General Electric; Market Cap (as of 17/04/2015): €276,45bn

 

Introduction

On April 10, General Electric Company made an enormous restructuring announcement to spin out the majority of financial services division, GE Capital, in a strategic effort to shift the company’s overall direction. The decision was made on the premise of GE looking to focus on being solely a pure-play industrial player and wanting to shift away from its current hybrid financial and industrial model. GE shares were up 8% pre-market upon the announcement of this news.

 

About GE

General Electric (GE) is an American based multinational conglomerate that was founded in 1892 and is headquartered in Fairfield, Connecticut, USA. It is the world’s 7th largest company with $648bn in assets, $149bn in revenues and over $15bn in net income as of 2014. The company’s main operating units include aviation, energy, financial services, healthcare, home business solutions, oil & gas, power, transportation and technology. The company has over 300,000 employees and has a presence in over 170 countries globally. GE was also ranked 9th globally for the world’s most admired companies, 7th for most valuable brand and 1st for top companies for leaders.

 

About GE Capital

One of GE’s main subsidiaries is its financial services arm called GE Capital. Within GE Capital, there are four main segments: GE Real Estate, GE Capital Aviation Services, GE Energy Financial Services and GE Commercial Lending and Leases. These businesses are responsible for offering a full range of financial services and products (such as equipment leasing, fleet services, corporate financing, M&A financing, buyout financing, restructuring funding, commercial real estate, credit cards, savings and deposits) across a variety of industries and consumer groups.  GE Capital is also heavily involved in developing joint ventures and strategic partnerships with other businesses. For the fiscal year 2014, GE Capital was responsible for $7bn of GE’s total $16.7bn total operating profit. GE Capital has over $500bn in assets, which would make it the 7th largest US bank.

 

Deal Structure

As GE moves to become an almost exclusive pure play industrial company, it has begun the process of dismantling and selling off the bulk of its assets from the GE Capital unit. The company announced that it would sell off the majority of its real-estate holdings (from GE Capital Real Estate) to the Blackstone Group and Wells Fargo for $26.5bn. In addition, the company also publicized that it would be returning money to shareholders in the form of a $50bn share buyback. GE also announced a decision to repatriate a sum of $36bn in cash that its GE Capital division had left over seas previously. As a cost of trying to spin out its GE Capital business, the company is expected to incur $16bn in after-tax charges during first quarter of 2015, the majority of which can be attributed to the repatriation of earnings that must be taxed. GE said it hopes to return approximately $90bn back to investors by 2018.

GE also plans to maintain its current dividend level until 2016 with increasing hikes thereafter. The company also is looking to reduce its total share count to 8.5bn by 2018, from its current level of 10.1bn shares.

 

Different Decades, Different Companies

The divestiture of GE Capital illustrates how companies such as GE adopt different market strategies to different and changing market conditions. In 1981 when Jack Welch, took over the CEO position in GE, the market conditions were convenient for companies, even for the industrial ones, to have financial operations. This was because the financial markets were less regulated and profit margins were higher. GE took advantage of these market conditions in the 80s and 90s while completing more than 600 acquisitions under Mr.Welch’s reign. During this timeframe, GE’s market value exponentially increased from $12bn in 1981 to $280bn in 2000.

By the time Mr.Welch delivered the flag to Jeffrey Immelt, GE had operated in diverse businesses such as aviation, power and water, oil and gas, appliances and lighting, energy management and capital. However, as the financial landscape changed in the 2000s Mr. Immelt sold 65% of the businesses he inherited from Mr.Welch.  Over the past 15 years, the company has been in the processing of transforming itself into a “focused infrastructure leader” from its previous model of being a “diverse portfolio of leading businesses.” The recent divestiture of GE Capital is another example of GE’s continued strategy of shifting towards becoming a pure-play industrial player. GE has also previously divested many parts of businesses in the past including the sale of GE Plastics to SABIC, the sale of Appliances business to Electrolux, that of NBC Universal to Comcast and public offering of Synchrony Financial.

 

Deal Rationale

The most important reason for the divestiture of GE Capital is the 2008 financial crisis and regulatory effects spread globally afterwards. Since the crisis, the US Federal Reserve started to establish new rules to take control over wholesale-funded financial companies, even if they are not technically banks. In 2013, GE Capital was titled as a “systematically important non-bank” which made the company subject to the same capital standards and annual stress tests as banks. This was despite the fact that its lending operations do not depend on deposits which is the classical business model of commercial banks.

The divestiture of GE Capital will support General Electric to fend off strict regulatory requirements, simplify its business model and reduce risk. According to the company’s executives, GE will manage to discard its “too big to fail” title together with the regulatory pressures as a result of the reduction in the size of its financial operations. It will only retain a small portion of its lending operations that help customers finance their purchases of GE’s products. In addition, after the restructuring process, General Electric forecasts the proportion of earnings generated from industrial businesses will increase to more than 90% in comparison with 58% in 2014.

  

Valuation Problem

The valuation of General Electric has been a huge problem for the analysts. As a consequence of its large financial business, GE has been classified as a hybrid company in terms of valuation, causing GE to be cheaper than its industrial peers but more expensive than banks. In addition, financial regulation has increased the burden on the value, adding extra costs to the operations and limiting the growth prospects of the company. According to analysts, if the company focused exclusively on its industrial operations, it could increase its stock value as much as 16%, because of the valuation gap between GE and its industrial peers. As a result, the stock price can reach the pre-crisis level, around 30$ per share. According to Thomson Reuters data, General Electric is traded at 14,3x its 2015 Estimated EPS which makes the company cheaper than almost three-quarters of its peers operating in industrial sector such as Honeywell, United Tech and Boeing Co. which are traded at forward PE of 16,7x, 16,4x and 17,4x, respectively.

 

Financial Advisers

General Electric received general financial advice from JPMorgan Chase & Co and Centerview Partners. Its real estate deal was advised by Bank of America Corp and Kimberlite Advisors, while Eastdil Secured and Wells Fargo Securities acted as advisers to Blackstone and Wells Fargo.
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