When all is said and sold off, GE’s debt burden – much of it attributable to GE Capital – looks enormous versus the size of the remaining assets and cash flow.
By Leonard Hyman and Bill Tilles:
Three titans of invention dominated the dawn of the electric age: Thomas Edison, the founder of General Electric, Werner von Siemens, whose industrial conglomerate still bears his name, and George Westinghouse, inventor of compressed-air railroad brakes, and more importantly, the man who made alternating current the electric industry standard.
Toshiba-owned Westinghouse already filed chapter 11 bankruptcy. In less dramatic fashion, Berlin-based Siemens Corp. has been struggling mightily with downturns in its major business lines, particularly power generation. Meanwhile Boston-based GE not only has to deal with declining profits at a number of its businesses but also with largely self-inflicted financial missteps.
Of these three corporate entities, GE’s fate seems the most uncertain. Siemens may have already “turned the corner” so to speak, even talking smack about its Boston-based trans-Atlantic rival on its last conference call with financial analysts. And Westinghouse recently exited financial reorganization with a new, large private equity parent, Brookfield Energy Partners, and presumably more modest expectations.
GE’s shares are down almost 75% from their all-time highs in Sept. 2000 despite a raging bull market over the last 8 years.
GE’s underlying problem is the immutability of debt. That is, corporate managements have a relatively free accounting hand with respect to writing down asset values when things go “pear-shaped.” However, all the debt from these financially ill-fated ventures typically remains. In GE’s case the assets of GE Capital were approximately $157 billion at the end of 3Q 2017, and we suspect much of this is supported by debt rather than equity.
If we subtract GE’s “goodwill” – goodwill is an accounting entry that parks expenses temporarily on the balance sheet as an asset to be expensed on a later date – from equity (like Buffett says to do), we get a negative $40 billion. Back up and think about it. An almost $400 billion conglomerate with $40 billion in negative equity.
GE Capital’s assets of $157 billion are large in connection with the company’s total assets of $378 billion, many of which are in the process of disposition.
There is a lot of coming and going here from the perspective of corporate reorganization. The oil and gas business, Baker Hughes/GE, lighting, as well as the transportation businesses are all in various stages of disposition. The good news is that rising commodity prices and inflation expectations should boost BHGE’s value.
The rating agencies appear mollified that GE’s balance sheet will eventually self-improve. The firm carries an investment grade debt rating of single A.
But the question what is GE and why should it exist we believe requires an answer. GE’s management stated GE will remain in three core businesses: power, aviation, and healthcare along with a still-large residual finance portfolio with multiple components, some good some not.
The aircraft leasing segment of the finance portfolio looks solid, but we view the other finance components with some suspicion. Mere precaution. Why? Last quarter, one of these supposedly innocuous business units, Genworth Financial, an insurance entity totally in a run-off mode, punched an almost $8 billion hole in the conglomerate’s balance sheet.
The company has negative equity, is wildly overestimating the contributions from the power business, and has this enormous debt burden from their “capital verticals,” which is a fancy name for “discontinued ops that we pray don’t hurt us again like Genworth Financial did last quarter.”
With interest rates rising and markets increasingly in turmoil, we would look for more surprises from the finance unit ex-aircraft leasing. None of them good. The reason for this derives from an arcane adage of finance that begins “fool me once….”
The second leg of our bear thesis here is this. The heyday of the large gas-fired power turbine, while far from over, is indisputably in decline. We checked with competitor Siemens which reported that large turbine sales peaked around 2008-2009 at 134 units sold worldwide vs about 100 units sold last year – a rather steep rate of decline.
But the problem goes deeper. The competitive pressures on these large industrial manufacturers may force them to cut prices further on new business. This is a declining industry with considerable global excess capacity. Furthermore, margins on once lucrative service and maintenance contracts may be similarly under pressure. It’s a double whammy.
This to us is the key flaw in management’s strategy. We don’t think it’s likely that the power business can “pull its weight.” Management has already cautioned investor’s with respect to meagre results for this unit for 2018. The management at Siemens does not see a gas turbine business pick-up in 2019 either.
This leaves us with two remaining core businesses, aviation and healthcare, which contributed the lion’s share of operating profit of the total Industrial segment. These will provide the operating profit core of GE in the future, plus the contribution from the so called “capital verticals” – assuming the company remains in its present corporate configuration that is.
From an operating perspective, when all is said and sold off, this will not be a particularly large industrial conglomerate. But even after expected asset sales and debt paydowns, the debt burden, much of it attributable to GE Capital, looks enormous versus the size of the remaining assets and cash flow. And in a now rising interest rate environment, that debt burden becomes increasingly costly.
Private-equity investors have already assumed a seat on GE’s board. Ed Garden of Trian along with his father-in law-Nelson Peltz have a considerable track record in turning around underperforming, poorly managed conglomerates. They have their work cut out for them. Frankly this is the one we’d walk away from. By Leonard Hyman and Bill Tilles
In corporate bond la-la-land, it’s only a question of how disruptive the adjustment will be, whether it will be just a painful sell-off or junk-bond mayhem. Read… Corporate Bond Market in Worst Denial since 2007
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