The proposed GM public offering has some unusual qualities. For starters, it's not very common for a company to have an IPO a year after filing for Chapter 11 bankruptcy.
It has another unique feature, as well: GM plans to issue preferred stock. Common stock will also be in the offering because the U.S. government and the United Auto Workers will sell a portion of their equity stakes.
As an investor, you have the option of buying either one. So which is better? It's too soon to tell because the details are somewhat sketchy (over the next few months, the transaction information will be released in revised filings). But there are some general principles to consider.
Common vs. Preferred Stock
Common stock is the most familiar to individual investors. This type of security represents a part ownership in a company and offers at least one vote per share for key matters like mergers. In some cases, companies may have different classes of stock, which provide various voting rights. For example, Google's (GOOG) stock has Class A and Class B versions. The former has only one vote per share and is owned by the public. The Class B shares are held by the founders and top executives and have 10 votes per share. This is a way to keep power within the hands of a few key people.
Common stock is also the riskiest security. In the event of a bankruptcy, the holders are the last in line to get any proceeds from the liquidation. In most cases, nothing is left. This is why the common stock of companies like Lehman Brothers and the old GM saw prices drop to pennies.
Preferred stock is a hybrid of common stock and debt. It also represents ownership in a company and will generally rise as a company increases its sales and earnings. And it has downside protection. Preferred shares get priority above common shareholders if there's a liquidation. Also, this type of security usually carries a high dividend. So, even as the company's fortunes weaken, the preferred shares may not decline as much because of the attractive yield.
As you can see, preferred shares have some nice benefits. In fact, they're usually the type of security sophisticated investors like venture capitalists prefer.
The GM Preferred
In the case of GM, it's proposed security is called a Series B mandatory convertible junior preferred stock. What does this mean?
First of all, the preferred stock will get dividends or liquidation proceeds before any common stockholder. However, it will be second in line -- or "junior" -- to the Series A preferred shares and all the other debtholders. In fact, GM can issue another series of preferred stock that has a higher priority than the Series B. At the same time, any new debt obligation has priority. Thus, even though the Preferred B shareholders have some protection, the stock is still at the bottom part of the spectrum.
Next, the Preferred B shares will carry a dividend, which will be paid quarterly and be cumulative. This means that if GM skips a dividend payment, it must be paid to the preferred shareholders before any new dividends are paid to common stockholders.
Finally, there is a mandatory conversion. Basically, the Preferred B shareholder can convert each unit into a fixed number of common shares (the ratio has yet to be determined). GM will then force the conversion of these securities by 2013.
Why would anyone convert before this deadline? For high-end traders, there could be arbitrage opportunities when there are discrepancies in the pricing of the common stock and the preferred stock. But for the most part, it seems unlikely there will be many conversions.
While the details of the Preferred B offering aren't yet finalized, it appears to offer an attractive investment opportunity for investors -- especially those who want some level of downside protection, which can be critical in the volatile auto industry.
What are Penny Stocks
The lucrative and dangerous world of penny stocks.View Course »