GM Signals Policy Shift

The automaker bows to pressure to cut its dividend, as investors await word on the fate of its financing arm.
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Updated from 8:54 a.m. EST

In another acknowledgement that its financial condition is dire,

General Motors

(GM) - Get Report

said Tuesday that it would halve the dividend it pays to common shareholders and cap its contribution to the health care benefits of many retirees.

The dividend reduction is GM's first since the early 1990s, and it marks a major policy shift that had been sought by, among others, shareholder Kirk Kerkorian, who got his representative Jerry York named to the company's board last night. The move lowers the automaker's annual outlay to shareholders by more than half a billion dollars but also cuts the dividend yield on its stock, to 4.3% from 8.6%.

"I support this move because, in a perverse way, the more negative GM is, the better off the company will be," says Dennis DesRosiers, an analyst with DesRosiers Automotive Consultants. "I'm a big fan of Jerry York, and I think tough medicine is the right medicine for GM. That's the only way you're going save this company."

GM said the reduction to health benefits will lower its overall liability to retirees by $4.8 billion and trim its annual health care expense by $900 million on a pretax basis. In addition, the company said CEO Rick Wagoner will take a 50% pay cut, while vice chairmen John Devine, Bob Lutz and Fritz Henderson will receive 30% hits.

"These are difficult decisions that involve sacrifices by our employees, stockholders, retirees and the senior leadership team," Wagoner said in a statement. "However, we are confronting a dramatic change in our industry and in the global competitive environment, and that requires us to look for additional ways to reduce financial risk and improve our competitiveness for the long term."

While the addition of York, coupled with the adoption of his proposed cost-savings, marks a significant policy change for GM, the company is still wrestling with a few loose ends that are adding to uncertainty in the financial markets. It provided no update on its plan to sell off part of its financing arm, GMAC, and negotiations with the United Auto Workers union over its bankrupt supplier,

Delphi

, remain a wild card.

"Most investors wish they had made an announcement about GMAC 30 to 60 days ago," says Sean Egan, president of Egan-Jones Ratings. "The fact that they still haven't been able to make one indicates that obviously the sale process is not going as smoothly as they had wished."

According to

The Wall Street Journal

, buyer groups said to be in the hunt for GMAC include

Citigroup

(C) - Get Report

and hedge fund

Cerberus

, and a separate team of

Wachovia

(WB) - Get Report

and buyout maven

Kohlberg Kravis Roberts

.

Egan says any large, deep-pocketed financial institutions may be balking at the chance to buy GMAC, because any deal for GM's most profitable business would probably include large charges that the struggling automaker may be unwilling to take.

"Depreciation and bad-debt expense at GMAC has been declining, and the normal assumption on this is that there's some garbage in the portfolio," he says. "That isn't the end of the world. It's just that somebody will have to absorb the losses."

Furthermore, large financial institutions may be hesitant to give the automaker the strong voice that it wants to maintain in the workings of GMAC. If banks and large credit companies don't buy the unit, a group of private equity buyers could be left with the winning bid, and that could make it more difficult to boost GMAC's credit ratings back to investment-grade status.

"The primary reason for doing the deal was reducing the credit costs for GMAC," Egan says. "If it is a private equity group that buys the company, that becomes a more difficult proposition."

David Cole, the president of the Center for Automotive Analysis, says GM's lack of an update on GMAC shouldn't be blown out of proportion.

"Given the complexity of GMAC, it would've surprised me if something was announced today," Cole says. "There hasn't been any suggestion that what they were going to do with GMAC is going to be easy or fast. I think today's cost reductions show the company is serious about making real changes to turn the situation around."

Tuesday's moves continue a cost-reduction campaign inaugurated in October when GM got the United Auto Workers union to sign off on sweeping reductions to the company's cost structure, including nine plant closings and some 30,000 job cuts. Costs related to the restructuring, combined with poor North American auto sales,

produced a loss of $8.6 billion for 2005.

The pain is now being shared by salaried workers who were hired at GM prior to 1993 -- the only employees eligible for retiree health care benefits at the company. Beginning Jan. 1, 2007, GM will cap its contribution to its retirement health care program at this year's level and institute "cost-sharing features" when medical costs rise.

As a result, retirees could see higher monthly contributions, deductibles, co-insurance, out-of-pocket maximums and prescription drug payments, GM said.

"We are now aggressively implementing a solid plan to turn around the North American business and restore overall profitability as quickly as possible," Wagoner said in the statement. "It includes plans to grow our revenue base with great cars and trucks and the right marketing strategies -- and I have great confidence that we are moving quickly in the right direction here. We also have a clear plan to address our costs, especially in areas where we are not competitive -- our structural costs and health care and legacy costs."

Tuesday's moves are part of GM's plan to reduce global structural costs to 25% of automotive revenue by 2010, compared with roughly 34% in 2005.

"Our plan is focused on setting us up to be competitive for years to come, and to achieve strong business results -- in revenue, income, and cash flow," Wagoner said. "We need to improve our liquidity and our balance sheet, and to reduce risks to our business and financial viability going forward. And while the steps we've announced previously are big, we said at the time we would be doing more. The next steps are today's announced actions."

Many observers point to the $19 billion in cash sitting on GM's balance sheet as evidence the company has plenty of time to fix itself. But Egan says GM's liquidity issues may be worse than people think.

"Delphi could burn up $5 billion to $8 billion of that cash, depending on how labor negotiations turn out," he says. "And, you also have the rising legacy and health care costs, higher interest costs and higher commodity costs. All of these factors will be eating up more and more cash."

Meanwhile, as GM was making its announcement, its chief rival,

Toyota

(TM) - Get Report

reported a 34% rise in its fiscal third-quarter earnings, noting strong sales in North America. Toyata also said it is expanding production capacity at its new plant in Woodstock, Ontario by 50%. The contrast between the actions taken by the world's two largest automakers illustrates the challenges that still lie ahead for GM.

"GM is heading in the exact opposite direction," DesRosiers says. "They're closing plants, cutting dividends and reducing salaries. Toyota is growing its business in North America. So, it's not like people aren't buying cars. They're just buying alternatives."

GM shares recently were down 34 cents to $23.