Yesterday was a classic example of why I do not spend anytime whatsoever discussing market timing, defined as the purchase or sale of stocks based on expected short-term price swings rather than conclusions formed by studying the business itself. At the time I am writing this, General Electric—a staple in pensions, trust funds, 529 educating plans, 401(k)’s, IRAs, and taxable accounts around the world—is up over 10.8% on the day, which is a heck of a jump for a company that is valued in the $250 billion range.
The cause for investor elation is the news that General Electric will be selling off all of its financing divisions under GE Capital except the aviation, healthcare, and energy lending divisions because: (1) those divisions are directly tied to General Electric in that a robust commercial lending platform allows other companies to buy GE’s products, (2) the debt owed to GE will come from large commercial borrowers with low default rates, and (3) most of the debt issued by GE will be secured, meaning it can reclaim the property (usually heavy machinery) if a company defaults on its debt to GE.
Now, yesterday’s news regarding GE’s exit from most of GE Capital’s lending businesses was big news to be sure, but it perhaps possible that people are making a bigger deal out of it because the stock of a megacap went up 11% in one day so people presume it must be important.
In terms of GE’s story, arc, narrative as a company—whatever you want to call it—here is the way I see it: In 2007, General Electric’s financing unit was a $500 billion behemoth that made up 50% of GE’s profits. Because of low liquidity and unworthy borrowers, this unit strangled GE in 2008 and 2009, causing GE to slash its dividend, borrow money from the U.S. government and Warren Buffett, and lose the faith of long-term investors who had not experienced a dividend cut from GE in over seven decades.
GE did not immediately dismantle these financial assets in 2010 and 2011 as the financial crisis subsided. I regard this as an intelligent move in the best interests of shareholders. Now, I would have much preferred that GE structure this transaction as a stock spinoff (something I’ll explain in a post later this evening), but the fact that they waited five years for the financial divisions to regain value has served shareholders well.
Before yesterday’s announcement, GE had already committed to sell $110 billion of real estate and consumer lending assets over a two year period, the most famous of which is the Synchrony Financial spinoff valued in the $55-$65 billion range. These moves along would have made General Electric a 70% industrial and 30% lending company by the time the existing projects came to completion. At the completion of these moves, GE Capital would have possessed $252 billion in assets.
The news yesterday that got people so excited was this: GE is now going to sell its portfolio of $74 billion in commercial lending, $37 billion in international lending, $31 billion in international property leasing, and $25 billion in lending involving fleets. Put another way, yesterday’s news signaled that GE’s $252 billion GE Capital portfolio would be shrunk by another $167 billion so that the only remaining financial assets would be $85 billion in aviation, healthcare, and energy lending used by GE to finance the purchase of GE equipment for other businesses.
By the end of this transaction in 2018, GE Capital will become 10% of GE’s profits in 2008 compared to the 35% range now, and the high of 50% in 2007. If you had to summarize yesterday’s announcement in one sentence, it would be: GE Capital will be 10% of GE’s profits over the long haul rather than 30%.
GE Capital is now going to be a fifth of its 2007 size, and I wouldn’t expect any more reductions after this because GE’s remaining lending operations are perfectly tied to the purchase of GE products (unlike, say, the private-label credit card business of Synchrony Financial where using an Eddie Bauer issued credit card to purchase a backpack at Eddie Bauer has little to do with General Electric’s industrial side). General Electric essentially removed its wipeout risk with this sale, and that is why investors are getting so excited about this move because it represents the full return to GE being something you can tuck into a portfolio alongside Exxon, Coca-Cola, Nestle, and Johnson & Johnson, reinvesting each year on autopilot without having to think about it much.
Even though I think this is an intelligent move (if I could press a button to undo yesterday’s transaction, I would not do so), I do not share the same degree of elation as much of the financial media on this. There’s a lot of double counting in the financial media when it comes to GE’s announced buyback—it makes $1.51 in profits, but that profit base will decline to $1.15 at the end of the GE Capital sales. It will take a substantial buyback to get those profits back up to $1.51.
And frankly, GE has been announcing buybacks every year since 2010, and they have only reduced the share count from 10.5 billion to 10 billion. That’s only a 4.75% reduction in share count over the course of five years. This not IBM, Exxon, or Wal-Mart when it comes drastically reducing share counts through buyback programs. What makes it even more insulting is that GE bandies about large numbers–$90 billion in cash returned to shareholders—when the reality turns out to less impressive. The firm’s “other” founder, Edwin Houston, was famous for saying that you should underpromise and overdeliver. That part of GE’s DNA seems to have been lost, as GE seems to overpromise and underdeliver when it comes to share buybacks.
Don’t get me wrong–I am excited about General Electric’s future. It had been one of the best blue-chip investment ideas I’ve ever come across. In October, I wrote this article: “I Feel The Same Way About General Electric Right Now As I Did About Johnson & Johnson In 2011.” When I was a student at Washington & Lee, all I did was drive a night bus from 10 PM to 2 AM called Traveller (a good gig that paid $20 an hour and did good work to deter drunk driving) and use the available cash to buy General Electric stock. So I remain quite excited about General Electric’s long-term future, but there are more mountains left to climb than the investor community’s reaction to yesterday’s news would suggest.
Originally posted 2015-04-11 12:01:41.