Bond prices suggest GM stock may be overvalued in IPO

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Bond prices suggest GM stock may be overvalued in IPO





Investors thinking about getting in on General Motors' initial public offering may want to check the bond market before buying.

Although the company has not specified the price or size of the offering, GM's /quotes/comstock/13*!gm (GM 0.00, 0.00, 0.00%) IPO is expected to raise about $16 billion, making it the second-largest in U.S. history. It's not clear how the offering will value the auto giant, but there are already clues in the bond market.

There are billions of dollars of bonds left over from GM's previous incarnation. Motors Liquidation Co., the surviving entity, listed $32.2 billion of liabilities at the end of June, including more than $28 billion of unsecured bond debt.

This debt still trades a lot. The bellwether issue is a bond that GM sold in 2003. It matures in 2033 and initially yielded 8.375%. This bond is currently trading at about 34 cents on the dollar.


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Owners of GM's old bonds will get 10% of the new equity, plus warrants to buy another 15%. Factoring in things like dilution, bond holders will probably end up with about 20% of the new equity in GM after the IPO, according to Shelly Lombard, an analyst at independent fixed-income research firm Gimme Credit.

The price of GM's 2033 8.375% bonds suggest investors are willing to pay 34 cents on the dollar, or about $10 billion, for taking on liabilities of more than $32 billion -- knowing that they could end up owning about 20% of the new company.

That implies GM's equity value is about $50 billion. GM reported $2.2 billion in net income attributable to common stockholders during the first half of 2010. That suggests the company might be able to make $4.4 billion this year. That means GM is worth about 11 times earnings.

In contrast, rival Ford Motor Co. /quotes/comstock/13*!f/quotes/nls/f (F 11.77, -0.12, -1.01%) has a market value of about $40.5 billion. The company is forecast by analysts to make $6.65 billion in net income this year, according to FactSet data. That's about six times earnings.

However, Ford has a large finance unit, so it's difficult to compare the company with GM, which currently doesn't have such a business, Lombard said. (GM recently bought an auto loan company, but the deal hasn't closed yet).

During the first half of 2010, Ford's finance business contributed about a third of the company's total profit. That suggests Ford's auto business on its own could generated net income of about $4.4 billion this year. That would mean the company's current market value is just over nine times earnings.

If GM's stock is overvalued versus Ford, that doesn't bode well for the IPO. Concern about a slowing economic recovery and the effect this could have on demand for cars won't help either.

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"Equity valuation is an art, not a science, but in the near term the price of GM stock could be depressed by the mood of the market and the economic outlook," Lombard said in an interview Friday.

"It would be better for the government not to force out a lot of stock into the market now," she added.

Instead, the government should hold on to more of its shares for longer and wait for GM to recover further and for the economy to slowly improve, Lombard said.