The Death of GE?

January 28, 2018

 Conglomeration, at one point a driver of GE’s success, is now threatening its very existence. Hard decisions about company structure and capital allocation are going to have to be made.

 

Conglomerates were heralded as a managerial and business godsend – corporations operating across multiple sectors yet run by the same management. By diversifying its business model, the parent company is in theory hedging against risk and losses in one particular sector. But for General Electric (GE), a champion of the conglomerate business model, the music might have finally come to a halt.

 

GE truly rose to prominence under Jack Welch, the CEO who spun the traditional energy and

manufacturing company into a corporate behemoth. With new exploits in media, finance,

and even pet insurance, Welch spearheaded the expansion of GE. The most notable offshoots

was GE Capital in the 1990s. GE Capital served as GE’s financial services unit, focusing on

credit card, mortgage, and insurance businesses. The firm behaved more like a hedge fund,and created enormous shareholder value, especially during the bull market of the

1990s. The results of the expansions spoke for themselves as the stock price increased by 4,000% under Welch till 2001. But a look at GE’s performance in the last decade shows the company is a shadow of its former self.

 

GE stock has dropped by more than 35% since June, and the company recently cut its dividend for the first time since the Great Depression. Most recently, the company pledged to pay $15 billion over the next 7 years due to liabilities in its previously owned insurance operations. When GE earnings are taken into account, this means a charge of $6.2 billion – another spot of bad news for shareholders. So, what solutions does newly the appointed CEO, John Flannery, have?

 

His first priority was to continue the process of winding down of GE businesses lead by his predecessor, Jeff Immelt. Immelt inherited a grossly inflated and complex GE, and took it upon himself to wind down operations and sell off subsidiaries that weren’t adding to shareholder value. This resulted in withdrawing GE from various divisions, including financial services, entertainment, and plastic and jettisoning businesses - including NBCUniversal and Welch’s crown jewel, GE Capital. Flannery’s plans to take this forward by selling off even more business arms and refocusing growth on GE’s three core operating and revenue-generating divisions – power equipment, aviation, and healthcare. However, in light of the most recent blowback, he has suggested a pathway which previous executives firmly rejected – a fully-fledged GE break-up.

 

At a time where no solution seems to be stopping the bleeding, Flannery said that the company was examining options for the aforementioned divisions and that, ‘There are no sacred cows…[which] could result in many, many different permutations, including separately traded assets really in any one of our units.” But would a breakup solve GE’s problems? Cases can be made for both sides.

 

On one hand, a demerger could allow GE to separate its flailing assets from the revenue generating divisions. By spinning off its businesses, GE could unlock capital through an IPO – a route taken by electrical company Siemens. It would also allow for a reallocation of capital and enable GE to deepen its influence and progress in a specific industry as opposed to widening its influence. But most importantly, it would allow for a radically different management structure which is perhaps what the individual businesses need.
Conversely, a breakup might not serve as the panacea for GE’s problems. Analysts state that for a breakup to be even moderately effective, the sum of the parts needs to be greater than the whole. But GE’s breakup value lies around $3 shy of its current value, which means that a breakup could potentially destroy value as opposed to generate it, not to mention the complexities that accompany a breakup. Furthermore, the apparent synergies between the industries allows for shared R&D as well as a common pool of solutions. Being under the same umbrella also enables the individual arms to access cheap capital and the GE brand name.

 

In closing, the question is not over whether the once great conglomerate will break up or not. The real issue is how Flannery will steer GE out of this trench created by 2 decades of ineffective management and unwise investments.

 

 

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