GM Spins Off Delphi

Commentary about business and finance.
Aug. 5 1998 2:04 PM

GM Spins Off Delphi

The stock market's head-snapping volatility is continuing, but elsewhere it's pretty much business as usual. The most important news of the week from corporate America was the long-awaited announcement that General Motors will be spinning off its Delphi Automotive Systems parts division as a separate company sometime next year. Analysts have been both expecting and clamoring for Delphi's independence for a while now, and GM apparently decided that in the wake of the long UAW strike it might make sense to get back on Wall Street's good side.

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Because of the peculiar way in which investors tend to undervalue large, vertically-integrated companies like General Motors, the Delphi spinoff will almost certainly create additional shareholder value. The Street will perceive a stand-alone Delphi as more valuable than it was as part of GM, so that Delphi + a smaller General Motors = more than GM alone, even if the actual business of the two companies changes not a whit. So from a strategic, long-term perspective the decision was inevitable.

The irony here, of course, is that what GM is doing is the inverse of what every other large corporation in America seems to be doing, namely merging. When Citicorp and Travelers or Bell Atlantic and GTE join, that supposedly makes each of them more valuable together than they were apart (1+1=3), but when GM divests itself of Delphi, each of them is supposed to be more valuable apart than they were together. There is, in other words, confusion (and I think the confusion is genuine) about whether smaller or bigger is better.

That aside, though, GM's decision to push immediately ahead with the spinoff is a curious tactical decision, since it's guaranteed to annoy the UAW (which has already announced its opposition to the divestment). Delphi head J.T. Battenberg III is known for his hard-line approach to labor relations, and the Delphi spinoff is generally seen as a prelude to more plant closings and serious labor-force reductions. The consistent rap on General Motors has been its inability to get its cost structure under control, and making Delphi independent is seen as essential to changing that.

But the importance of labor costs per se to General Motors' competitiveness, or lack thereof, has been overrated. At present, labor makes up just 15 percent of the production cost of GM's autos, and that number is dropping. As Peter Drucker wrote recently, "Once direct labor costs go down to 12 percent, low-wage labor simply no longer has a competitive edge. What one can save by paying lower wages one loses in freight costs, even if the productivity of the low-wage labor is high." (And that "if" is a big one.) The real issue is not labor costs, but plant capacity.

That doesn't mean that the problem is any easier to solve, or that its solution will be any less painful for U.S. workers. Delphi has already closed 53 plants since 1992. And General Motors is a company designed to own 50 percent of the U.S. market when in fact it owns just 30 percent. It's like a thin man whose closet is full of suits tailored when he was 40 pounds heavier. For the Delphi spinoff to create real value, it'll have to be part of a coherent strategy to make those suits fit again, and not simply a short-term way of appearing serious about cutting labor costs.