Industrials

Brooke Sutherland is a Bloomberg Gadfly columnist covering deals and industrial companies. She previously wrote an M&A column for Bloomberg News.

Nelson Peltz may be losing a bit of his magic touch with his fellow GE shareholders.

The $257 billion industrial giant on Wednesday outlined a plan to eliminate $2 billion in costs over the next two years and said it would more closely tie the management team's bonuses to its ability to follow through on financial targets. GE said the move followed discussions with Peltz's Trian Fund Management, which has reportedly been disappointed lately with the company's missed earnings goals and underwhelming share performance. Trian, a shareholder since 2015, praised the actions within minutes.

Prove It
While GE has stuck to its target for $2.00 in EPS, analysts have grown increasingly less optimistic
Source: Bloomberg

And yet, while even unoriginal commentary from Peltz has often been enough to get GE shares moving -- at least for a day -- on Wednesday they were essentially flat and even traded down at times. Perhaps investors are onto the fact that much like when Trian first spoke out about GE in 2015 and essentially told CEO Jeff Immelt to keep doing what he was doing, this latest statement in part amounts to an endorsement of something GE had already signaled was coming.

GE says the "new" goal of $17.2 billion in industrial operating profit is consistent with the company's existing framework for 2017 -- although it does add transparency and in theory will force the company to grow EPS the old-fashioned way rather than through financial engineering. Meanwhile, the company in December committed to $1 billion of cost cuts, but indicated a bigger savings opportunity was out there, noting $1.7 billion of ideas. CFO Jeff Bornstein said two weeks ago that the company had been working over the last two months to dig even deeper for cuts. So it's unclear what impact Trian, which has a less than 1  percent stake, had on the numbers behind those goals from its "intensified" dialogue with GE over the past month.

Don’t get me wrong, this is a meaningful cost-cutting effort that should help GE improve its margins and drive earnings growth. Corporate costs amount to about 2 percent of its sales, compared with less than 1 percent at operating standouts like Honeywell International Inc. or Danaher Corp., Barclays Plc analyst Scott Davis noted in a report earlier this week. But this doesn't appear to be the game changer GE investors were looking for.

Bumping Along
GE has essentially performed in line with the broader industrial sector even after several big transformative moves, suggesting more change may be needed
Source: Bloomberg

The fact that shareholders still seem to need a game change at all has got to be a little bit frustrating for Immelt. The company has had a remarkable run of breakups and deals, from shedding the bulk of its GE Capital assets to the $10.6 billion takeover of Alstom SA's power assets. Any one of those steps could fairly be considered transformational; taken together, GE is a completely different company than just a few years ago. And yet what isn't all that different is the company's stock price. 

The answer to getting the stock out of its rut in Trian's mind appears to be breaking management out of this pattern of overpromising and under-delivering on earnings. GE's guidance for as much as 4 percent organic revenue growth in 2016 always looked aggressive, but after sales actually ended up flat, it just looked a bit foolish. Nevertheless, GE was back with another ambitious revenue outlook for 2017. It's also stubbornly stuck by a goal of reaching $2 in 2018 earnings per share even as a slump in its oil and gas business and weak industrial markets made that goal increasingly untenable in analysts' minds. This has, rightfully, driven some investors crazy.

Coming Up Short
GE had one of the most ambitious 2016 revenue outlooks among industrials. It had to reduce that throughout the year and organic growth ended up being flat for 2016, excluding the impact of the Alstom acquisition.
Source: Bloomberg
Data reflects the midpoint of the guidance range.

So GE -- with some input from Trian -- is now going to cut the bonuses for Immelt and each of his direct reports at the senior vice president level and above by 20 percent should the company fail to achieve both the operating profit and cost cut targets.

Making management more accountable and giving executives clear-cut financial incentives is a good idea. In theory, this may make GE play things more conservatively when it comes to future guidance. But it's curious to me that there will be no impact on bonuses if GE meets only one of these goals. The cost cuts appear to be an easier hurdle to clear than the profit target.  A situation where GE achieves the additional cost cuts, but misses its operating profit goal for 2017 (and, by association, likely its 2018 EPS goal) is a situation investors have already been preparing for. This agreement with Peltz won't necessarily change their outlook. 

The real magic touch for GE shares is going to come from execution.   

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

  1. Organic growth including the impact of the Alstom acquisition was 1 percent. 

  2. Conversely, bonuses will be increased by 20 percent if GE hits both targets.

To contact the author of this story:
Brooke Sutherland in New York at bsutherland7@bloomberg.net

To contact the editor responsible for this story:
Beth Williams at bewilliams@bloomberg.net