dimon.  Our fortress balance sheet… provides us with excess capital to invest, and we always are thinking way ahead about the best ways to deploy it. As we have said in the past, after steadily increasing dividends, our favorite deployment is in growing our businesses. After investing in the growth of our businesses, we look at other ways to use the remaining excess capital. One use we consider is buying back stock – but only at a price we think is good for shareholders. The priorities for investing excess cash couldn't be clearer. First, JPMorgan will grow the dividend. Second, it will consider ways to grow the business. Third, it will look to spend cash in other ways, including buying back its stock.  When you find the companies that allocate excess capital wisely – like JPMorgan has – well, I can't stress enough how highly valuable that is to you as an investor. It's like knowing who's going to win an Olympic gold medal before the event begins.  Second, great business leaders want to be held accountable. They want to give you, the shareholder, an objective benchmark for measuring their success.  Consider 3M (MMM), a conglomerate that produces everything from Post-It notes to welding goggles.  Its shareholder letter provides investors with a crystal-clear set of financial benchmarks they can refer to in the future, to make sure management is performing well.  Here's what 3M Chairman and CEO Inge Thulin said in the 2012 shareholder letter:  Finally, we set out financial goals for the next five years. We now have targets that are both realistic and aggressive, and that provide a real possibility of upside. The five-year goals are as follows: •   Grow earnings per share 9-11 percent per year, on average •   Grow organic sales 4-6 percent per year, on average •   Maintain return on invested capital above 20 percent •   Free cash flow conversion of 100 percent Shareholders can note these objective benchmarks and know in five years if management is performing up to speed or not.  Most shareholder letters don't do this. They aren't crystal clear about how to gauge success because they fear they won't measure up. But great managements believe in what they're doing. They want to be held to an objective standard.  Humans are ego-driven. They want recognition. But they like their recognition to come with as little effort and commitment as possible. So it takes a special kind of person to draw a line in the sand and let the world know that's the point from which his future progress will be measured.  There's one more big idea you'll find in many good shareholder letters. Simply put, you want a manager who can explain the industry he's in and what makes his company's approach to it different and better… For example, here's a clear explanation of how and why apartment REIT Equity Residential (EQR) changed its business…  Approximately ten years ago, we made a monumental shift in our company's investment strategy away from two- and three-story walk-up garden apartment properties with surface parking in suburban locations across the 50 largest cities in the country, towards higher density, urban properties in a handful of gateway cities in the northeast and West coast… We also wanted to invest where the construction of new housing would likely continue to be constrained, such that demand would exceed the supply of all forms of housing. Letters like this – that explain the company and the industry in plain English – provide a free, high-quality (and sometimes entertaining) financial education that will take very little of your time.  Those are just three examples of several great shareholder letters we read during our project. We found 79 that show the companies are dedicated to paying out their excess cash to shareholders… keeping themselves accountable… and explaining their business and industry in plain language.  Of course, there are great companies that don't have great shareholder letters. But it's hard to find the opposite – a really great shareholder letter that isn't written by a great CEO of a great business.  I've never heard about anyone undertaking a project like we did… But I believe in those kinds of "manual" methods of stock screening. It's easy for computerized screening tools to miss things an experienced human being carefully poring over the same data would find.  To be a great investor, you have to be willing to look at the stock market in ways most other people don't.  Reading the shareholder letters of the companies you invest in is invaluable when it comes to understanding the business, the industry, and what you can expect from your management team. Especially when you find one that's sending the right message in a clear, credible way.  Good investing,  Dan Ferris Source: Daily Wealth Follow us on Twitter: @blacklioncm

The U.S. Gov't Owes You $1 Million

The U.S. Gov't Owes You $1 Million

By Porter Stansberry

Tuesday, November 19, 2013 It's a funny thing about people and lies…  If a lie lasts long enough… and is repeated enough… it becomes a kind of truth. Not a real truth, of course… just a lie that has become accepted and respectable.  That's what's happening right now to the idea of inflation… Long (and rightfully) seen as the bane of the working man, the inevitable consequence of paper money, and a hidden tax… inflation has suddenly become not only acceptable, but lauded. In fact, central bankers and economic leaders – people who should really know better – are now saying in public that what we really need is more inflation.  Three weeks ago, The New York Times published what I would describe as an ode to inflation. Said the Gray Lady:  There is growing concern inside and outside the Fed that inflation is not rising fast enough. Some economists say more inflation is just what the American economy needs to escape from a half-decade of sluggish growth and high unemployment… Janet Yellen has long argued that a little inflation is particularly valuable when the economy is weak. Rising prices help companies increase profits; rising wages help borrowers repay debts. Inflation also encourages people and businesses to borrow money and spend it more quickly.  The school board in Anchorage, Alaska, for example, is counting on inflation to keep a lid on teachers' wages. Retailers including Costco and Wal-Mart are hoping for higher inflation to increase profits. The federal government expects inflation to ease the burden of its debts. People who believe that inflation will lead to an increase in prosperity or our standard of living are simply fools. Cutting more slices out of a pizza doesn't create more pizza.  What inflation does accomplish is shift the dynamics of who wins and loses in our economy. Very simply: People whose income and wealth are manufactured through their asset base become vastly wealthier on a relative basis. People whose wealth is tied to their labor and wages become vastly poorer.  For example, retailers want inflation because it enables them to mark up their goods. And combined with negative real interest rates (like we have now), they can maintain inventories for free (or even to produce a carrying profit). The school board knows that inflation will eat away at the real costs of the wages it must pay. And the federal government – the world's largest debtor – needs both inflation and negative real interest rates to pay for the absurd promises it has made to voters.  In current dollars, based on the net present value of all of its current and future obligations, the federal government owes more than $1 million to every citizen of the United States.  Hopefully, you realize that these promises cannot be kept. What you might not realize is that absent negative real interest rates (driven by inflation), the federal government's current obligations couldn't be financed.  Inflation, unlike what our economic leaders seem to believe, isn't Santa Claus. It can't bring gifts to everyone. All it does is shift the benefits of our economy around. In the immortal words of President OBAMA!… inflation "spreads the wealth around a little."  Inflation penalizes wage earners for the benefit of asset owners. It benefits debtors at the expense of creditors. There's no net increase in the nation's wealth. One group is merely taxed for the benefit of the other. This is sold as a benefit to the country by our government. It has to sell it to us because without inflation it couldn't pay its bills.  Ironically, left-leaning middle-class citizens believe in the benefits of mild inflation most fervently. They are simply bad at math.  Since 1971, when we left the gold standard currency system, wages have stopped tracking gains to productivity. In the past, when innovations would cost some workers their jobs, there was a reciprocal benefit: The real value of wages increased at the same pace as productivity. Thus, they could be nearly assured higher wages in their next position.  The fact that wages were tied to productivity through a stable, gold-backed currency was what propelled the middle class to prosperity. And it led to the United States' political dominance.  But as you can see in this chart, based on one originally published by the Economic Policy Institute think tank… when we took the dollar off gold and allowed the central bank to continuously debase the currency, the dollar and the wages paid in the dollar no longer kept pace with inflation. Thus today, when trade or innovation leads to a gain in productivity (and the loss of a job), there is no reciprocal benefit to wages for the middle class. The replacement job is sure to come at a much lower real wage.  ​ It's this gutting of wages that most appeals to corporate America. To the wealthy, inflation provides easy ways of increasing the size of their asset base: All they have to do is borrow money at a negative real rate of interest and buy up productive assets. That's why farm prices have soared, why private-equity funds now control trillions in assets, and why the wealthy now dominate the middle class politically.  There are two good reasons to believe our current love affair with inflation will end badly…  First, real wages have fallen so far and for so long that they are no longer attractive to many workers. The lack of labor participation has become an enormous burden with a record number of healthy Americans no longer working and instead living on taxpayer-funded assistance.  The other, even more powerful reason is that negative real interest rates have enabled our government to borrow truly unbelievable amounts of money. Not only will this eventually lead to a crisis in the U.S. Treasury market (with soaring interest rates), but this chronic borrowing has transformed America from the world's largest creditor nation (with massive income from global investment) into the world's largest debtor nation.  Foreign investors now own $5 trillion more of America's best assets than we own of foreign assets. Generations of Americans will be sending foreigners net investment income, month after month. If these capital flows continue, it won't be long before no one wants to hold a U.S. dollar.  What's the trigger? When will my dark fears about the future of our economy come to fruition? When will the inevitable next crisis strike? No one knows, of course. My "canary in the coal mine" is the dynamic between the price of gold (which represents sound money) and the price of U.S. long-dated Treasury bonds (which represents the global paper money system).  You can track long-dated Treasury bonds (which mature in 20 years or more) by tracking TLT on the stock market. It's an exchange-traded index fund that holds a basket of long-dated U.S. Treasury bonds. Over the last year, it's down by 15%. You can track gold using the SPDR Gold Shares Fund (GLD), which holds gold bullion. Over the last year, gold has corrected significantly (after a massive 12-year bull market) and is down about 25%.  When the market finally realizes that inflation isn't good for the economy… that wages are far too low… and that debts are far too high, you won't want to be holding U.S. long-dated Treasury bonds. I expect within the next few years, we'll see a real panic in Treasury bonds, with annual yields reaching more than 10%. Many investors will flee into gold, as the U.S. dollar will be seen as unstable.  You'll see a dramatic inversion between TLT (which will collapse) and GLD (which will soar). This prediction, by the way, isn't really a prediction at all. It's a trend. Over the last five years, gold has outperformed the long bond by more than 100%.  That tells you all you really need to know about inflation.  Regards,  Porter Stansberry Source: Daily Wealth Follow us on Twitter: @blacklioncm

The Story of How America Was Packaged and Sold

The Story of How America Was Packaged and Sold

By Porter Stansberry

Friday, October 25, 2013 A building – One Chase Plaza – was sold last Thursday in New York for $750 million.  Not surprisingly, the building was bought by a Chinese asset-management firm, Fosun.  Today's essay is about this deal… and the massive economic forces that lie behind it. The story of One Chase Plaza is the story of how America was sold to its bankers. It's the story of how inflation plundered our wages. It's the story of how credit, rather than savings, came to dominate our economy and transform our way of life.  It's the story of how America was packaged and sold to our foreign creditors – mostly the Chinese… Since 1996, the Chinese have made 51 major acquisitions in America, including deals to own or control iconic U.S. assets like computer giant IBM, carmaker GM, meat producer Smithfield Foods, U.S. power company AES Corp., major airplane lessor International Lease Finance Corp., investment bank Morgan Stanley, and private-equity firm Blackstone Group. They've also bought trophy real estate around the U.S., like the GM Tower.  These deals didn't happen by accident. They happened because the U.S. continues to consume far more than it produces. We finance this consumption with debt that's owned in large measure by foreign creditors. Take the U.S. Treasury debt, for example. At nearly $17 trillion, this is the world's largest pile of obligations. If you exclude Treasury obligations held by the U.S. government and the Federal Reserve, 54% of the remaining obligations are held by foreign creditors. And these foreign debts continue to grow rapidly – at about $500 billion annually.  Debt service on these obligations allows our foreign creditors to continually buy America's best assets. Today, foreign creditors directly own and control U.S. assets worth more than $25 trillion. That's roughly a third of all the wealth in America. And that's far more than what Americans own overseas: Americans only own about $20 trillion of foreign assets.  Every year that goes by, our foreign rivals will earn more on their American assets than we're able to earn on our foreign investments. They will grow wealthier and wealthier… while we become poorer and poorer in comparison.  As Warren Buffett famously said about this situation 10 years ago: "We have entered the world of negative compounding – goodbye pleasure, hello pain."  How did this happen? Why is it continuing? And why is it almost certain to lead to an enormous currency crisis? The story starts with One Chase Plaza…  In 1957, America was the most powerful country in the world. We controlled roughly 75% of all of the world's economic activity, and we owned the three most important corporations in the world: General Motors, Exxon (Standard Oil), and Chase Bank (the Rockefeller Bank). Our country's products – like the '57 Chevy – were the finest available in the world. We dominated every foreign competitor in manufacturing, energy, banking, and just about every other industry, too.  At the time, you might recall, our dollar was literally as good as gold: By international agreement, our foreign creditors could exchange their dollars for gold for $35 per ounce at the Federal Reserve Bank of New York. This firm limit on the value of the dollar protected the middle class in America, guaranteeing that every wage-earner in the economy would share in gains from increased productivity. As productivity increased, the dollar bought more goods and services. As a result, real after-tax income increased. What was good for GM actually was good for America, too.  The firm value of the U.S. dollar also protected America from the temptation of credit. By linking the dollar to gold, expansion of credit required an increase in gold reserves. Under these rules, the supply of additional gold bullion (through new production or trade) limited the banks' ability to create new credit.  This made credit expensive (in real terms) and encouraged savings. Those savings then powered stable investment into our economy. Thus, the U.S. government debt actually declined in 1957, falling by $2.2 billion. Surely, no sane person in 1957 imagined that would be the last time the total debt of the U.S. government would ever again decline on an annual basis.  In 1957, work also began on the first modern skyscraper in lower Manhattan. Commissioned by legendary banker David Rockefeller, One Chase Plaza featured space-age materials (anodized aluminum panels) and soared 60 stories high. Covered in glass, it reflected light, unlike the older sandstone buildings around it that absorbed light. The building would serve as a glowing new headquarters for Chase Bank. It was a towering statement proclaiming the bank's growing influence around the world.  Even today, One Chase Plaza is a signature piece of New York real estate. It remains the 15th-tallest building in Manhattan. Surrounded by Pine, Liberty, and Nassau streets, it offers tenants a direct connection to the Nos. 2 and 3 subway trains. It is even thought of as a key part of the infrastructure of the United States – housing the largest privately owned bullion vault, five stories underground.  Winston Churchill remarked that "we shape our buildings; thereafter they shape us." Just 10 years after the completion of Rockefeller's global banking trophy at One Chase Plaza (construction was completed in 1961)… the link between the dollar and gold would be permanently broken.  Richard Nixon closed the gold-exchange window in 1971. America reneged on its debts to foreign creditors. Even more important, banks no longer had to back up their loans with reserves linked to gold. Now, all public and private credit would be backed by "Federal Reserve notes" – so-called "fiat," or paper, money.  As a result, banks no longer faced any physical limit to how much credit they could extend. And the U.S. dollar no longer had any firm value. Nothing guaranteed the real value of wages. Nothing linked increases in productivity to increases in wages. Nothing protected the middle class from the rising tide of inflation… or the soaring power of the banks.  You can see how the change is destroying the middle class. Today, gains in productivity benefit our creditors… not our wage earners. Take a look at this chart, based on one originally published by the Economic Policy Institute think tank. Based on Bureau of Labor Statistics figures, the chart shows the cumulative growth in hourly productivity for the total economy compared with cumulative growth in inflation-adjusted hourly compensation…    These changes transformed our economy and the nature of capitalism itself. No longer would our economy be driven by investments fueled by savings. Instead, our economy is funded by debt.  Debt of every kind has soared. Measured in inflation-adjusted dollars, America's total debt has increased from $5 trillion in 1957 to more than $60 trillion today – a 12-fold increase. Meanwhile, our gross domestic product has only increased from $2.5 trillion to $16 trillion, a six-fold increase. As a nation, we've mistaken credit-fueled booms for true prosperity.  But there is a major difference, of course. Credit must be repaid. While real prosperity leads to greater abundances, increasing debt produces greater burdens. The cost of servicing our debts has become so large that our creditors now routinely buy our country's best assets using the debt-service payments we send abroad. Ironically… the "butcher's bill" of servicing our debts now includes the iconic building that launched America's credit bubble.  On August 16, the New York Times broke the story that One Chase Plaza was for sale. JPMorgan Chase & Co., the successor entity to David Rockefeller's bank, was shopping the building through CBRE, the international commercial realty firm. Speculation at the time was that the building might be converted into condominiums and fetch $1 billion. Last Thursday, news broke that Fosun bought the building for $750 million.  And so… America has become just a little bit poorer. Our ability to generate wealth has been marginally decreased. One of Manhattan's most valuable buildings has been sold. The rents will now be sent overseas to China. The real earning power of our currency has declined just a bit.  For now, the changes seem small and have such a minor impact that hardly anyone notices. But the compounding nature of this shift in wealth is incredibly powerful and very, very hard to stop. Over time… real wages will continue to fall. Over time… our ability to service our debts without additional inflation will erode. (That's why the Fed can't stop its bond-buying program of quantitative easing.)  One day, no one knows when, the world will simply decide that we're not creditworthy anymore. We will have burned too much of the family furniture trying to keep our house warm.  On that day, you won't want to be holding U.S. dollars or Treasury bonds… or be dependent on the U.S. government. When that day comes, people will look back on the sale of One Chase Plaza and realize… it was one of the last, most obvious warnings, that something had gone badly wrong with America.  Regards,  Porter Stansberry Source: Daily Wealth Follow us on Twitter: @blacklioncm

An Honest Letter from the Chairman of General Motors

Editor's note: Porter Stansberry first started reporting on the debacle at General Motors back in 2007, with a "tongue in cheek" letter from the company chairman. This letter and his follow-up proved to be so prescient that many subscribers thought they were actually written by General Motors' chairman. Of course, no figurehead would be so honest about his company's problems. So once again, Porter is stepping into the role… An Honest Letter from the Chairman of General Motors By Porter Stansberry Wednesday, October 2, 2013

Dear shareholders, Moody's Investors Service recently upgraded General Motors' rating. The major credit-rating agency bumped our rating from Ba1 to Baa3 – its lowest tier of "investment grade" credit. Nobody was more surprised than me. Let me tell you plainly, I do not believe our company is an investment-grade credit. Nor are our operations likely to improve in a way that would have led any reasonable analyst to conclude such. That is why all of the other major ratings houses (S&P, Fitch, Egan Jones) continue to rate our corporate obligations as "junk" – speculative debts that have a significant risk of default. I now understand what Bill Gross means when he says investors shouldn't trust Moody's ratings because the company has become a de facto arm of the U.S. government. Or as he put it recently: Moody's and the U.S. Treasury are just one big "happy family." Gross manages hundreds of billions of dollars in private capital for the investment management firm PIMCO. So he has the luxury of being able to say whatever he wants in public. I don't have that luxury. I'm the chairman of a publicly owned corporation, whose debts are soaring, whose margins are collapsing, and whose capital structure is still controlled by the government and our unions. So when the reporters called me to ask about the Moody's upgrade, I said: "Good things happen when you build great cars and trucks and deliver strong financial results." It's a great line. It still makes me chuckle. Read it carefully. You'll notice… I didn't say anything about GM. What I couldn't say is that our business is already beginning to collapse, again. Look at our core automotive operating profits. In the first six months of 2012, we generated $2.8 billion in automotive operating profits. In the first six months of this year, we made a little more than $2.1 billion. Thus, our core, global automotive business has seen its operating profits decline substantially… by more than 24%. We are approaching another crisis at GM, one that has its roots in the bailout of 2008/2009. The faulty bankruptcy process caused this crisis by failing to address our largest obligations (pensions and retired employee health care). And the crisis results from the motivations of our government owners – motivations that do not square with capitalism. Like my predecessor, Rick Wagoner, did… I plan to write to you from time to time, privately, here in these pages. I will tell you what is actually happening with our great company – an institution that was once the largest privately financed endeavor in human history. You'll get the truth here, even if I'm not allowed to say it anywhere else… What's happening with GM is a microcosm of what's happening with the rest of our society. Where once we sought only a fair opportunity for greatness, now we seek the false security of collectivism. I see it happening right in front of me every day. I believe an honest discussion of what's happening with our business could help educate the public about the failure that's inevitable when resources – like our capital, plants, and people – are governed by politics rather than by markets. At GM, we abandoned capitalism in 2010 when we emerged from bankruptcy. Instead of treating all of our creditors fairly, we gave the lion's share of the company's assets to the federal government and the UAW health care trust. Meanwhile, we didn't do anything to mitigate our enormous pension liability, which today stands at $26 billion. At the end of the bankruptcy process, none of our 400,000 retired workers lost a nickel. On the other hand, our shareholders, creditors, and many of our suppliers were wiped out. That's not the way capitalism is supposed to work. And still today, GM isn't really privately owned. Instead, the company is a kind of public-private "partnership," where actual control rests with the government. Today, GM is more like a Ponzi scheme than a real business. How so? Ponzi schemes don't generate any actual profits. They require greater and greater sums of money to work. Sooner or later, there simply isn't enough capital available to maintain the mirage of a functioning business. That's exactly what's happening at GM. Don't take my word for it. Consider the facts below. Then, decide for yourself. Is GM a real business, owned by capitalists, driven to create real profits, to be shared by its owners as they see fit? Or is it a kind of elaborate, government-sanctioned scheme, meant to enrich a few chosen, special interests? PART I: Who Are the Real Owners?  All of Our Profits… and More… Are Going to Retired Workers Since GM emerged from bankruptcy protection in mid-2010… we've done great. The last few years are the best years in the history of our company. We've never built better cars. The market research firm JD Power says GM has the highest-quality cars of any major carmaker. Our trucks, it says, compete with Porsche for the highest-quality vehicles made anywhere in the world. We've never generated more revenue. In total, we've made about $26 billion in operating cash flow – what our main business generated before paying capital expenses and similar costs – since we emerged from bankruptcy. It all sounds good, I know. The bad news is that our business requires massive amounts of capital to sustain its operations. These so-called capital expenditures consumed roughly $20 billion of those operating profits. That left us with roughly $6 billion-$7 billion in actual cash that we could, in theory, return to our true owners (our shareholders) or re-invest into profitable lines of business. So where did this money – the so-called free cash flow – go? All the money – and a lot more – went to retired workers, unions, and the government. In total, we've sent around $18 billion in cash to these interests – far more than we've been able to earn. These payments started with $3.9 billion in dividends on special "preferred" shares the union, the U.S. Treasury, and the Canadian government got during the bankruptcy process. Keep in mind, our creditors got none of these shares, and we've never paid a cash dividend to regular, common stockholders. Another $8.5 billion went to repay debts to the U.S. Treasury and the union, obligations that we were saddled with in bankruptcy. And that's not all. In 2012, we announced with great fanfare that our operating results were so good, we were going to begin buying back shares. Normally, that's great for common shareholders. But in this case, the $5.1 billion worth of stock we bought back ALL came from the U.S. Treasury. No former creditor or any other public shareholder was able to sell to us. That's not all… We paid a $2-per-share premium to the actual market price of our stock. We simply gave the U.S. Treasury another $400 million "gift" for allowing us to buy back the shares it held. Remember… private investors didn't have a chance to sell their shares to GM at a $2 premium. That deal was nothing less than a crime. It was the U.S. Treasury stealing $400 million from the shareholders. If any other business in the country did something like this, it would get hit with a hundred lawsuits overnight. But when GM did it? The press cheered. How can you explain that? So we continue to owe far more to unions and governments than we're earning. If that were our only problem, perhaps we could envision a light at the end of the tunnel. But these obligations are only the beginning… That $26 billion in operating cash flow already accounted for about $8.8 billion in cash payments we made to support our pension plan and other retirement benefits. Without those obligations… our number would have looked even better, with operating cash flow of nearly $35 billion. That anchor around our neck isn't going anywhere. In addition to the cash, we contributed in 2011 60 million shares of stock (worth $2 billion) to the pension plan. No, that wasn't a cash expense. But believe me, shareholders should wish it was, as the expense will end up coming out of their pockets, instead of ours. Just think about what that means… Instead of the workers supporting the shareholders… at GM, the shareholders are supporting the workers. Sounds a little bit like communism, doesn't it? Well, just wait. The nonsense is only getting started… In 2012, we announced a big deal to eliminate our entire legacy, white-collar-salary pension obligations. We paid the Prudential insurance firm around $3.5 billion to manage $25 billion worth of our pension liabilities, taking them off our books. Don't forget… we also gave Prudential $25 billion from the pension fund to manage. Think about that for a little while. When is the last time you had to pay your broker 14% of your assets upfront to manage your account? Hedge funds normally charge 2%. They're considered expensive. Paying 14% sounds a little steep, doesn't it? No one ever explained it to me, either. My guess is a lot of that fee ended up in union offices or political piggy banks. Whatever happened, all of the money is gone. In the three years after bankruptcy, we made roughly $6 billion-$7 billion in "free cash flow." Somehow, that cash was supposed to cover $18 billion in obligations… including almost $1 billion a year in preferred-stock dividends to the union's health care trust and the Canadian government. That also includes the $400 million "gift" to the U.S. Treasury and the $5.1 billion worth of shares we bought from it. And for our common shareholders, our real owners? We haven't paid a cent. So who really benefits from our brands… our research and development… our decades of investment… and the tens of billions of capital we have at stake? Is it our shareholders? No, it isn't. It's the union. It's the retired workers. And it's the government. Is any of this likely to change any time soon? No, it's going to get worse… a lot worse. Look at our preferred shares. They were created to make sure the union got most of the value out of our remaining assets. (Our bondholders didn't get any of these preferred shares.) The shares pay a 9% annual dividend. Try to find any other preferred stock issued by a major corporation that pays a coupon that large. You won't find another example. We were simply hijacked by the bankruptcy court and the Obama administration. And we have to pay this dividend before we pay anything else. If we don't, these obligations accrue, a situation that would rapidly warp our entire capital structure, placing the whole company in the union's control. So one of my most important jobs is to buy back these securities as quickly as I can. The problem is, they're extremely expensive. I've just negotiated a deal to buy back 120 million preferred shares at $27 each from the union's medical trust. That's $3.25 billion. Believe it or not, the medical trust will still own 140 million of these preferred shares. The Canadian government also owns a few of these shares (16 million). We can redeem all of these remaining shares in 2014, but it will cost us almost $4 billion – in cash. To pay off the union then, we'll have to borrow money… billions. Now, you know the real reason why Moody's just raised our credit ratings. I'm sure the government told Moody's to help GM raise the money so we can pay off the unions. Shall I feign indignation that the country's most politically powerful union is able to manipulate Moody's credit ratings? PART II: Since Government Can't Let Automakers Fail, Overcapacity Is Getting Worse and Worse I'm proud of GM's cars. As I mentioned, we've made huge strides in increasing the quality of our vehicles. But guess what? So has every other carmaker in the world. The competition makes it harder and harder to make a profit. Just look at our actual numbers. In the first six months of 2012, we sold $74.5 billion worth of cars around the world (automotive revenues). We made an operating profit of $2.8 billion. That's a minuscule operating profit margin of 3.8%. The situation is getting worse. In first half of 2013, we sold $74.6 billion worth of cars around the world, fractionally more revenue. But we earned a lot less, only $2.1 billion. Our costs rose, and we could not pass these costs on to our customers. Our operating margin declined to less than 3%. These are razor-thin margins. Margins this small are dangerous to operating companies, like ours, that have huge volumes. If anything were to happen to consumer demand – for example, if the economy were hit with a recession or we were unable to finance our customers (more about this below) – these puny margins would disappear overnight. The result would be sudden, large losses. You should know: An "accident" like this is inevitable. It's going to happen. And it's going to happen soon. The auto industry suffers from a tremendous glut of capacity. According to different sources, 20%-30% of global production isn't profitable. My counterpart at Nissan, Carlos Ghosn, is one of the few senior executives who has spoken honestly about this major problem. At a recent car show in Geneva, he said, "All of the car manufacturers have capacity problems – all of them." Sergio Marchionne, the chief executive of Chrysler and Fiat and the president of the European Automobile Manufacturers' Association, estimates the auto industry needs to cut capacity in Europe by 20%. Automakers employ or support 2.3 million people in Europe. Just like in the United States, the auto industry is too politically powerful to be allowed to fail. It's the same thing, all around the globe. So how likely is it that any automaker, anywhere, will be able to significantly reduce production? Capitalists making tough, but realistic, decisions no longer control this industry. Instead all of the capital-allocation decisions are being driven by politics. Whether you call it "welfare," "socialism," or "communism" doesn't matter. As long as this continues, it's inevitable that GM's operating margins will continue to deteriorate. And that means, it's only a matter of time before we're dealing with huge quarterly losses. Bernd Bohr is the head of the automotive group at Bosch, the privately held German company that's the world's largest manufacturer of car parts. He explains the current problems by pointing out that none of the major carmakers was allowed to fail in 2008/2009. "It was a peculiarity of the 2008-09 crisis," Bohr said, "that practically no capacity was taken out of the market due to state intervention…" While hard to fix, the problem is easy to understand. As long as no carmakers are allowed to fail, the ability of the entire industry to earn a profit will be greatly compromised. GM is the largest car company in the world (roughly tied with Toyota). It has the highest labor costs. It is heavily burdened by its pension obligations. It has, despite my best efforts, several weak brands. In this scenario, GM is extremely vulnerable, the most vulnerable large carmaker in the world. My advice? Don't pay attention to our revenue figures. Watch our margins. It's overcapacity that will kill us this time, not quality or a lack of demand. PART III: We're Doing It Again: Selling Cars to Unqualified Buyers Think about the dead-end GM faces strategically. We can't compete on brand. No one under 40 years old would rather drive a Cadillac than a BMW. Almost no one at any age would rather have a Chevy Malibu than a Honda Accord. And even though our trucks are great, Ford's are just as good (if I'm being honest). We can't compete on price because we don't have the cheapest costs. Instead, we have the highest. And no matter how much money we make, all of it (and more) will end up being siphoned off to either the union's health care trust or the pension fund. What would you do in this scenario? I've thought about this question every single day for three years. There's only one answer. And it's a lousy one. GM will have to compete on credit. We'll have to work out a deal with Wall Street to borrow billions and billions and funnel the money to car buyers who the other makers won't lend to. Our only chance is to, once again, become too big to fail. In the fall of 2010, we acquired a financial business, now called GM Financial. It exists to provide financing to buyers of our cars in dealer showrooms. You might recall that our company's last foray into finance didn't end well… huge losses at our former finance subsidiary were one of the primary reasons our company spiraled into bankruptcy back in 2008. We're doing it all again. As our margins have declined, we've attempted to grow by making more and more loans. Our loan book has ballooned to $11.5 billion. We made about 75% of these loans to borrowers with FICO scores lower than 600. Unbelievably, we're even lending billions (more than $3 billion, actually) to folks with FICO scores less than 540. It seems implausible to me that these loans will work out for us in the end. By the end of 2012, nearly $1 billion of these loans was already in default. Just imagine what will happen to these weak borrowers when we eventually enter another recession. Just as our sales are declining, all of these bad debts will come due. All the repossessed cars will flood the market, driving down recovery values and destroying demand for new cars. Haven't we learned anything from the last financial crisis? Apparently not. You will see as we move forward, our margins will continue to decline because of the global problem of overcapacity. Charities – which is what all of the major car companies have become – don't make a profit. As our margins decline and our cash flow disappears, the union and retiree demands on our remaining capital resources will grow more intense. We'll have to borrow more and more simply to fund our pension obligations. We will also be borrowing, massively, from Wall Street to finance our car buyers. Sooner or later, we will end up losing money on every transaction, while trying to make it up on volume… and financing that volume using our own balance sheet. It's insane… unless you understand it's my only hope. I've got to borrow billions and billions over the next few quarters. I've got to scale up, so that we're so big we can't be allowed to fail. It will be the same madness we saw in 2008 all over again. But this time, it won't take decades to unravel. It will happen much faster. My guess is within five years, we'll be in a crisis again. And our stock, which is currently valued at $50 billion, will be worth nothing. Please invest accordingly. Best regards, The Chairman of General Motors Source: Daily Wealth Follow us on Twitter: @blacklioncm