General Motors Corp. likes to emphasize its creativity in manufacturing cars, but last week Wall Street analysts were more excited about the company's use of an innovative financing technique for new acquisitions.
When GM announced on Wednesday that it had won the bidding contest for Hughes Aircraft Co., the company said it would pay for Hughes with $2.7 billion in cash and 50 million shares of a new GM "Class H" common stock. It was the second time in less than a year that GM had created a new class of common stock to help pay for a multi-billion-dollar acquisition.
GM demonstrated the enormous strategic and financial benefits of this technique last year when it purchased Electronic Data Systems Corp. for $2.55 billion using a combination of cash and a new common stock it named "Class E." GM's Class E stock, which is listed on the New York Stock Exchange, has more than doubled, from the mid-30s, when it officially began trading last December, to Friday's close of 72 5/8.
By purchasing EDS with the new class of stock and establishing the company as a separate entity, GM demonstrated a way to retain key employes of a new acquisition. By creating stock bonus plans tied to the future performance of EDS, GM gave EDS employes the financial incentive to remain with the company and avoided destroying the entrepreneurial spirit that has built the firm.
If GM had simply acquired EDS and merged the company's operations into its own, the computer and data processing firm's value would have been overlooked by the stock market, analysts said. Instead, by issuing a new class of stock that has performed phenomenally in the market, GM also has benefited its own stockholders, because they received a special dividend last December of one Class E share for every 20 shares of GM common stock.
"The basic philosophy starts from two ideas," said F. Alan Smith, GM's chief financial officer. "We had a very successful enterprise there, EDS, well known on Wall Street and with an outstanding forecast for growth ahead of them. They had a strong management team that we wanted to retain, and we wanted to provide an incentive for them to maximize the success of that operation.
"For those reasons, we came up with this idea of a new class of General Motors stock that was rooted in the success of EDS. The dividend that a stockholder receives is based on the earnings of the EDS piece of our business . . . .We did it all through the EDS structure, kept them as a separate operating entity, and their management runs the business. You have seen what happened in the stock marketplace."
The Hughes acquisition "has got the same characteristics. The idea is to take a piece of GM GM's Delco and AC Spark Plug subsidiaries and put it along with the newly acquired piece, Hughes Aircraft, . . . and then operate it separately."
By creating the Class H stock to help pay for Hughes Aircraft, one of the world's leading defense electronics companies, GM was able to save more than $2 billion in cash. Although the value of the Hughes bid is more than $5 billion, the issuance of the new class of stock means GM only requires a cash outlay of $2.7 billion.
Wall Street appears to be eagerly awaiting the new Class H stock. In addition to the current Hughes Aircraft Co. businesses, the separate GM Class H operation will include GM's automotive electronics business and a portion of GM's defense operations. While Class H will be a vehicle for investors who want to own shares of a defense electronics company, GM common will continue to be a vehicle for investors interested in an automobile stock, and the GM Class E shares will attract investors interested in a computer services and data processing company.
GM has guaranteed the Hughes Medical Institute, which sold Hughes Aircraft, that the 50 million Class H shares it receives for Hughes Aircraft will be worth a minimum of $60 a share in three years. When GM acquired EDS, it promised EDS owners that the Class E stock they received would be worth at least $125 a share in seven years. Both promises put a floor under the value of those shares for all investors, Wall Street analysts said, and guarantee that GM will do whatever it can to maximize the market price of those shares.
"Using the Class H stock is spectacular from GM's point of view," said Maryann Keller, an analyst with Vilas-Fischer Associates. "As far as I know, this is going to be a replica of the GM Class E, and there is nothing like success to breed more success. The stock market is valuing GM Class E on a much higher multiple of earnings than it accords General Motors . . . . The market looks at this as a totally distinct and separate company.
"Had you taken Hughes Aircraft and melded it into GM, it would simply be lost. This is also an unbelievably attractive mechanism for GM to reduce the total amount of money they have to spend for this acquisition," Keller said.
Robert Scully, an investment banker with Salomon Brothers, said a new class of GM common stock to help pay for acquisitions was first developed last year at a dinner where two Salomon Brothers bankers, two Skadden, Arps lawyers and two GM executives tried to figure out a way to acquire EDS without hindering that company's operations. Scully said GM Chairman Roger Smith had suggested creating a new vehicle to acquire EDS, which led to the development of the new class of stock.
Thus far, no other companies have used the technique, and Scully said one reason is that its success relies heavily on the financial integrity of the issuing company.
"There are few companies whose integrity is as unquestioned as GM's," Scully said.
"Since the Class E stock has worked so well, I think this Class H is a great idea," said E. F. Hutton analyst Joseph Phillippi. "I think it is a better way to realize value for the shareholder, instead of GM swallowing Hughes, which would not do much for GM's multiple and stock price . It is a way of achieving recognition in the marketplace for the value of Hughes and the Delco assets they will put in there. They GM were the ones that broke the ice with this technique , and now they have done it twice."
Phillippi said creation of the new class of stock gives GM additional financial flexibility in the future, because the Hughes subsidiary could sell additional shares to the public if it needs to raise capital, rather than relying on the GM parent to raise the funds. GM said it plans to issue at least 20 million additional Class H shares within three years of completion of the acquisition.
"The important thing about EDS or Hughes is that a great deal of the technology has feet, and these guys are very portable and can pick up and go somehwere else," Phillippi said. "You want to find ways to keep these people. I would not be surprised if GM had some kind of Class H stock bonus for Hughes employes to keep them around."
GM could be delisted from the NYSE as result of its decision to create a special class of common stock to help pay for the Hughes acquisition. NYSE listing rules specify that all of the common stock of companies listed on the Big Board must have equal voting rights, NYSE officials said. The Class H stock that GM has created will only have one-half of a vote per share, while the regular GM common stock has a full vote on matters of GM corporate governance.
But it appears that the NYSE, locked in a competitive battle for listing with the American Stock Exchange and the over-the-counter market, will do its best to find a way to avoid delisting GM, one of its most prestigious companies.