Break Up GE To Unlock Its Value
GE’s stock has been in a 5-year slump since 2001. Immelt’s got a tough job. He’s been relentlessly doing everything humanely possible to make the same GE sales pitch to analysts, major shareholders, the board, customers, employees, Dave Calhoun and himself. Fortune’s November issue runs a cover story on him and the photo displays his now completely-turned-silver hair. I recall his hair was mostly black when I saw him in Tokyo in mid–2001. Despite the best efforts from one of the best CEOs working today, investors are through buying it. GE stock is still going nowhere.
In the mean while a noticeable exodus is taking place with some of GE’s brightest executives. Cerberus Capital Management, the all-mighty hedge fund that trumped KKR in the then-landmark GMAC deal, has become a hub for GE alumni. GE managers, some of who report directly to Immelt’s staff (which means they have a legitimate shot at being CEO/CFO for many Fortune 500 companies, except for the top 20) , are quickly populating the ranks of various private equity and hedge fund firms. The exodus reached alarming level when Dave Calhoun, a 27-year GE lifer who was once a front-runner in the horse race to succeed Jack Welch and now a vice chairman of the company, quitted in Aug 2006 to run a far smaller private media company VNU (backed by KKR, Blackstone and Carlyle), with a rumored $100MM potential incentive.
Much has been talked about the benefits of turning a company into a private one. The advantages are especially pronounced given today’s corporate governance activism (whether an ordinary man in the street agrees or not, some managers ARE worth hundreds of million dollars in pay, not to mention private jet or Manhattan apartments) and Sarbanes Oxley Act. So my initial thought on how to salvage GE was on this path - what if we can LBO GE…? Well I quickly dismissed that myself. Indeed PE and Hedge Funds (the line to distinguish the two is fairly blur right now) are calling the shots all around, evidenced by the fact that the record for highest LBO deal has been set TWICE already in 2006, eclipsing the heyday of the greedy 80’s (on a side note, Lous Gestner - then in RJR Nabisco, is now back in the game with Carlyle, completing a full circle). Now they’re setting their eyes on Dell ($60BN) and Ford ($35BN). Only sky is the limit for those cowboys.
However GE with $362BN market cap is clearly too much for PE firms to make a run at. Besides the obvious financial hurdle, the current LBO model doesn’t fit for companies like GE or Apple. Among all others, the biggest change LBO brings to a public firm is that it puts a time stamp on the life of the company, which is otherwise presumed to exist in perpetuity. Live if you can make a change within the next five years; die if you can’t. That new corporate goal changes the entire mentality and easily solves the century-old agency problem. It makes a lot of sense if the company in its past life as a public entity is just an also-run. What if you’re already the market leader? What if your existence serves a higher purpose for the society at large, and for the sake for preserving mankind dignity your existence should be expected and allowed to last in perpetuity (Apple is an example; GE, hmm...arguably so)? Businesses of that nature probably won’t appreciate the short-term focus of PE firms, but ironically the structural advantages that PE firms can bring about are exactly what such businesses need so that they can: 1) focus on actually delivering the best products and services instead of utilizing management’s intellectual prowess in strategizing how to hit the EPS; 2) stop trying to figure out how to allocate income “stretch” targets; 3) leave the explanation of options backdating to accountants only; 4) forget about balancing double-digit growth in revenue, income, cash simultaneously while maintaining 20% ROE, which is a more formidable feat than proving Poincare Conjecture (go Perelman!); 5) sit down, have a cigar, and think about what is the next big thing that will reshape the planet and mankind.
Enough said. So which model would fit GE? Berkshire Hathaway’s is pretty close. Buffett essentially runs that as a private company - no meeting with street analysts, no earning forecast (if you don’t manage net income, how can you forecast? And then everyone says managing income is evil…duh?), no excessive sales pitch other than Buffett’s legendary annual letters. That culture is what GE needs to liberate its highly competent management team from numerous mundane short-term tasks and allow them to develop truly long-term vision and strategy for the company. Nonetheless, GE has another unique, insurmountable challenge - its size. Berkshire Hathaway has $160BN market cap and GE’s more than twice of that. GE’s market cap has become so large and its business is so diversified (the bite for being the all-time champion for diversification), it’ll just take too much market movement to nudge its stock price. Unless GE has a true blockbuster product (like the light bulb a century ago), investors can hardly get excited about its performance (some washing machine and x-ray machines every now and then ain’t enough). Over the years the giant company has turned into a process-driven business rather than product/service-driven one. Everybody knows GE will methodically meet its every target and continue to churn out excellent managers, but few know GE Capital alone can rival Citi Group, Bank of America and J.P. Morgan Chase in size and product offering. GE is paying the price for its own size - its far-ranging products and services are all excellent in their own right and market segments, but they are trivialized when everything is added up to form the sum of GE. There is a ton of value within each GE division it almost seems that the entropy is lost or just cancelled out with each other.
Therefore IMHO the best way to unlock GE’s value is to break it up. It can be split into six businesses - Commercial Finance, Consumer Finance, Infrastructure, Healthcare, Industrial and transportation. It’s not exactly a clean-cut but it’s doable. Some of those P&Ls will be innerly harmonized enough to form their own identity, culture and mission to go to greatness on their own. Some of them may be more challenged with an identity crisis, but they will survive. GE’s portfolio model (used to be callled SBU... Anyone still remember?) has been extremely successful in the past, and to this date is still the envy for many other companies. It has four major advantages, but I’ll argue none of them should be a show-stopper to break up GE. GE’s old model has four distinctive features. In today’s world, either they’re no longer valid, or they’re no longer part of cost of living to stay in the game.
Human Resource Training
People is the best product coming out of GE. Millions of young, ambitious professionals flock to GE’s leadership training programs for their assortment of business and management training that is unparalleled in the world, both in breadth and depth. Once you’re marked as an “A” player, you’re expected to move to a new location, join another division, take new role and responsibilities every 18 to 24 months (yeah your kids will be multi-lingual, cross-culturally attuned by birth right). However, given GE’s size, even after break-up, the new baby-GEs will still have enough critical mass to provide training opportunities in almost the same magnitude. All of them are already bona fide global platforms. In addition, people start domain specialization fairly soon within 2–3 years after they join the company.
If I started out with NBC at Rockefeller Center, would I really want to accelerate my career in Cincinnati in GE Transportation (big plant there)? Well, I’m sure I can find equally appealing placement elsewhere in NBC Universal.
Capital Allocation / The Science of Levering
The magic mojo for GE that once dazzled many competitors.Some businesses like GE Industrial are cash cows that don’t make too much net income but generate cash consistently. GE consolidates that cash (the treasury operation is a wonder to behold) and throw that around in high-growth businesses to make acquisitions. It’s a very efficient use of capital and only possible when you have a mix of industrial/capital and “cash cow”/“star” businesses. I would very much like to indulge in a more detailed discussion of “levering” for people who still recall the basic corporate finance principles from Brealey and Myers, but I should probably stop right here since I’m not entirely sure such levering mechanism is public knowledge. Mr. Bill Gross from PIMCO almost stepped on this in his 2002 crusade on GE. Long story short, GE recapitalized quickly in response to Gross’ assault, and that discretion on capital allocation among its myriad of businesses is now gone (there are other benefits of NOT doing that though). Also, there is so much liquidity in the market now - GE is no longer the privileged few who can amass large sum of capital on a minute’s notice (just think about Blackstone’s $20BN fund). This paragraph may have unintended gaps in logical reasoning.
Portfolio Diversification
Old topic with a new twist in the age of ultra rapid value creation. Business 101 says that diversification is useless (“home-made” effect), and in fine print below it also says that “… except for GE”. GE has been the consummate poster-boy defending the value of diversification. It’s a simple premise: its 1,000+ businesses are all in different industry cycles; at any given point, some will do well and some will not. The good and bad cancel out each other and usually what is left is gravy. It is a good, almost risk-free strategy, but not a particularly exciting one. Andy Grove says “Only the Paranoid Survive” (btw, that book doesn’t offer that much insight really. The old man is repeating himself too much), I say " Only the Double-Down Survive“. GE’s diversification has created a false sense of safety. 10% year-over-year steady growth may suffice in the past 100 years, but it’s not going to cut it in the new century when a garage business of 40 people can create $1.6BN over 18 months. On the other hand, GE Capital raised many eyebrows when it quietly started dominating GE’s balance sheet and profit and loss statement left and right. Indeed, if every soul on the street looks at GE as a finance company, GE will have to carry the same inspiring PE ratio as those financial firms - not a pretty outlook (but in a way it’s already happening). Therefore GE has to”balance" its Capital business growth with that of its Industrial business. I say, if GE Capital can grow 30% a year, let it roll and maybe that’ll be more than enough to make up for a lower PE.
One Corporate Brand Image
Another argument for one GE lies in the brand name of GE. This is a touchy subject and I hold tremendous pride for this name. However I would tentatively toy around some timid thoughts that may suggest GE’s size is approaching to a level that could diminish its image and brand recognition. If one think about “What is GE?”, an old tag line emerges “Bring Good Things to Life”. True, GE used to exist for betterment of mankind in general, and it actually carried out that mission fairly well. What does it mean today? With all the breakthroughs in consumer technology and unprecedented business models, it doesn’t mean a whole lot. GE has way too many products and services for average consumer to make out a sketch of what it really is. It’s not like Apple=Innovation+Cool, or Walmart=Evil Empire/The Only Mall That Matters For Your Neighbourhood, or Google=Wonder Boy Wandering in Wonderland. Regardless of whether those images are good or bad, they are engraved in people’s minds and investors can easily relate to them. Immelt saw the statement become a bit staled and hollow. He made a sweeping change in 2005, opting for “Imagination at Work”. Immelt is smart. He certainly felt the coming of an identity crisis. Do people really buy that? Only time will tell but I can at least argue that the inclusion of certain businesses do not necessarily inspire aura of “imagination” for average Joe. If GE were broken up into a few pieces, the new baby-GEs will be more recognizable with potentially more coherent messages to convey to their respective targeted customer segments.
To round up my 20 cents, going private will give GE much needed structural and process advantages to let it focus on running the business. Today’s PE models and Buffett’s Berkshire Hathaway model provide bits of the elements that will be helpful to GE, but the transition from current GE to those models is beyond the capacity and technology of today’s financial market (we need another Michael Milken). A detour that may get GE there and fully unlock GE’s value seems to be breaking it up into a few baby-GEs. It’s an audacious thought that challenges several conventional wisdoms built around GE’s success to date, but in today’s changed environment, those words of wisdom are in need for new validation and interpretation anyway.
Does that make any sense to you … no?
