The Synchrony Spinoff From General Electric

Amazing that an entire marketing department at General Electric found it wise to combine the words sin + crony in launching the Synchrony Financial, the former private credit card label arm of General Electric that has been gradually working its way towards becoming a standalone company (I can’t, for the life of me, figure out why General Electric decided to structure this deal as a share swap rather than an outright spinoff, especially when you take into consideration GE’s betrayal of historical expectations when profits collapsed and the dividend got cut in 2009 which is something General Electric had not done since 1938).

Normally, a straight forward spinoff is most enjoyable for shareholders because they feel like they are getting a “free” business and they get the full autonomy to decide whatever they want to do with the shares. When Conoco shed Phillips 66, you got to own both Conoco and Phillips 66. When Abbott Labs shed Abbvie, you got to own both Abbott Labs and Abbvie. When the old Philip Morris became Altria, Philip Morris International, and Kraft, you got to keep ownership in all three. If you wanted to convert them all into a monster Kraft position, you could. If you want to get rid of Altria and evenly divide the proceeds between Philip Morris International and Kraft, you had the ability to do so. The fun part is that the default position of doing nothing made you the owner of an additional business.

With the Synchrony spinoff from General Electric, shareholders faced a spinoff that wasn’t really a spinoff at all—it’s a share swap—in which you have to trade in your General Electric shares in order to receive shares of Synchrony. There’s no “free” business that you get to pick up; you have to forfeit your GE shares or use available cash to buy shares of Synchrony if you want to own some.

Even though I understand GE’s rationale for the move—it provides cash for buybacks at decent valuation levels and even some cash to make new investments—it is not how I would have gone about distributing shares of Synchrony given that: (1)  GE has a poor record of actually reducing share count with its buyback program, as it has a two-decade record of barely mopping up executive compensation with its buyback, (2) human nature is certainly wired to prefer receiving ownership of two companies rather than having to choose between two companies, and (3) the backdrop of the 2009 dividend cut gives the impression that General Electric management lacks the shareholder friendliness of, say, a Conoco/Phillips 66 management style, and the share/swap + a dividend that is yet to be fully restored gives the impression that GE doesn’t have that “drown shareholders in as much wealth as possible” fire that typified its returns during the second half of the 20th century.

By the way, even though this sounds as if I am critical of General Electric, I am quite excited about the company’s long-term prospects despite these concerns. When it comes to medical imagine, building aircraft turbines, and actually drawing up the logistics for oil and natural gas transportation, the company is almost peerless in a field that has high barriers to entry and creates high profit margins. The company makes $17 billion in profits per year—it’s almost twice the size of Coca-Cola which sells soda in 210 countries! With most of the low-quality property loans off its balance sheet, you’ve got an industrial division that is probably going to grow around 8% annually over the long haul. Combine that with the current 3.83% dividend yield, and you can see why I find it attractive. The recent 4.5% was likely cautionary in response to lower oil prices and the increased possibility of a moderate economic recession, and seems to be the kind of dividend increase that understates GE’s future earnings power.

In the case of Synchrony, which currently trades at $28-$29 per share, you’re looking at the kind of company that someone might be interested in buying once they’ve got 30-50 stocks in their portfolio of the highest quality and are looking to, in the words of Benjamin Graham, take some actions that are indicative of an “enterprising investor.”

Basically, Synchrony is in the business of running the private label credit cards at retailers across North America (this accounts for about two thirds of their profits). At the present time, GE Capital (which is still part of General Electric) still owns 85% of the Synchrony business. It’s a pretty sturdy business, with a $60 billion portfolio that has grown from being a $50 billion loan portfolio at the time GE started releasing independent data for Synchrony in 2012. It earns 3% on total assets, which is very lucrative for a lending arm. This likely translates into profit growth around 9-12% each year in healthy or ordinary economic conditions.

Synchrony has yet to initiate a dividend, which bars a lot of institutional investors (endowments, pension funds, annuities, and the like) from making investments in the company according to the terms of their governing charters. Usually, credit companies can hit a dividend payout ratio between 40% and 60%, and given that Synchrony currently earns $2.60 per share in profits, you are looking at an eventual dividend payout between $1.04 and $1.56 based on the company’s current profits (though Synchrony won’t come out and just start paying this amount—usually, it’s more fun for the Board to start the payout at $0.10 per share or something absurdly low so that it can then brag about growing the dividend at 15% per year for a decade, or something like that). Assuming there is no impending financial crisis on the horizon, this is the type of stock that is worth something around $40 per share.

If you are contemplating an investment in Synchrony, it probably makes sense if: (1) you already have a very well diversified portfolio, (2) you are looking for higher than market average capital gains and eventual dividend growth and have the patience to see it through, and (3) you conclude that we are far removed from another financial crisis. For the truly conservative account, Synchrony does not make sense—if a retiree had to consolidate all of his wealth into two dozen positions, Synchrony wouldn’t get a slot.

Even though it got a $14 billion cash infusion from GE, the company’s capitalization hovers around the federal government’s statutory minimum. And plus, private label credit cards aren’t where you want to be invested heading into a deep recession. Stores stop extending credit to all but the most qualified buyers, people cut back on spending, and defaults rise (and the share price and dividends get whacked). If we had a repeat of 2008 or 2009, I would imagine Synchrony’s stock and dividend performance would be similar to Capital One’s during the Financial Crisis, and the business results there sure weren’t pretty in 2008 and 2009. But if there is no 1930s, 1973, 1991, or 2008-2009 type of event, Synchrony Financial could be a very lucrative investment until that once-in-a-generation crisis arrives.