By Daniel M. Ryan
As of last Thursday, there were two plans presented to keep General Motors from going into formal bankruptcy. The first, from GM itself, offers the U.S. government a 50% stake; the UAW health-care trust would get 39%, and current bondholders would get 10%. Current shareholders would wind up with 1% of the company. The alternate plan, from a GM bondholders committee, would assign 58% of the company to bondholders. 41% would go to the trust, and nothing would be for the government except a respite from future bailouting. Existing shareholders would get 1% of the company.
Those shareholders, as of now, have 100% of the company. Under both plans, the existing shareholders would be diluted by 99%. The current number of GM shares outstanding are 610.50 million. If either proposal goes through, the number of shares outstanding would be jacked up to 61.050 billion. For symmetry's sake, the post-restructured GM might consolidate its shares 100 to 1, which would bring the outstanding shares back down to 610.50 million – even though they wouldn't quite be the same shares.
Allow me to elaborate on the 'quite.' If John Doh has 1000 shares of GM, he owns about 0.0001638% of the company. Either restructuring plan would knock his percentage down to 0.000001638%. If GM later decides to push the shares outstanding back down to 610.50 million, Mr. Doh will have 0.000001638% * 610.50 million…which equals 10 shares.
Yep, the fellow will have the equivalent of a hundredth of the equity that he previously had. Regardless of the size of any consolidation, if any, the percentage will have two zeroes added right after the decimal point if either plan goes through. It makes things clear to assume the symmetrical option, even if an asymmetrical one is more likely. Regardless of the form, every 1000 worth of GM common will be equal to 10 if either plan goes through.
You may have come across a pillar of finance theory called the "efficient market hypothesis." The most known variant is called the semi-strong hypothesis, and it goes like so: the stock price reflects all known information about the underlying company, and the best estimations of value using that information. That's because, in a widely-traded and widely-watched stock market, there are enough participants placing money on or off the table to keep the stock price in equilibrium. "Equilibrium" means that there's no way to profit from known information, whether by going long or selling short, without assuming a deterring level of risk. GM is close to an ideal stock for this hypothesis, as even the daily news watcher knows the company's in the overhaul yard. The information about both plans can be said to have been widely disseminated. GM usually trades in tens of millions of shares per day, so it's widely traded. It's also widely watched, being (for now, anyway) one of the Dow 30. It comes close to being an ideal stock for the efficient market hypothesis.
Last Thursday's close for GM was US$1.92 per share. 1000 of those shares, excluding commissions and bid/ask spread, would cost US$1,920. GM stock is quite liquid, and deep-discount commissions are as low as a few bucks per plunge. So, US$1920 is quite close to the real cost if bought just before Thursday's close by a value-maximizing plunger. Remember: US$1920 buys 0.0001638% of the company.
Should either plan goes through, that US$1920 will have gotten 0.000001638% of the new GM. If the symmetry option is followed, then US$1920 will have gotten ahold of 10 post-consolidation shares. Cutting either dealie would give each slice of equity equal to the piece now represented by 1 share, a value of US$192.00. Assuming that the market is efficient, of course, and that the dilution proceeds expeditiously enough to make any time-discount immaterial. (Given today's depositor's rates, the second condition actually gives a fair bit of time.)
Let us pause and reflect over this miracle. A present share of post-dilution GM will have a value of 192 greenbacks. This price is more than double GM's all-time high in May 2000. Through the magic of dilution, as interpreted through the efficient market hypothesis, a specified equity slice of the current wreck will be worth more than twice the valuta that same slice commanded when GM was still a powerhouse.
A miracle indeed! Especially given the fact that both plans are rescue plans, designed to veer GM away from outright bankruptcy. I need hardly forecast how well GM shares will do if the Gospel According To Insolvency, Chapter 11, is invoked. It's reasonable to assume that either para-bankruptcy initiative would be better for the equity than the real thing.
Of course, using the word "reasonable" might evoke a few doubts about the assumption that the stock market is a superb discounting machine. I myself can't quite explain why a troubled company with far less debt would be valued more than the same company when it was mighty and profitable, even if more indebted. Still, the efficient market hypothesis is well ensconced: every biz school grad knows what it is, and many institutions use it. I don't want to be accused of being a peace-breaker, or some other kind of warlock, so I'll have to leave it be. Instead, I marvel at the miracle (as of the closing price on April 30th, 2009.)
The wonder of it all moves me to recommend the first plan, despite its presumed unfairness to GM's bondholders. If miracles be involved, who better than the U.S. government as the major shareholder? Many expect economic miracles from the government as it is, so who better for GM's dominant shareholder?
Besides, the collapse of socialism has left a palpable hole in the clouds. Something should fill it. What better than the Miracle of Government Engineered Dilution? Seems to have worked for the banks, come to think of it.
Disclosure: Financially, none. Other, none while sober.
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