GE and the Fall of Giants
“The inherent vice of capitalism is the unequal sharing of blessings. The inherent virtue of socialism is the equal sharing of miseries.” -Winston Churchill
During the 2016 primaries, Bernie Sanders ran on a platform which included thirteen steps to reduce income and wealth inequality in the United States. Three of his suggestions focused on higher levels of tax for the wealthy and ten promoted higher levels of spending on the disadvantaged. His campaign webpage includes a pie chart illustrating 58% of all new income since the 2008-2009 Wall Street crash had gone to the top one percent of the population. Although I would argue against some of his solutions, I must agree that we have a problem for which politicians exploit for photo ops-then quickly disappear in stretch limos headed for airports catering to private jets and back to their gated communities.
I’m not a fan of crony capitalism-democracy. In fact, I abhor it, long believing that Wall Street exists mostly to move money around so that eventually more of it finds its way back to Wall Street pockets. For years at Smith Barney (now Morgan Stanley), brokers were judged and rewarded for revenue on client assets. Not return to the client, return to the firm!
For many years I believed General Electric deserved a place in client portfolios. We started purchasing shares in the mid 1980’s- Investing in a company managed by a Wall Street superstar, the longest standing institution in the Dow Index, a company which had never lowered their dividend, and a company that was a world leader in about ten diverse industries! In exchange for a hyperbolic rise in stock price, we accepted a comparable hyperbolic rise in compensation for the executives. Jack Welch retired in 2001 with a package which included a $9 million per year pension, health benefits for life, $85,536 for his first 30 days of consulting work each year and $17,307 each day thereafter, a $90,000/month Manhattan condo, unrestricted use of a company 737 jet, all expenses and tickets to the Yankees, Red Sox, Wimbledon, U.S open, and all Olympic events. GE endured a controversary of sorts after Welch retired when divorce filings revealed in 2002 the executive was still receiving salary and other perks worth $447 million. Hmm!
Welch was followed by hand picked Jeffrey Immelt. During Immelt’s tenure (16 years), GE lost about $150 billion in market cap, made 380 acquisitions for $175 billion, and sold 370 assets for $400 billion (and created $1.7 billion in M&A fees for Wall Street advice folks). The company repurchased over 2 billion shares (now all at losses), underfunded their insurance reserves by $15 billion, slashed profits and free cash flow, underinvested in existing business’s and paid dividends at a rate the company could ill afford. Not surprisingly, exclusive of dividends, the stock lost 30% of its value over Immelt’s 16 year reign of error! Interestingly, the day Immelt announced his retirement, GE shares rallied 4%. The stock has now lost another $100 billion under the new CEO’s tenure as he uncovered issues Immelt’s minions either wouldn’t disclose or didn’t discover. I’m not sure which would be worse. Post Immelt, earnings have been restated for 2016, and 2017 (revised down). Many billions have been set aside for unfunded insurance reserve balances, the sacrosanct dividend has been slashed 50%, 2018 estimates have been slashed, and 25% of the Board has been fired. New CEO John Flannery has the task of righting the ship and step one was to fix the leaks. Step two will be improving profitability.
Jeffrey Immelt departed with a retirement package estimated to be about $211 million. Imagine the package had he turned the -30% change in market cap to +30%. Although using Immelt’s exit compensation as an example of crony capitalism run amuck might be the most egregious, it does not stand alone. Marissa Meyer who spent five years running Yahoo into the ditch got a severance package of $260 million. Viacom which has lost 50% of its stock value in the past three years provided CEO Phillipe Dauman a compensation package worth $93 million in 2016. As my old coach proclaimed- “That don’t seem right”!
General Electric’s founding can be traced to Thomas Edison’s invention of the light bulb. Market cap rose from zero to over $400 billion and now back to $113 billion. Current market cap is less than the $122 billion reported in revenues the last twelve months. The reduced dividend now yields about 3.7% however I suspect profitability might need to return to 2015 levels to sustain it. The stock now trades for about a 13 multiple on reduced earnings expectations which seems reasonable if not cheap. It should be noted, GE has a substantial percentage of its debt due for payment in the next couple of years. Refinancing could be a hurdle and an equity raise could be possible. The stock at $12.80 is back to level not seen since July 2009.
CEO Flannery has pledged to retain focus on healthcare, aviation, and power. According to Morningstar, these businesses boast market leadership positions, strong customer relationship, massive installed bases, and high proportions of sales from after market services. The remaining businesses all seem at risk of being sold or spun off. Flannery has already identified about $20 billion in asset sales. A reasonable question for investors should be, “If the other businesses are sold or shuttered, would the value of the remaining three exceed current market price?”. Slashing jobs, restructuring the Board, selling existing businesses, and slashing corporate overhead have all been part and parcel to Flannery’s attempt to reinvigorate the sick giant.
The stock now trades as the biggest dog in the DOW! The contrarian in me has me once again interested in this old friend. If Flannery succeeds in righting the ship, will shareholders once again enjoy GE’s old slogan “We bring good things to light”?