Jack Welch's Risky Last Act

Will Honeywell throw a wrench into his well-oiled GE?

It was vintage Jack Welch. At the Oct. 23 press conference announcing General Electric Co.'s $45 billion acquisition of aerospace and industrial conglomerate Honeywell International Inc., the GE chairman and CEO strutted around the stage, boasting of the promise of the deal and challenging analysts who hinted that he'd face tough antitrust scrutiny. Welch spoke bullishly of the acquisition--"It's exciting as hell"--and dismissed the notion he was having a hard time relinquishing power. "It ain't anything to do with 65 or hanging on," he insisted.

As a performance, it was long on charismatic promises and short on details. More important, it raised questions fundamental to the continued success of America's most widely held corporation: Why would the chief executive officer of one of America's best-managed corporations take on such a challenge only weeks before announcing his successor? Welch's move risked undermining a decision that has been eagerly anticipated, prepared for, and massaged for years. And aside from that, how would the company manage the integration of the troubled conglomerate it had just snatched from the hands of rival United Technologies Corp.? For all the looming questions, though, the Welch magic seemed to work. Most investors embraced the deal. And after dropping some $6 a share on news of the purchase, GE's stock rebounded to $54--just below its pre-merger price--in the wake of Welch's performance.

Whether investors care to admit it or not, the acquisition will by no means be an easy one, especially for Welch's eventual successor. Honeywell--itself the product of a less-than-successful merger of the old Honeywell and AlliedSignal Inc. just 11 months ago--has been a far weaker performer than GE and is saddled with some low-margin, slow-growth businesses. And even though the potential for improvement is clear, bringing Honeywell's unit up to GE's performance standards will neither be a simple nor short-term task. Meanwhile, Welch's announcement that he'll stay on for eight months beyond his planned April, 2001, retirement--with hints he could remain even longer--has upended what had been hailed as a model succession plan for one of the country's most respected CEOs.

It all made for one heck of a surprising last act for a man who had already started to leave the stage. Adding to the drama is the fact that this deal is unlike any GE has tackled. It's the largest acquisition GE has ever done, comparable only to the $6.4 billion buy of RCA back in 1986 in terms of what it adds to the company's size and scale. The new GE will be a megabehemoth, with expected 2001 revenues of $176 billion. Honeywell's avionics and engines unit will add significant muscle to GE's jet-engine business, an operation that will account for an estimated 13% of the new company's sales. The deal also bulks up GE's offerings in businesses such as industrial controls and power generation.

Sure, GE has proven its expertise in doing smaller acquisitions--it has gobbled up some 134 companies worth $17 billion last year alone. But the much larger Honeywell acquisition will require different skills altogether. "It is easy to merge a small company," says Patrick A. Gaughan, a graduate professor of Mergers & Acquisitions at Fairleigh Dickinson University. "But the integration problems are magnified exponentially here."

The bigger question, however, is whether or not Welch's as- yet-unnamed heir will be able to manage what will be an even more Roman-like empire. The company Jack built is in many ways an old-fashioned conglomerate that, unlike many, works because of Welch's phenomenal management skills and the knowledge he has built up over two decades of constructing the GE edifice.

But there will be important differences for the next CEO. The new GE will initially have more than 450,000 employees, up from a current 340,000, operate in more than 100 countries, and sell everything from circuit breakers to refrigerators to jet engines to mutual funds. Even before this deal, some questioned whether, without Welch, GE was becoming a company too big and complex to manage effectively. "Adding Honeywell really raises the stakes," says Edward E. Lawler, director of the Center for Effective Organizations at the University of Southern California's Marshall School of Business. "It's a huge order for somebody to step in and manage the complexity that has been created by this acquisition."

It is precisely Welch's record in managing such complexity that has made him an icon. Through a flurry of handwritten notes to employees, endless plant visits, and a hard-driving, hands-on style, Welch has insinuated himself into every nook of the business. His personal charisma and one-of-the-boys style inspire an intense loyalty and teamwork; his ruthless obsession with the bottom line inspires fear. Together, the combination has kept the $130 billion conglomerate riding high in both stock and earnings performance for the past decade. And there's little doubt that GE's rich price-earnings valuation--it trades at 42 times expected 2000 earnings, far above that of other conglomerates--stems directly from the "Welch premium." It's a reflection of investors' faith in Welch's record and mystique. In fact, Honeywell Chairman and CEO Michael R. Bonsignore says the Honeywell board felt comfortable accepting GE's overture in large part because Welch made it clear he would stay on to oversee the merger.

Comforting as that may be in the short term, the move creates great uncertainty surrounding one of the most closely watched successions in corporate history. Welch had been expected to name his successor within weeks; now, he says the announcement may not come till yearend. The betting remains that the top job will go to 44-year-old Jeffrey R. Immelt, president and CEO of GE Medical Systems. He has boosted sales 23%, to $6 billion, at the once-sluggish unit and has the team-building expertise and whiz-kid style Welch so greatly values.

Still, many GE observers say the Honeywell deal could give a big boost to the chances of W. James McNerney Jr., head of GE Aircraft Engines. McNerney would play a critical role in integrating Honeywell's aerospace operations, the business at the heart of the Honeywell deal. At his Oct. 23 press conference, Welch called McNerney, 51, the driving force behind the deal. But if Immelt gets the nod, executive recruiters say McNerney would likely bolt for a CEO job elsewhere. That would be a major loss, making the task of integrating Honeywell far more difficult.

Even more disturbing is that Welch's vow to stay raises questions about whether GE's vaunted executive bench is as deep and rich as people think. Roger M. Kenny, a managing partner at New York-based Boardroom Consultants, notes that the potential successors have run single businesses--not the mix of disparate operations that make up GE. "They've never run multiple business lines at the same time," says Kenny. "Now, there's a tremendous amount of complexity." Adds Charles M. Elson, director of the Center for Corporate Governance at the University of Delaware: "The fact that Welch is staying an extra year suggests that combining the two companies would be too much for the heir."

Regulatory delays could give Welch the opportunity--or the need--to extend his stay even further. While the CEO has maintained the deal will close in February, antitrust experts think that's a long shot. They warn that approval may be delayed many months as the merger gets tough scrutiny in the U.S. and in Europe. Even though there isn't a lot of direct overlap between GE and Honeywell products, regulators will take a particularly hard look at the two aerospace businesses. They will be studying whether GE could grab market share by bundling certain products they want to promote with other more popular products or services.

Regardless of when it gets approval, there's no doubt the Honeywell deal creates real opportunities for GE. From the get-go, GE expects the buy to add at least 7% earnings per share, or 10 cents, in 2001. And Welch figures combining the companies should ultimately yield $1.5 billion in cost savings. While he gave few specifics on where those savings would be found, analysts expect brutal workforce cuts.

Of course, the real payoff comes by adding muscle to GE's already powerful business franchises. The best fit is clearly in the combination of the aerospace units. That will yield a $22-billion-in-sales operation that marries Honeywell's strength in business-jet engines and cockpit avionics with GE's massive business in larger jet engines. Combining them should strengthen GE's hand in cross-selling other products and services to big customers. In fact, analysts figure it was the threat of United Technologies garnering that sort of edge with Honeywell that prompted Welch to swoop in and snatch it in the first place. "The company will be able to give full nose-to-tail coverage for customers such as Boeing," says Steven Roorda, an analyst at American Express Financial Advisors, an investor in both GE and Honeywell.

Some other GE and Honeywell businesses enjoy a similar complementary fit. Honeywell's microturbine business--small gas turbines used by some large companies for backup power--should bolster GE's offerings in the power sector. And in industrial systems, while GE focuses on making plant controls for industries such as aerospace and autos, Honeywell sells gear and software to manage oil, gas, and chemicals plants.

Despite such tantalizing synergies, Welch's Honeywell bet also carries substantial operational risks. For one thing, customers may not want one-stop shopping. "We don't buy engines, auxiliary power units, and avionics on one purchase order, and we don't expect to in the future," says Boeing Chairman and CEO Philip M. Condit. Instead, he will continue to look for the best supplier in each product line.

Moreover, Honeywell is no star performer. It has been battered by external forces and internal mistakes. Higher raw-material costs because of rising oil and gas prices have hurt divisions such as the $4.1 billion performance-materials unit. And the company has suffered from poor execution, such as when a decision to outsource key aerospace components was followed by supplier shortages.

Honeywell's bottom line has been hit hard by these headaches. Management originally promised 20% earnings-per-share growth this year, but in July, CEO Bonsignore said growth will come in at only around 12% to 14% and that sales would grow at an even more modest 8% to 10%. GE's earnings per share this year should be up 19% on sales growth of 16%. "The issues at Honeywell run a bit deeper than we thought" in terms of it being a quick-fix candidate, says Art Barry, portfolio manager at Federated Investors, a Honeywell investor.

Indeed, academic research would have shareholders nix many such deals at their announcements. Timothy Loughran, associate professor of finance at University of Notre Dame's business school, studied 947 acquisitions from 1970 to 1989. Over the long term, he found that shareholders generally do not benefit from mergers--and that the worst performance came from friendly stock deals such as the GE-Honeywell deal.

GE's troops are betting that they can defy that history. Most observers say Honeywell operations will be divvied up and quickly folded into existing operations. Then, GE's management will aggressively try to expand into higher-margin service businesses that can be developed from Honeywell's manufacturing base. While Honeywell has been aiming to build up those sorts of annuity-like revenue streams via services such as the management of process-control systems at oil refineries, only 40% of sales now come from services. Compare that to 70% of GE's total sales. And while there are certain Honeywell units that analysts say GE could jettison, including some low-margin performance-materials businesses, GE's use of pooling accounting may preclude major divestitures for up to two years.

Welch & Co. will also be looking to wring inefficiencies out of Honeywell. Its average employee generates about $209,000 in revenue per employee, vs. $382,000 at GE. To improve Honeywell's productivity, GE will push its expertise with Six Sigma, the manufacturing-efficiency program that attempts to cut defects to a minimum, throughout Honeywell.

Certainly, execs who grew up in the former AlliedSignal, run for years by GE vet Lawrence A. Bossidy, who had embraced Six Sigma, may be comfortable in GE's culture. But managers from the old Honeywell, where the focus on efficiency was less intense, may suffer. "GE has to manage a cultural change," says Prudential Securities Inc.'s Nicholas P. Heymann. "GE moves at the speed of light, while these other guys move at the speed of sound." The question now is whether GE's speed--and Welch's expertise--will be enough to make his swan song a thing of beauty or an ugly duckling.

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