Barron’s published a great article featuring guru Mohnish Pabrai (Trades, Portfolio) discussing his investments in General Motors (GM, Financial) warrants, Fiat Chrysler Automobiles (FCAU, Financial) and Southwest Airlines (LUV, Financial). Today, I will review Pabrai's case for General Motors as it looks like a highly compelling opportunity. Pabrai's discussion on GM with Barron's (emphasis mine):
"GM has a market cap around $50 billion, and nearly $20 billion in cash. It trades for four times earnings. But the four times earnings has embedded in it a finance business that could generate $2 billion a year in cash flow by 2018. It should get a 15- or 20-times multiple since it isn’t a cyclical business. Then you have the GM auto parts business, which serves the aftermarket. That also has no cyclicality. The China business lacks cyclicality because it is growing. There is about $5 billion in cash flow coming from very stable businesses. They are worth $70 billion or $80 billion; yet, the whole company is worth about $50 billion, based on its current stock price."
General Motors is a very different beast compared to what is was pre-crisis. Though not as dominated as far as market share goes, it is much more nimble and should be able to operate though a crisis period without becoming massively unprofitable. Cyclical as they are, automakers should not get high multiples when they are producing top of cycle earnings. However, it could be a stretch to call current earnings “top of the cycle.” I am not sure but it does not feel like the top of a cycle to me, although the market itself does seem rich.
When I pull up the General Motors'Ă‚ GuruFocus valuation page, Pabrai gets backed up by the numbers:
Relative to competitors, General Motors is one of the cheapest both on price-earnings (P/E), price-sales (P/S), EV/EBIT and EV/Sales. Take note especially of the EV/EBIT which tends to be a reliable metric to find value. There are few competitors more attractive.
This is before considering Pabrai’s assertion that $5 billion of its cash flow is coming from stable businesses, deserves a much higher multiple and should not trade like a cyclical automaker.
Five billion dollars represents about one-third of its total operating cash flow. Pabrai argues just that piece is worth much more than the whole market cap of the company, or $70 billion.
If we add to that a modest 5x multiple and $10 million of operating cash flow, General Motors would be worth about $120 billion. That implies General Motors could go up 118%, right in line with Pabrai’s observations. He told Barron’s he thinks it could trade in the sixties in a couple of years (a 50% increase).
That is not all though.
Pabrai holds the warants and commented on them (emphasis mine):
"The warrants date back to 2009, during the auto bailouts. They are unusual instruments that the company never would have issued if it were as healthy as it is today. It was forced to issue them. The warrants have a 10-year life and some unusual provisions. For example, I can put the warrants back to the company anytime and exchange them for shares. I don’t need to sell them into the market. That has a tax advantage for me.
The warrants are an option. If GM’s stock price doubles, I will make 3.5 times on the warrants."
The warrants will pay out 3.5x the investment if GM doubles from here. Perfectly in line with his philosophy, as explained in the "Dhando Investor":
“Wall Street sometimes gets confused between risk and uncertainty, and you can profit handsomely from that confusion. The low-risk, high-uncertainty [situation] gives us our most sought after coin-toss odds. Heads, I win; tails, I don’t lose much.”Â
Disclosure: Author owns none of the discussed securities.
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