GM Reports May have $39 Billion Tax Bill

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November 7, 2007

updated November 8, 2007

General Motors just released their 2007 Q3 results.

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GM continues to lose money in North America (NA) and Europe. Combined, these operations lost $337 million.

GMAC, primarily because of Residential Capital's exposure to the sub-prime house melt down lost $757 million.

If not for GM booking the sale of Allison GM would have had a negative cash flow of $2.5 billion. The overall performance of their regional operations were as expected.

Now the real surprise is GM accounting for $39 billion of previously deferred tax assets in the US, Canada and Germany. This charge has resulted in some confusion in the press as to what this actually means. GM for very good reasons has not gone out of their way to explain what and why they wrote down $39 billion in deferred tax assets.

After reviewing CFO Fritz Henderson's Conference Call, and an interview with CEO Rick Wagoner, I have updated this article with what I believe is a more accurate assessment of the facts and what this means.

According to Accounting for Income Taxes - SFAS 109. (Statement of Financial Accounting Standards), GM was obligated to account for their tax deferred assets as a loss. With the write down, GM is recognizing their deferred tax assets accrued from their continuing operation could turn into a liability given their current financial condition. That is because GM has not been profitable for three years and has not had the ability to invest in capital programs and equipments to offset older tax deferred obligations. To sum up what has been going on, GM has been writing down assets faster then they have been investing in new capital programs. As a result this could have negative tax implications for the company.

In review of GM's financial statements, this is not a deferred tax liability just yet but it is a warning that it could be.

Almost this entire write down was for their NA region which has account for a majority of their losses since 2005. This loss in the near term should not result in negative cash flow.

Assuming GM can turn the company around, GM does have tax loss carry back/forward credits which shall offset their tax burden further freeing up money to offset their future deferred tax liabilities.

If their new product is successful, the recent UAW agreement frees up additional cash and GM can invest in their future, the $39 billion write down yesterday has little meaning and their liabilities will be as before. But if GM cannot do that, this may have serious implications for the future of the corporation.

What has me troubled is GM's 2005 restructuring plan was relying on a US annual sales of 17 million vehicles. Over the past few months, the annual sales rate has been in the low 16 million. If this continues, this will further strain GM's ability to turn around their US operations. Also, there is much uncertainty with GMAC and their exposure to the sub-prime housing market. This can further hamper GM's turn around.

On a brighter note, total revenue for the global auto operations was up and only slightly down in NA. This is a good indication that GM has reduced their reliance on incentives given that sales volume continues to be down in NA as they reduce their fleet sales.

Beyond the headlines, I think the results are mixed but a warning that should be taken seriously. NA and Europe continue to struggle adding to the problems but their Asia, Latin American and non-traditional markets continue to grow.

All things being equal, I suspect NA will fluctuate around breakeven for the next few quarters given the uncertainty in the US economy and the full benefits of the recent UAW agreement will not be realized until around 2010. If not, the $39 billion may become a legitimate liability and the future of the company very suspect.

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