Industrials

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

General Electric Co. may have a new leader, but the pattern of over-promising and under-delivering is the same.

CEO John Flannery hosted an investor meeting in New York today to lay out his plan for digging the industrial giant out of its current cultural and cash crisis. Nov. 13 has been circled on investors' calendars for months and the hype only grew after GE's dismal earnings report last month.

Until now, Flannery had held off on concrete details but said all the right things, promising that "no stone has been left unturned" in an "exhaustive" review. Even as GE's shares plunged, some investors were hopeful that we might finally see some radical thinking at GE. It wasn't to be.

More Talk than Action
Investors were initially optimistic that GE's 50 percent dividend cut could foretell dramatic change. But the plan outlined in CEO John Flannery's presentation on Monday was more of the same.
Source: Bloomberg

GE kicked off the morning by announcing a 50 percent cut to its quarterly dividend, a major, if necessary, step for a company that prides itself on the payout and caters to a large number of individual investors. Looking at GE's projected 2018 numbers released just a few hours later, however, it's not clear the company cut deep enough.

The reduced dividend still costs about $4 billion annually. And while GE's targeting $6 billion to $7 billion in industrial free cash flow next year, that's based on a "cherry-picked definition", says Cowen & Co.'s Gautam Khanna. The real number appears to be close to zero if you account for pension and capital expenditures as other industrial companies would, he says. 

Tight Squeeze
GE still has a cash flow problem even after cutting its dividend
Source: Company reports, Bloomberg
Note: Industrial CFOA excludes deal taxes and pension. New 2017 guidance includes dividend from GE's Baker Hughes energy operations. GE defines industrial free cash flow as industrial CFOA plus Baker Hughes distributions, excluding deal taxes and backing out capital expenditures, capitalized software investments and pension funding. Cowen strips those puts and takes away.

This is bad. For one, it means GE's dividend will still soak up a lot of its cash. Its payout ratio will continue to rank near the top for high-grade industrials. And while the company is aiming to simplify its convoluted reporting metrics, it's still relying on a number of puts and takes that make it harder to discern the true health of its businesses. 

Starting in 2018, the company plans to ditch its "industrial operating plus verticals EPS" metric and shift to a benchmark of continuing EPS excluding gains, restructuring costs and non-operating pension expense.  Its decision to still exclude pension commitments will still stand out for some investors as many industrials include the expense.

And about that "exhaustive" review of GE's portfolio -- it was kind of a dud. Flannery called out GE's transportation, lighting and industrial-solutions operations as divestiture candidates. Well that's good news, seeing as GE already agreed earlier this year to sell its industrial-solutions business to ABB Ltd. for $2.6 billion. The lighting unit has also reportedly been on the block for quite a while now, and every GE follower had transportation on their divestiture bingo cards. Flannery did mention 10-plus "other" transactions, but those are likely to be small carve-outs within businesses.    

Who Are You Calling Simplified?
The piecemeal divestitures GE is targeting won't cut it. Even if it gets rid of transportation and lighting, the company is still huge and highly diverse.
Source: Bloomberg

Basically, this is about what was expected when GE highlighted $20 billion of asset sales on the third-quarter earnings call, and it's no game changer. There is "optionality" with the publicly traded combination of its energy assets with Baker Hughes Inc., Flannery said. That could include GE winding down its 62.5 percent stake in the company. This is new-ish for GE, but not unexpected and the company will have to sit on the stake a bit longer to get a good price.

Flannery is making some long-overdue cultural changes, including reducing GE's 18-member board to 12 directors, three of whom will be new. But it's going to take time for this renewed focus on accountability to hit the bottom line, particularly as GE's power unit continues to slog through slumping demand. And Flannery's plan for the meantime is in some ways just an echo of what we'd previously heard from his predecessor Jeff Immelt: asset sales and cost cuts to help the strength of the underlying businesses shine through.

It's now obvious to everyone that Immelt didn't actually do particularly well as far as executing on that strategy. If Flannery can do a better job, perhaps that will be enough to stop the stock's free fall. He, like Immelt, seems convinced that GE's main businesses all add value and it's worth keeping them in  a conglomerate structure. But they're increasingly in the minority.

Flannery missed an opportunity to dramatically remake GE through a full-scale breakup, and at best, that positions the company for a tough grind through years of weak earnings.  There's nothing radical about that.

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

  1. GE has taken out $6 billion of debt to prepay its pension through 2020.

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