When General Motors Corp. announced last December that it would fill its vacant CFO position with John Devine, who had held the top finance spot at Ford Motor Co. for the better part of the 1990s, investors bid GM stock up a point and a half on the news. Why was the Street so pleased? Not because it expected the new CFO to help transform GM into a New Economy powerhouse–although he may well do that, down the road. No, the arrival of Devine was one of the strongest signals to date that General Motors is serious about fixing the old-fashioned financial and operational problems besetting the largest automaker on the planet.
“This would never have happened a few years ago,” declares David Cole, director of the Center for Automotive Research, a division of the Environmental Research Institute, in Ann Arbor, Michigan. In Detroit, it’s rare for a senior executive to move from one Big Three company to another; a 32-year veteran of Ford becoming CFO of GM is practically a seismic event. “If you’re looking for a sign that this is not your father’s General Motors, this is it,” says Cole. Hiring Devine, he believes, is part of CEO G. Richard Wagoner Jr.’s attempt to put his own mark on the company and speed up its turnaround.
Certainly, the 57-year-old Devine is anything but a tired retread. He comes to GM fresh from a stint as chairman and CEO of Fluid Ventures Inc., a San Francisco E-business venture capital firm. At Ford, he won plaudits from analysts for his performance, during a time when GM’s archrival solidified its lead in profitability and market capitalization. At one point he was considered a possible successor to CEO Alex Trotman, but in 1999 Jacques Nasser won the top job. Still, Devine’s relentless cost-cutting there earned him a reputation as a no- nonsense, can-do numbers guy.
But it’s Devine’s ability to communicate with the financial community for which he is best known. “His reputation as a straight shooter who acts in the best interest of stockholders is well known on Wall Street and the broader investor community,” said Wagoner when Devine’s hiring was announced. “Devine has an excellent reputation with investors and Wall Street,” confirms John Casesa, an analyst with Merrill Lynch & Co. “He’s a dynamic guy who is an objective and focused communicator.”
Today, those communication skills, as well as the cost-cutting eye, are being put to the test. John Devine has a lot to tell investors about GM–and much of it, unfortunately, isn’t very encouraging.
Start with GM’s totals for the first quarter of 2001: earnings of $225 million (excluding the effect of an accounting change) on revenues of $42.6 billion. The positive spin is that the 50-cents-per-share result soundly beat analysts’ consensus forecast of 26 cents per share, according to Thomson Financial/First Call. But there’s no hiding the fact that earnings fell 88 percent from the same quarter a year ago, thanks largely to the economic downturn, pricing pressures, and continuing losses from European operations. “The loss in Europe is less than expected, but we don’t consider that good news,” Devine said during GM’s conference call to discuss first-quarter earnings.
While GM’s stock managed to rise a measly 2 percent during the first quarter, Ford’s climbed 20 percent. Perhaps investors felt that Ford is better positioned to take advantage of the surprisingly resilient auto market (analysts expect automakers to sell about 16 million units in the United States this year, down from a record 17.4 million in 2000 but still healthy). Ford virtually equaled GM’s sales during the first quarter, while earning four times the profits. Ford’s production cuts were smaller, and it made money in Europe. So it comes as no surprise that despite taking in $14 billion less in 2000 revenue, Ford has a market cap of $31 billion, compared with $29 billion for GM. Subtract GM’s stake in Hughes Electronics Corp.–valued in the neighborhood of $10 billion–and the difference is glaring.
(At press time, GM disclosed that it was in talks with Rupert Murdoch’s News Corp. to combine Hughes with News’s satellite operations- -talks in which Devine is playing a leadership role.)
Indeed, despite completing two of the best years in its recent history in 1999 and 2000, GM has little to show for it. Critics carp that its cars and trucks are dull and unimaginative, and the company’s domestic market share continues to slide. GM has a bloated amount of capacity, which eats into profits, and little recourse for drawing it down. It’s hemorrhaging cash in Europe, where it lost $676 million in 2000. Ratings agencies are threatening to levy a downgrade, because of high debt levels at financing arm General Motors Acceptance Corp. (GMAC), which would wreak havoc on its cost of capital.
“I don’t get the sense that GM is leading the auto industry in any category,” comments Anjan Thakor, a professor of finance at the University of Michigan Business School. “And there is no reason why they shouldn’t be. There is no reason why they shouldn’t be in the same boat as Coke, Wal-Mart, or GE as far as creating shareholder value.”
Elite company, to be sure. But creating shareholder value is “the primary reason I’m here,” says Devine (who will be paid handsomely to deliver: eventually he’ll be eligible to receive 500,000 options, on top of his signing bonus of at least $1.5 million). “There’s no secret in terms of what we have to do. We have to put some clear objectives on the table, and we have to perform against those objectives.”
Already Devine, who is known for conservative, realistic forecasts, has set some lofty ambitions for GM, even as it deals with one of the nastiest economic downturns in a decade. He endorsed 2001 earnings expectations in the neighborhood of $4.25 per share, even though the analysts’ consensus estimate is only $3.62, according to First Call. Then he set goals of moving cash flow into positive territory by the end of the year and improving net-income margins from roughly 3 percent to 5 percent down the line. “Those are small numbers, but they have a long way to go to achieve them,” says Domenic Martilotti, an analyst at Bear, Stearns & Co. “A lot of things have to go right.”
To begin with, GM and Devine have to fix critical short-term problems, starting with excessive inventories. Coming off a record year for light-vehicle sales and facing an economic downturn, GM needed to slow down production. Devine successfully pushed for cuts in North America of 21 percent in the first quarter and 17 percent in the second (later revised down to 15 percent)–higher than GM had initially wanted, according to analysts. Some factories will be shuttered, but most of the cuts have been made by idling plants. The move will help GM get inventory closer to expectations for the year, but it won’t solve the company’s overcapacity problems, which some estimate to be as high as 15 percent worldwide.
“There is way overcapacity worldwide for cars,” says Jim Glickenhaus, managing partner at Glickenhaus & Co., a large GM shareholder. “I’m not sure Devine can do much to help.”
The biggest impediment to cuts is the unions. Although the automaker temporarily idled around 18 plants in the first quarter, affecting as many as 30,000 employees, according to analysts, savings will be negligible. Under their contract, union workers who are temporarily laid off receive 95 percent of their regular pay. GM’s contract with the United Auto Workers isn’t up for review until 2003.
Devine hopes that focusing the organization on better financial metrics will improve operating efficiencies. In recent years, GM has used return on net assets (RONA) as its key measure of performance, and as a benchmark for incentive compensation. But some analysts argue that RONA hasn’t always been the best guidepost at GM.
“Historically, [GM managers have] been known to manipulate performance to meet the targets,” says David Bradley, an analyst at J.P. Morgan Securities Inc. “They would do things like write off assets to meet the RONA goals.” Devine wants the company to focus on other measures, including aftertax return on sales margin and operating cash flow, the latter by business as well as in total. While the CFO says that RONA will continue to play a role, he hints at the possibility of scrapping it one day. “You have to be careful about having too many metrics, because you can lose focus,” he says. Indeed, Devine didn’t seem too concerned that GM’s RONA for the first quarter was a scant 5.1 percent, well below the company’s hurdle rate of 15 percent. “It’s going to be a tough year to achieve that goal,” he admits.
PROFITS VS. MARKET SHARE
More than anything else, though, Devine wants to improve GM’s profitability. “Profitability is the key metric here, there’s no question about that,” he says. But what happens when profits and market share are at odds? Will the automaker continue to put capital behind low-margin products to maintain its vaunted top spot?
“Devine will be very influential about getting them to focus on profit share over market share,” predicts Merrill Lynch’s Casesa. “In the long term, market share and profits come together, but for now there are too many mouths to feed. There are limited sources of capital, and they are stretched too thin.” The decision to phase out the Oldsmobile unit, made the day before Devine came on board, is a start. And while Devine says there are no immediate plans to put other units or product lines on the chopping block, you can bet that new products will be on a much shorter leash when it comes to profitability.
“I think it’s fine to be number two if the foundation is more solid than it is today,” says Casesa. “Getting smaller is better if it makes you stronger. It’s better to shrink on your own accord than to let the market do it for you.” Indeed, Ford seems poised to grab the top spot in revenues, if not market share. Its U.S. market share is 23 to 24 percent, compared with GM’s 28 to 29 percent; and in the first quarter, Ford’s sales of $42.36 billion came within a hair of GM’s $42.62 billion.
But Devine doesn’t seem ready to cede GM’s position as the world’s number-one automaker, which it has held since 1931. “Some stability in our market share is a very important metric,” he says. “It drives a lot of things, like capacity utilization and our image in the marketplace.” But to achieve that stability, he adds, “we have to do it smart. We have to do it with the right products. And we have to do it while we are improving our margins.”
To be sure, GM is placing its bet on a higher-margin product mix, emphasizing sport-utility vehicles (SUVs), light trucks, and hybrid vehicles. Later this year, the automaker will begin to sell the much- anticipated Chevrolet Avalanche, a cross between a big SUV and a pickup truck. And by year-end, Saturn is also expected to put its first SUV, the VUE, into production. GM is also throwing its weight behind a scaled-down version of the Hummer, which will retail next year in the estimated $50,000 to $60,000 range.
Trouble is, the slowing economy and high gasoline prices are likely to dampen demand for these big-ticket vehicles. And competition in the SUV and light-truck markets is red-hot; GM, Ford, and DaimlerChrysler will offer a combined eight new models this year in the already-crowded midsize SUV market alone. For the first time, automakers are offering rebates and incentives to attract buyers in this segment, which can cut into profits by $1,500 to $2,000 per sale.
SHORING UP GMAC
One business that continues to produce healthy profits for GM is GMAC, the financing arm. In 2000, the unit was responsible for more than a third of GM’s total income. Its operating earnings of $431 million in Q1 2001 represent more than 100 percent of the company’s total, thanks to a loss at Hughes, and analysts say it could contribute as much as $3 of the expected $4.25 per share to the bottom line in 2001. “GMAC is essential to GM. They can’t be competitive without the finance company,” says Casesa. “The big question is, can it be a growth platform in its own right?”
Indeed, GM has grown GMAC through aggressive diversification into such nonautomotive businesses as mortgages, insurance, and business loans. Some think that GMAC could emulate the tremendous success of General Electric’s vaunted GE Capital unit. “A lot of manufacturing companies dream of building the equivalent of a GE Capital,” says Casesa. “But only GE has been able to do it.”
Other analysts speculate that GM might sell or spin off some of GMAC’s nonautomotive lending operations, as Ford did under Devine in the late 1990s. But don’t count on divestitures yet, says Devine. “[GMAC] has done a good job growing their nonautomotive business,” he says, “principally on the mortgage and the insurance side. They have done everything we have asked them to do and more. There are peaks and valleys to that business, but I think there is more growth there.”
With the growth comes risk, though. To fund the diversification, GMAC has had to leverage up, taking on $134 billion in debt at the end of 2000, up from $122 billion in 1999, including $56 billion of short- term obligations. Although GM commercial paper currently enjoys top credit ratings, Standard & Poor’s placed GM on credit watch in February, lowering the outlook for GM’s debt from “stable” to “negative.” A downgrade would have a dramatic impact on GMAC’s profitability, making it difficult to refinance maturing short-term debt.
“[GMAC has] a very large balance sheet, and we are always looking at ways to strengthen it,” says Devine. “We are working hard to avoid a downgrade.” Under Devine’s watchful eye, GM trimmed its reliance on short-term commercial-paper financing from $32 billion at the end of last year to $18 billion.
“Devine has always been a champion of a strong balance sheet,” notes J.P. Morgan’s Bradley. “He did a lot of strengthening of the balance sheet under his reign at Ford. He’ll look at debt levels–more cash and less debt–and make sure that retiree benefits are adequately funded.”
In fact, Devine was quick to point out to analysts that GM’s pension plan lost 5 percent in the first quarter; if that rate were to hold for the year, it could affect its fully funded status, and thereby cost the company as much as $1 billion in pretax expense next year. “It’s premature to assume that [the pension plan] will impact 2002 results,” he says, “but it is something we take very seriously.”
Fine-tuning a success story like GMAC will be a Sunday drive for Devine compared with the effort that will be needed to turn around GM’s loss-laden European division. “The key concern is that we are not making any money,” he says, deadpan. “That’s real clear.” In fact, GM Europe lost $676 million in 2000, and it’s running $86 million in the red as of the first quarter–putting in doubt even its modest goal for 2001 of breaking even.
Why is GM falling down on the Continent? For one thing, its overcapacity problems are even more conspicuous in Europe, where competition is getting fiercer. “The main problem is that continental automakers like Volkswagen, Peugeot, and Renault have got their act together,” says Casesa.
Also, GM fell behind on a European favorite: diesel engines. “Diesels have been an important part of the picture in Europe for some time,” says Devine. “They’re running roughly 40 percent of the mix right now, and in many countries it’s higher than that. And for the last couple years, we have been short on diesels.” But, he adds, “we are catching up.”
GM has also been hamstrung at times by its alliance strategy. Unlike Ford, which prefers to buy foreign businesses outright, GM has chosen to create alliances by taking minority positions in its overseas partners. Doing so, explains Devine, “gives us an ability to work with our alliance partners on identifying and developing synergies, and get those done without making a total commitment either way on the company and getting into pretty large financial and social issues in running companies.”
But when things start going south, GM is little more than a passenger. “It’s hard to have the real influence [as a minority partner] to make the difficult decisions and get it turned around,” says Casesa. That’s the situation in Asia, where a 49 percent ownership deal with Isuzu Motors Ltd. bought GM a minority interest in a disaster. In April, Isuzu said it would probably post a loss of about $550 million for the fiscal year ended March 31.
Some analysts expect that Devine, and GM, will soon run out of patience with the financial performance of alliance partners. At the least, the CFO will “take a more skeptical view of entanglements abroad,” says Bradley. The morass in Japan with Isuzu could sour GM from getting involved in South Korea with troubled automaker Daewoo. During the February analyst call, when asked if he wanted to talk about Daewoo, Devine drew laughter with his one-word answer: “No!”
Such exchanges demonstrate that Devine hasn’t lost his ability to work a crowded room. “In the past, GM has been known to be standoffish with the financial community,” says Cole of the Center for Automotive Research. “Wagoner’s new model is one that is open and communicative. Devine is a good fit.”
Still, Devine knows that charm and candor go only so far with Wall Street. “They love you when the numbers are good, but they shoot you when they’re not,” he says, laughing. “They appreciate consistency–but at the end of the day, it’s results they want.”
Joseph McCafferty is a senior editor of CFO.com.