Will Hedge Funds Force General Motors to Burn $8 Billion?

By Markets Fool.com

Continue Reading Below

General Motors headquarters in Detroit. A group of hedge funds is trying to elect a director to GM's board, part of a plan to force the automaker to spend $8 billion on a stock buyback. Source: General Motors.

General Motors announced Tuesday morning that Harry J. Wilson, a former Treasury Department official who helped with GM's restructuring, has nominated himself as a candidate for the company's board of directors -- and that he plans to propose an $8 billion share buyback.

That news sent GM stock up over 3% in premarket trading. But is it good news for shareholders?

This is a hedge fund raid, plain and simple
Here's what is (apparently) going on: According to GM, Wilson said he has been hired by four hedge funds that together own 2.1% of GM's common stock. His mission is to get elected to the board, after which he will demand the company commit to $8 billion worth of share repurchases within one year.

If he succeeds, he gets a cut of the profit the hedge funds expect to make by selling their GM shares into the resulting rally.

Continue Reading Below

Here's what is driving this move: As of the end of 2014, GM had $25.2 billion in cash and another $12 billion in available credit lines -- a total of $37.2 billion in reserves available to its automotive businesses.

General Motors has said its hefty cash position is a key component of its "fortress balance sheet" strategy. The cash is intended to ensure the company can continue making aggressive investments in new products even through a severe economic downturn that might erode much of its profits.

That is critically important to GM's long-term health.

Why a big cash reserve isn't optional for GM
As we saw in the aftermath of the 2008-2009 economic crisis, having ample cash during a downturn can make a huge difference once the economy starts to recover

Automakers that sustained investments in new products during the downturn --Fordand Hyundaiin particular -- had fresh new products in their showrooms when the crisis receded and sales picked up. Remember those huge sales gains Ford posted in 2011 and 2012? Remember how GM scrambled to catch up while rivals took market share?

That's why GM has a big cash reserve now.

General Motors executives are determined to learn from the company's past mistakes, including that one. And they aren't alone: Most other automakers now hold similar reserves, for similar reasons. Fordhad $32.4 billion in cash and credit lines as of the end of 2014, and Fiat Chryslerhad 26.2 billion euros (about $29.7 billion).

But apparently, some hedge fund managers believe GM has too much of a cash reserve, so they're taking this step to get the company to cough up some money.

Will long-term shareholders support an $8 billion artificial stock rally to benefit some hedge funds?
The hedge funds want the company to use $8 billion to buy back GM shares, creating an artificial rally in share price the hedge funds can use to unload their GM holdings at a profit. That's their idea of "creating shareholder value."

Left to its own devices, GM might use that cash to develop new products, expand its factories, and hire additional workers -- things that benefit the economy and increase the long-term value of General Motors itself. The company already pays a pretty good dividend, and it isexpected to boost that payoutlater this year.

That's my idea of "creating shareholder value." And I'm a GM shareholder, so I get a vote on this.

There's another factor to consider here. GM might also need some of that cash to settle lawsuits and potential criminal charges related to its recalls. A big settlement plus an $8 billion share buyback could leave GM's coffers uncomfortably thin, and leave the company vulnerable during the next recession.

How will GM's board respond to this?
To be fair, Wilson might plan to use his board seat for something more than trying to force GM to burn $8 billion to appease some hedge funds. I'll listen carefully to what he has to say before I vote. But I'm not liking what I've heard so far.

General Motors said in a press release that the board will evaluate Wilson's proposal and "make a recommendation based on the best interests of all shareholders."

I suspect GM might be willing to meet Wilson and his backers partway. CEO Mary Barra has already signaled that the company plans to raise its dividend in the second quarter, and CFO Chuck Stevens said last week that GM will will explore more ways to return cash to shareholders later this year.

But critically, Stevens wants to wait until he has a clearer understanding of how much GM is likely to have to pay to settle the recall mess. That makes sense. But it might not be enough for these hedge fund managers.

The proposal will come to GM shareholders for a vote later this year -- with a recommendation to vote "yes" or "no" from GM's board. What happens between now and then is likely to happen behind closed doors, but we'll be watching.

The article Will Hedge Funds Force General Motors to Burn $8 Billion? originally appeared on Fool.com.

John Rosevear owns shares of Ford and General Motors. The Motley Fool recommends Ford and General Motors. The Motley Fool owns shares of Ford. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.