GM Alliance Chatter Raises the Stakes

The possibility of an alliance with Nissan and Renault has boosted the stock and bonds of General Motors ( GM) from already heady levels. Given the fundamental troubles at the junk-rated automaker, investors' optimism about the proposal only makes the stakes higher and the fall potentially harder if the deal doesn't happen.

GM shareholder Kirk Kerkorian's suggestion last Friday that the Detroit automaker ally with Nissan and Renault is just an idea thus far, but it sent GM's stock and bonds up about 8% on June 30. The rally punctuated the extent to which GM's securities have underpinned the performance of their broader universes this year. GM is the best-performing stock in the Dow Jones Industrial Average, up 51.5% through July 5 vs. 4.1% for the index. GM, whose current weighting in the Dow is 2.1%, is even more important to the high-yield bond market, as autos compose over 10% of junk bonds.

GM and Ford ( F) have added about 1%, or 100 basis points, to the overall high-yield market's first-half total return of 3.14%, according to Lehman Brothers. Without the autos, the high-yield market returned 2.19% through June 30.

The possibility the alliance doesn't become a reality could be a foil for those markets as much as it might be for GM.

"The autos have tempered what could have been greater damage in the high-yield market amid the interest rate fears and stock market volatility," says Brian Hessel, managing partner at Stonegate Capital Management. High-yield spreads have only modestly widened as stocks have faced much rougher waters of late.

GM Chairman and Chief Executive Rick Wagoner and his team are expected to treat the proposal as a hostile move to oust current management, and they are working on counter-arguments, according to a report Thursday in The Wall Street Journal. After the report, GM shares were recently down 0.7% at $29.21; its most volatile 8 3/8% bonds due in 2033 were off by about 1 point, or 1 cent on the dollar, to trade at 80 cents on the dollar.

The alliance, according to Kerkorian and Jerome York, his representative on the GM board, would streamline auto parts and production processes and require Nissan and Renault to take a nearly 20% stake in GM.

Unlike the markets, analysts have been skeptical about the proposal, and many have highlighted roadblocks to the deal, including management egos and control issues, and cross-border operation challenges. Nissan and Renault CEO Carlos Ghosn is known for brave pronouncements and thinking outside the box, while Wagoner is just beginning to make headway on his plans to revamp the company. The alliance would likely not affect GM's efforts to negotiate with the United Auto Workers, or aid its attempts to trim legacy costs or pension obligations.

"Until we see the whole proposal, we don't know what the structure is, what type of alliance it is, or what the full benefits are ... what does an alliance mean?" wonders Gregg Klein, an analyst at BNP Paribas.

News of management's opposition is hardly unexpected, given Wagoner's fight to regain credibility and craft a restructuring plan amid GM's rapid loss of U.S. market share. It continues to bleed market share in its key North American market to foreign-based competitors such as Toyota ( TM). Last week, GM reported a 25.9% decline in year-over-year sales for June.

Earlier this year, GM orchestrated a plan to sell a majority stake in its finance arm, General Motors Acceptance Corp. The company further restored some investor confidence with its successful efforts to cut jobs. GM has said it is seeking to cut 30,000 hourly jobs by 2008 through attrition and other methods; last week GM said 37,000 UAW employees have accepted its buyout package. Also, the flare-up in labor negotiations that took place when its bankrupt parts supplier and former subsidiary, Delphi, filed motions to cancel its labor contracts has subsided for now.

But the impact of the proposed alliance or its possible failure should be taken in context of GM's dominance thus far this year, particularly in the high-yield market.

The entire GM bond complex, including GMAC bonds, returned 12.52% through June 30, while GM bonds alone returned 29.98% in the same period, according to Lehman Brothers. GMAC bonds alone returned 7.5%. Ford, which typically trades alongside GM in the bond market, has provided weaker returns, but it also has buoyed the high-yield bond market. Its bonds have returned 8.58% through the end of the first half.

Also belying enthusiasm for the alliance, the credit default swap market, which allows investors to buy protection against default, reversed the likelihood of default at GM and Ford on the heels of the proposal. That market now prices the cost of GM protection lower than the cost of Ford protection; this suggests that investors believe a Ford bankruptcy is more likely than a GM bankruptcy.

The cost of GM protection itself has fallen from a premium of about 16.25% at the end of May to an 8.5% premium since the alliance was announced. It costs an 8.75% premium for Ford protection, according to a hedge fund trader who spoke on the condition of anonymity.

GM bondholders hope that a failed alliance would, at worst, bring their bonds and shares back down to where they were before Kerkorian's statement. But the emotional impact of losing such a surprise "bail-out" might cause a greater plunge than that. "If this alliance fizzles, watch out," says one high-yield investor who was not permitted to speak on the record about individual credits.

Staff reporter Nat Worden contributed to this story.

In keeping with TSC's editorial policy, Rappaport doesn't own or short individual stocks. She also doesn't invest in hedge funds or other private investment partnerships. She appreciates your feedback. Click here to send her an email.

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