If I were running General Electric, I would have chosen to spin off GE Capital to the existing General Electric shareholders as a tax-free spinoff rather than sell $150+ billion of the remaining GE Capital to outside buyers (principally Wells Fargo and Blackstone).
Spinoffs are preferable to asset sales because of tax efficiency. General Electric is going to record $16 billion in charges in connection to yesterday’s announced restructuring. Selling appreciated assets to Blackstone and Wells Fargo costs money, with estimates ranging from $4 billion to $6 billion in tax payments alone.
It is also choosing to repatriate $36 billion in cash that is sitting in 175 countries around the world. This is a move GE hasn’t done in a big way since the Bush administration’s tax repatriation holiday in 2004, and the 2015 repatriation will cost the company $6 billion in taxes. Considering that the repatriation rate for large companies is 35%, it is a testament to the effectiveness of GE’s tax and accounting division that the bill is being lowered from the expected $12 billion to $6 billion. You have $6 billion in taxes from the repatriation, $4-6 billion in the sales to Wells Fargo and Blackstone, and another $4-6 billion in taxes from the rest of the GE Capital sales that are spread out across many buyers over the next three years.
The return of $30 billion in cash (after taxes) from overseas is something that is necessary for General Electric to have dividend stability. Right now, General Electric makes $1.51 per share. The $0.23 quarterly dividend is $0.92 per share. That’s a moderately high, but manageable, dividend payout ratio of 60%. But during the period when these GE Capital asset sales complete (but before the three-year enlarged buyback program takes place), the profits at the industrial division will be $1.15 per share and the GE Capital profits won’t be around to support the dividend.
This means that GE’s dividend payout ratio will be $0.92 compared to $1.15 per share in profits for a temporary dividend payout ratio of 80%. This does not give GE much wiggle room to make new investments from incoming profits and places the dividend coverage at risk in the event that a moderate (or worse) economic recession arises between now and 2018. By bringing $30 billion back to the company’s American treasury, it can position itself to maintain the $0.23 dividend even if the worldwide demand for GE’s industrial products cool during a recession.
Over the next ten years, General Electric ought to see significant dividend growth in the upper single digit range. That is a perfectly acceptable growth rate for a $250 billion with a dividend yield that is still around 3.2% (the recent 10% single-day gain may have moved GE from “great” to “good” investment status for the 2015-2025 period). But I don’t think investors will see significant dividend growth from GE in the next two years. My basis for this conclusion is that: (1) GE will be deploying significant sums of cash to pay for taxes and expenses related to the unwinding of GE Capital over the next two years, and (2) the currently ballyhooed $50 billion buyback won’t start reducing the share count by a significant amount until 2017 and 2018. GE says that the share count will be 8 billion to 8.5 billion at the end of the process, and my guess is that it will be closer to the 8.5 billion side given that GE does not have an impressive track record of actually reducing the share count when it engages in buybacks under current management.
Even though the sale of the financial arm was a good decision, it may not have been done in the best way possible. Neville Isdell, the former Chairman and CEO of Coca-Cola, used to joke that analysts assumed that all decisions were made in the rational, long-term interests of owners, and it is a common cognitive block among those studying companies to ignore the management politics and self-serving power maneuvers that can factor into the decision-making process.
I thought it was telling that CEO Immelt mentioned that he plans to make $5 billion per year in investments from the G.E. Capital sales that don’t go towards the stock buyback. Those may very well be intelligent moves, but they also seem to indicate a desire to engage in empire building. If, before yesterday’s news and the announcement of the Synchrony spinoff, Immelt announced a complete stock spinoff of G.E. Capital, GE investors could have received one share of GE Capital for every share of General Electric owned, and investors could have owned two stakes in an excellent industrial and above-average financial company that would be valued around $130 billion each. The spinoff would have cost the company around $2-$3 billion, much lower than the $16 billion in charges that are being announced as a result of the recent unwinding.
However, if G.E. pursued this strategy, it is entirely possible that the existing management would have experienced a loss of power and a significant blow to pride. The best performing industrial division of GE over the long haul is the oil & gas equipment division that regularly grows sales at a rate between 8% and 12% annually, but has experienced a drop-off in demand over the past year due to the 50% decline in oil prices. It is entirely possible that a spunoff GE Capital would have a higher market capitalization than the parent GE Industrial, and this is often seen as an embarrassment for the parent company when the junior company becomes bigger.
Furthermore, GE’s merger & acquisition activity would be limited. That $13 billion Alstom deal couldn’t happen, as GE has been funding deals in recent years by using the profits that GE Capital sends to the parent company. It’s been a diversification through deposits strategy—GE Capital has returned to profitability post-recession, and GE would take those GE Capital profits and reinvest in the industrial business. This lets you make big deals. By choosing to sell GE Capital rather than spin it off, the parent GE company will have tens of billions of dollars to deploy over the next five years, and this permits them to make headlines with transformative acquisitions. If they had spun off GE Capital, they would be stuck paying out 65% to 80% of profits as dividends, and only have $2 billion in incoming profits to make acquisitions without adding debt to the balance sheet.
The sale of GE Capital to Wells Fargo and Blackstone is better than the status quo, but not as intelligent of a move as it could have been. The next two years will likely experience limited, if any, dividend growth as GE temporarily deals with profits per share declining to $1.15 while it takes a few years to reduce the share count from 10 billion to 8.5 billion. However, a golden age for GE shareholders does still loom in the background. The demand for healthcare equipment has the division growing by 5% annually each year. If the oil and gas division reverts to high single digit growth by the end of the decade, and this is combined with a significant share buyback occurring simultaneously, it seems likely that high dividend growth will await GE shareholders during the 2018-2020 stretch absent a deep recession intervening before then.
Originally posted 2015-04-11 13:45:06.