General Electric shares finished 2017 as the biggest dog in the Dow Jones Industrial Average — down 43% — and 2018 hasn’t gotten off to a much better start.
By now you’ve likely heard that GE GE, -1.58% missed analysts’ fourth-quarter earnings estimates, reporting a loss of $10.01 billion on continuing operations, thanks mostly to a previously-announced $6.2 billion one-time charge in GE Capital’s insurance business.
“I realize the news we’ve shared [since August] has been tough, “ new CEO John Flannery said on a conference call with analysts Wednesday. “Our first priority is running the company well.”
But that’s not the half of it. The Securities and Exchange Commission has launched an investigation of GE’s accounting, The Wall Street Journal reported. And Flannery told analysts a team of GE execs is figuring out the best way to restructure the company — a process that Flannery himself has said could mean breaking it up.
These headlines promise to settle the two long-standing questions about GE: Whether it has manipulated reported earnings, in part by juggling the timing of moves by its GE Capital division, and what the company is worth after a decade and a half (at least) of misrule by former CEO Jeff Immelt.
Maybe we’ll even settle whether Immelt’s predecessor Jack Welch, who left in 2001, was a masterful leader or just someone who knew how to time dividends from GE Capital to smooth over inevitable bumps in the road.
Flannery’s challenge is to convince investors that he understands all of GE’s problems and has a clear plan to fix them.
“We have to know the company has a direction it wants to go in,” CFRA Research analyst Jim Corridore said. “You have to have a point of view and stick to it.’’
GE basically has three choices: It can break itself up, it continue to sell or spin-off a limited number of assets, or it can put its head down and clean up divisions one by one.
For now, Flannery is focusing on the latter. The company has already cut $1.7 billion in annual costs, with $800 million of that coming from its power-generation business, the world leader in making turbines to convert natural gas into electricity.
Breaking up isn’t a serious option, CFRA’s Corridore argued in an interview — not least because the company may be worth more than the sum of its parts, given the serious problems in the power business and the expectation that it will be years before GE Capital again pays dividends to the parent company. In a report in November, Cowen & Co. estimated GE’s breakup value at $11 to $15 a share.
GE still gets cost savings from central corporate functions and sharing research and development across units, with at least some knowledge-sharing between businesses such as power and aviation, he said.
Flannery needs time before markets demand a breakup, Corridore added. “You can’t expect a turnaround to take hold in three months,’’ he said. “It’s a one-to-two-year problem. The market gave Immelt a decade. It’s not giving Flannery three months. He’s been more honest than Immelt was in 10 years.”
Perhaps. But the best path for GE shareholders may be for the company to liberate better-performing units such as the health-care imaging machines division and aviation businesses, Melus Research analyst Scott Davis said.
“Flannery has not yet convinced market that he has a plan that will work,” Davis noted in an e-mail Wednesday morning. “ We would think a break-up of the company is definitely on the table.’’
Davis says GE could generate value by spinning off its aviation and health-care businesses, its two healthiest units. Those two businesses account for all of GE’s market cap, he said, implying that investors are assigning no value at all to businesses like power generation and GE’s 62.5% stake in oilfield services company Baker Hughes BHGE, -4.35% — which stand to appreciate as Flannery and Co. implement more cost-cutting and bet on a recovery in oil and gas drilling due to higher prices. .
Under a breakup, GE stock and any spinoffs could rise to about $25 per current GE share in their combined value, Davis said in a Jan. 23 report.
The good news is that either path looks promising for GE stock.
If Davis is right, of course, $25 is more than the current $16-plus share price. Moreover, there’s precedent for spinoff companies that clean up their act once separated from more-profitable corporate siblings. The healthy medical-imaging business, for example, is likely to command higher earnings multiples than GE as a whole.
If CFRA’s Corridore is correct, GE should simply be a restructuring story that sparks a profit turn by about 2019.
Flannery gave little indication of his leanings in the conference call, saying a team at GE is studying how to restructure the company. For the time being, he emphasized operating details, saying the company has more room to cut costs in its power generation turbine business and that Baker Hughes has a clear path to boost profits this year.
But he was clear that investors need to watch this space. “We have a lot to work on, but we have a lot to work with,’’ Flannery said. “There will be a GE in the future, and it will look different.’’