General Motors paid $975 million to its largest shareholder Tuesday in an effort to patch up what had become a contentious dispute over the automotive giant’s 1985 purchase of Hughes Aircraft.
A sweeping agreement signed by GM and the Howard Hughes Medical Institute, the previous sole owner of Hughes Aircraft, is designed to settle a number of differences and fix certain provisions of the original 1985 sales agreement that are now considered badly flawed.
Under the restructuring of the Hughes deal, GM on Tuesday bought back from the medical institute 35 million shares of GM’s H class stock, which the company issued when it acquired Hughes Aircraft. Until the sale Tuesday, the institute held 99.5 million shares, worth about $2.7 billion.
Price Guarantee Voided
In addition, GM and the institute agreed to nullify a complex $30-a-share guarantee that GM had given the institute on the price of its H shares, a provision that was threatening a Wall Street showdown in which the medical institute would try to drive down the price of H stock and GM would try to drive it up. The guarantee provided that, if the price of H stock were below $30 at the end of this year, GM would make up the difference, a potential liability of $2 billion.
Now, in place of the guarantee, GM has issued the medical institute a series of calls and puts--options to buy or sell shares--on 55 million of its H shares. The options establish a price ceiling and floor between 1991 and 1995 for blocks of H stock that the institute continues to hold.
The final part of the agreement disclosed Tuesday provides for an end to private arbitration in which GM was seeking to retroactively reduce by $200 million the $5.2-billion price it paid for Hughes. That disagreement, which was first disclosed in a Times story last December, resulted from a huge penalty on a Navy contract imposed on Hughes Aircraft during the closing of the sale of the company.
If the medical institute sells all of the 55 million shares covered by the options, it would be left with just 9.5 million shares at the end of 1995. It agreed to hold those shares as part of its “core investment portfolio.”
Investors greeted the news negatively, driving down the price of GM H shares in trading Tuesday on the New York Stock Exchange by $1.25 to close at $26.50. Many individual owners of H shares had apparently hoped to “piggyback” on the medical institute’s price guarantee. They now face an unknown situation that may increase their risks, though GM officials said Tuesday that the restructuring is beneficial to shareholders.
General Motors Treasurer Leon J. Krain said in a telephone interview Tuesday that he did not regard the original sales agreement as flawed, but he acknowledged that it did not work out as “originally envisaged.”
Possibility of Manipulation
A major problem has been the relatively small number of shares held by the public, allowing the possibility of price manipulation.
Until Tuesday’s sale of the 35 million shares, the medical institute’s 99.5 million shares represented about 79% of the 126.5 million H shares publicly outstanding. GM held 273 million shares. That left only 27 million shares in the hands of outside investors, and many have been held by employees who do not actively trade. In addition, GM has actually repurchased 3 million shares, further reducing trading.
“The market didn’t develop,” Krain acknowledged.
As a result, the price of H stock came to be viewed as artificially set by GM, which had an interest in propping its value up above the $30-a-share price guarantee to the medical institute. Under the guarantee, GM was liable for up to $2 billion to bring the medical institute’s shares up to the full $30 value.
But Krain took sharp exception to the perception that the auto maker was controlling the market, saying, “I am totally against the assertion that we propped up the stock.” He said GM’s purchases of H stock were done in accordance with federal securities regulations.
Nonetheless, the medical institute apparently was increasingly concerned that the H stock would collapse below the $30 level as soon as the price guarantee expired at the end of this year. Securities analysts said Tuesday that H stock is grossly overvalued on its fundamentals and should be selling at no more than $20 per share.
Medical institute trustee Irving Shapiro, in a Times interview late last year, raised the possibility that the medical institute would dump H stock on the open market to drive down the price, thus triggering the guarantee. Shapiro’s sharp words indicated that relations between GM and the institute had badly deteriorated.
The options issued in place of the price guarantee provide for GM to buy the medical institute’s shares in blocks between 1991 and 1995, which should eliminate any incentive for either party to attempt to manipulate the price of the stock.
In February, 1991, for example, GM has a call option to buy 20 million H class shares at $35 per share. The following day, the medical institute has a put to sell its shares to GM at $30 per share.
The mechanism effectively creates a price floor for the medical institute and a cost ceiling for GM. For example, if H shares were trading at $25, the medical institute could exercise its put and get $30 per share. On the other hand, if the price was $40, GM could exercise its call and pay only $35.
The other options may be exercised in 1992, 1993 and 1995. The agreement prohibits the medical institute from selling its puts and from selling any shares covered by the puts before the options mature. That agreement does not cover the 9.5 million shares that the medical institute has said it will retain as part of its “core investment portfolio,” however.
Securities analysts said the agreement should help promote a more orderly market in H shares. Prudential Bache analyst Paul Nisbet said the market for H shares until now has been a “sham.”
“They eliminated the potential for a very contentious period between now and the end of the year, when there could have been a war going,” he said. “It invited a situation where GM wanted the stock to go up and the medical institute wanted it to go down. They didn’t anticipate that when they wrote the agreement.”
At the same time, GM and the medical institute made significant monetary concessions.
GM essentially had to buy 35 million shares of an overvalued security, Nisbet said. On the other hand, the medical institute is now locked into its investment for an additional five years, since the final put may not be exercised until 1995.
Analyst Wolfgang Demisch of UBS Securities termed the agreement “a fairly carefully balanced arrangement.”
Krain said the repurchase of shares will have no material impact on profits attributable to GM common shares. He also cautioned that the $975-million payment to the medical institute, which includes $600 million in cash and $375 million in notes, is part of an overall agreement package and should not be considered as the price of the 35 million shares alone.
Although GM will incur higher interest charges to pay for the purchase of the 35 million shares, it will also capture dividends on the shares.
Krain estimated the after-tax H stock dividends and the after-tax cost of financing the purchase at $70 million, based on 1988 financial results.
“For practical purposes, it’s a wash,” he said.
GM pledged to increase the publicly outstanding shares of H stock from the current 27 million to 50 million by 1994.