Radical Thinking

Why Not a GE Breakup?

Perhaps CEO John Flannery should contemplate something radical.
Photographer: Simon Dawson/Bloomberg
GENERAL ELECTRIC CO
+0.55
At Closing, April 20st
14.54 USD

Perhaps a wholesale breakup of General Electric Co. isn't such an improbable idea after all.

The industrial conglomerate has lost $100 billion in market value this year as investors came to terms with the dawning reality that GE's businesses don't generate enough cash to support its rich dividend. It's also now clear that years of streamlining didn't go far enough as challenges of dumpster-fire proportions at its power and energy divisions overshadowed what were actually pretty good third-quarter health-care and aviation numbers. 

New CEO John Flannery's pledge to divest $20 billion in assets risked being but another piecemeal breakup. But as details leak on the divestitures and other changes Flannery's contemplating, there's at least a shot he could be positioning the company for something more drastic. 

Simple is a Relative Term

Small asset sales might not cut it. There is a logic for a radical break-up of GE.

Source: Bloomberg

One argument against a breakup of GE was that it would detract from the breadth of expertise and resources that set the company apart in the push to make industrial machinery of all kinds run more efficiently. But now, GE's approach to digital appears to be changing. Rather than trying to be everything for everyone, the company is refocusing digital marketing efforts on customers in its core businesses and deepening partnerships with tech giants including Microsoft Corp and Apple Inc. It hasn't announced any financial backers yet, but that's a possibility former CEO Jeff Immelt intimated before he departed. GE's digital spending is a likely target of its cost-cutting push.

Tightening the Purse Strings

GE is targeting $7 billion in industrial operating cash flow. But after accounting for pension and capital expenditure commitments, it really only has about $2 billion with which to cover its dividend.

Source: Company reports, Bloomberg

Note: CFOA excludes deal taxes and pension. New 2017 guidance includes dividend from GE's Baker Hughes energy operations. Industrial free cash flow backs out capital expenditures and pension commitments.

This downsizing will please investors who have viewed digital as an expensive pet project of Immelt's, but it's sort of a weird thing to do if you still want to turn GE into a top 10 software company. As is the divestiture of the digital-facing Centricity health-care IT operations that GE is reportedly contemplating.

The company is unlikely to abandon digital altogether. Industrial customers have been trained to expect data-enhanced efficiency, and GE has to offer that to be competitive. As Flannery said at GE's Minds and Machines conference last week, "A company that just builds machines will not survive." But if all we're ultimately talking about here is smarter equipment, as opposed to a whole new software ecosystem, GE doesn't necessarily need a health-care, aviation and power business.

Creating four or five mini-GEs would likely mean tax penalties. 1  That's not in and of itself a reason to maintain a portfolio that's not working. If it was, GE wouldn't also be contemplating a sale of its transportation division. 2 But one of GE's flaws in the minds of investors right now is its financial complexity, and there's something to be said for a complete rethinking of the way it's put together. For what it's worth, the average of JPMorgan Chase & Co. analyst Steve Tusa's sum-of-the-parts analyses points to a $20 valuation -- almost in line with GE's closing price of $20.79 on Friday. Whatever premium the whole company once commanded over the value of its parts has been significantly weakened. 

Garage Sale

JPMorgan's Tusa ran the numbers using Ebitda and free cash flow multiples. There's hardly a swell of value to be unlocked via a GE split. But there's also not much to lose.

Source: JPMorgan

At the end of the day, it comes down to what kind of company GE wants to be. The financial realities of a breakup might be painful, but so would years' worth of pain in its power business as weak demand and pricing pressures drive a decline to a new normal of lower profitability. Does it really matter, then, what the growth opportunities are in aviation and health care? As head of M&A at GE, Flannery was at least partly responsible for the Alstom SA acquisition that swelled the size of the now-troubled power unit inside GE. If there really are "no sacred cows," he has a chance to rewrite that legacy.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
  1. GE's on track for a rate in the low-single digits this year -- well short of the U.S. corporate maximum of 35 percent.

  2. The tax bill involved in a sale of the century-old locomotive operations would pale in comparison to the tax leakage from a full-scale breakup, of course. A sale is arguably a better strategy than a spinoff. Potential buyers include a Chinese industrial company or perhaps an engine maker like Cummins Inc. 

     

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

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