Talk in the marketplace, Detroit and Washington has been percolating about giving General Motors (GM) and the auto industry in general a bailout ala the TARP for the banking industry. GM is on the verge of running out of money. Cash received from auto sales, down dramatically from last year, will not cover the cost of running its business. GM has a monthly cash burn rate of $2 billion or more per month and only $16 billion in cash left on its latest quarterly balance some of which needs to be held in reserve.
GM blames the current economic environment on their woes. Year-over-year sales at month end October saw a 45% decrease, worse than almost all of their competitors. Toyota (TM) for instance, which will soon overtake GM’s market share in the space, saw sales decline a significant but less severe 23% over the same period. But GM’s execs are not being genuine. GM has never been a great business.
Warren Buffett in a 1991 gave a speech to Notre Dame students and faculty. In it he compared two businesses – Company Agony and Company Ecstacy. Company Agony lost its investors more money than virtually any business in the world while the other, Company Ecstasy did nothing but make money.
The difference in the two businesses was Company Agony, which in Buffett’s story was American Telephone and Telegraph had all kinds of employee benefit programs, stock options, pensions, the works. The business operated under heavy regulation, was heavily unionized and extremely capital-intensive. In fact, shareholders had to continually reinvest in the company simply to keep it going.
Company Ecstasy on the other hand, Thompson Newspapers, didn’t have elaborate compensation programs and never needed to reinvest in the company. They simply wrote a story and produced it by putting ink to paper. Thompson was able to raise prices which raised earnings and there was nothing to do with the money except to return it to shareholders or purchase more profitable businesses.
In advising his audience about which kind of businesses to work for, an Ecstacy non-capital intensive business or an Agony capital-intensive business, Buffett said,
“One is a marvelous, absolutely sensational business, the other one is a terrible business. If you have a choice between going to work for a wonderful business (Ecstasy) that is not capital intensive, and one that is capital intensive (Agony), I suggest that you look at the one that is not capital intensive.”
The same can be said for investing in capital intensive businesses. Investment in a capital intensive, Agony business like GM where market share [chart below] is eroding which began well before an economic recession, labor costs are the highest in the industry at $73 per hour [$30 higher per hour than Toyota’s], the workforce is heavily unionized and it makes products consumers don’t want (i.e. gas-guzzling SUVs), doesn’t seem like a smart move to me.
The government is our investment manager now. It must make prudent investments and should make sure we see some return. GM has not returned any money to investors for years and years. In fact, an investment in a simple index fund like the Vanguard S&P 500 Index Fund (VFINX) would have been a much better investment over the long haul. [See chart below].
If an investment in GM never made money in the past, what would be different now? I venture to say, nothing.