Shares of General Motors Company (NYSE:GM) jumped almost 5% last Tuesday amid major news that the car maker is in talks with Peugeot SA (OTCMKTS:PEUGY) to sell its money-losing European business. Investors in General Motors stock cheered the move, with good reason. The sale of the Opel and Vauxhall brands would help earnings and cash flow, and allow GM to better focus on faster-growing markets (China, in particular).
I’m not quite as bullish as Barron’s, which predicted GM stock could hit $50 with the exit from Europe. And the deal isn’t done yet, with political resistance on the Continent a potential roadblock.
But General Motors stock looks cheap regardless, and the sale of the European units would help the bull case for GM stock.
A Good Deal for General Motors Stock …
Reports suggest a $2 billion price tag for Opel and Vauxhall. That alone isn’t enough to really move the needle for GM, which has a market capitalization over $55 billion.
But the value of the European deal for General Motors stock isn’t just a billion in cash and another billion in assumed liabilities. GM’s European operations haven’t been profitable this century. General Motors has lost a staggering $20 billion in Europe over the past 17 years.
It’s not as if GM hasn’t tried to turn the business around. In fact, General Motors made some progress of late. Its adjusted operating loss narrowed to $257 million in 2016 from $1.37 billion two years earlier. Heading into 2016, the company was confident that it could return the Opel and Vauxhall businesses to profitability. But according to General Motors’ Q4 conference call, Brexit doomed those hopes.
At this point, a turnaround just seems too difficult.
Opel and Vauxhall together grabbed less than 6% market share during the last three years. The impact of the weaker pound isn’t abating. General Motors exited Russia in 2015, and a smaller geographic footprint likely would save capital expenditures and management resources as well.
The deal makes sense for GM — as does the increase in General Motors stock on the news.
… If the Deal Gets Done
The primary concern is whether General Motors actually can get the deal approved by European regulators. Labor unions in the U.K. and Germany already are voicing oppositions. European politicians are asking for guarantees if the deal doesn’t close. And Brexit itself appears to add a layer of regulatory uncertainty to the transaction.
The major risk for General Motors is that it will head down the path of a sale only to come up short. GM already came close to exiting Europe in 2009. Then, the company backed out of a deal with Magna International Inc. (USA) (NYSE:MGA). Working to sell the business — and potentially put jobs at risk — only to back out again could hurt the Opel and Vauxhall brands in Europe, and the U.K. specifically.
Bear in mind that the decision isn’t necessarily a slam-dunk, either. Investors in General Motors stock similarly cheered when GM left Russia. Meanwhile, rival Ford Motor Company (NYSE:F) stuck it out, and saw sales there increase by 10% last year. The situation in Europe is different in many ways. But after 17 years, there’s a possibility that General Motors is leaving just as profitability is within its grasp.
What the Exit Means for GM Stock
Still, I think the market has it right relative to General Motors stock. Overall, this looks like a good deal if it can get done. Simply removing last year’s $250 million-plus operating income loss likely adds 12 to 15 cents in EPS, more than a 2% increase.
GM already trades at a ridiculously low multiple — barely 6x 2017 estimated earnings. Exiting a market that doesn’t seem particularly strong from a long-term standpoint would seem to eliminate some of the cyclical risk that (apparently) is dogging the stock.
General Motors stock trades at a discount to Ford shares, and narrowing that gap alone would put General Motors stock over $40. That doesn’t seem particularly aggressive, given GM’s success in China and its potential de-risking in Europe. Again, the deal has to get done and General Motors has to be right.
For now, investors in GM stock seem confident on both points. And I think they’re right.
As of this writing, Vince Martin did not hold a position in any of the aforementioned securities.