GE's Dividend Assertion is Dangerous

In a climate where even governments are unclear about the true nature and depth of the global recession, Thursday’s assertion by General Electric (GE) that it will maintain its dividend is premature and misleading.

Already, for all material purposes, GE has become part of the bailout exercise. Last month, the company entered the Fed’s commercial paper facility. On Wednesday, GE announced that the Federal Deposit Insurance Corporation had agreed to guarantee $139 billion of short-term and longer-term debt issued by GE Capital. The threshold question is this: Should companies like General Electric be allowed to pay dividends in the first place as long as they are relying, in one form or another, on tax-payer dollars for survival?

General Electric spokesmen and some analysts have been making the case that the FDIC arrangement will lower borrowing costs and provide much-needed liquidity. That may or may not turn out to be a reality. In fact, economic data in forthcoming weeks might force GE to insure its insurer before it can identify the yield at which the international capital market will accept its longer-dated debt paper. As unlikely as it may sound today, the fact remains that CDS spreads on 10-year US treasuries (yes, US government risk) have widened, from a low of 1.6 basis points in mid-2007 to about 52 basis points today.

Moreover, recent treasury auctions suggest shallow demand (despite lower yields). The 2-year/10-year treasury yield curve is flirting with 250 basis points. Total treasury borrowings for 2009 could hit the $2 trillion mark in a highly complex environment.

In any event, bad economic statistics and the continuous stream of socialist-type bailouts will have the combined effect of moving government CDS spreads to 65-75 basis points by early 2009, in anticipation of rating downgrades (presently AAA). Logically, market misalignments apart, yields on GE debt issues should incorporate US government risk (believe it or not), default risk on GE itself, and the cost of funds for the buyers of debt.

So the issue is not whether FDIC guarantees will enable General Electric to access money on a “competitive” basis. The issue, rather, relates to the impact of both GE’s borrowing costs (and obligations) and GE’s debt maturity ladder (for solvency ratio purposes) upon GE’s dividend, after accounting for deteriorations in the value of all classes of assets, including its assets in the developing world, during the course of the next few months. GE’s non-US income contributes 50%-plus to its revenues.

This writer’s short call on GE was not a challenge to GE’s business model. On the contrary, the short call (details on Seeking Alpha) was premised on three factors: the mismatches (borrow short-lend long) in GE’s debt maturity matrix, the reality of higher funding costs (CDS-driven structures) despite lower Fed Funds and Libor rates, the degradation of GE’s domestic assets and, most importantly today, the sharp valuation adjustments urgently required in GE’s emerging-market assets.

Therefore, as opposed to simple feel-good statements regarding its dividend outlook, what General Electric’s investors (and potential investors) deserve is a detailed statement which addresses fundamental issues (and GE risks) in a precise and forthright manner. Only then will Warren Buffett’s Buy America call be heeded by the marketplace at large.

Disclosure: Author holds a short position in GE

Comments

[kevin dempsey:]

ist your short and love bad news that aside any company that wants to borrow from ge will have to pay up and if ge cost go up they will pay the difference . where else are they going to get the loan? who else will loan $$ to any companies for less? ps what you also fail to address who does ge capital compete with on giving these loans???? citi or any other large banks alll whos assests must be written down farrrrrrrr more than ge and none has aaa so who is going to beat ge on loans? pls tell me

2008 Nov 14 07:06 AM

[Echo To All:]

based on your short thesis, are you waiting for the conditions to change before closing your short or do you have a target price to which you will close out the short?

imo, the stock already discounts a lot of negativity.

2008 Nov 14 07:43 AM

[prudentinve...:]

You state that ".... bad economic statistics and the continuous stream of socialist-type bailouts will have the combined effect of moving government CDS spreads to 65-75 basis points by early 2009, in anticipation of rating downgrades (presently AAA). "

Who will you buy CDS against Govt debt from. AIG perhaps?

2008 Nov 14 08:13 AM

[Al White:]

Thanks to a free country, bottom feeders can make public statements with no viable or factual truth to further their own finacial well being. Shades of Enron. GE has been paying dividends since the 1800's and are a very ethical company concidering the company they keep in the financial world. The author holds (and is adding to) a long position in GE because he is LONG on America.

2008 Nov 14 09:47 AM

[Gem:]

I was not surprised by the final disclosure that you hold a short position in GE, as I was intellectually disgusted when reading the obviously biased "analysis" of the GE situation.
You are a prime example of why short selling needs to be regulated.

2008 Nov 14 10:03 AM

[monday1929:]

Delusional buying has done much more damage than short sellers ever could. If shorts are wrong they lose money. Does anyone understand that?


On Nov 14 10:03 AM Gem wrote:

> I was not surprised by the final disclosure that you hold a short
> position in GE, as I was intellectually disgusted when reading the
> obviously biased "analysis" of the GE situation.
> You are a prime example of why short selling needs to be regulated.

2008 Nov 14 11:07 AM

[NK:]

"Should companies like General Electric be allowed to pay dividends in the first place as long as they are relying, in one form or another, on tax-payer dollars for survival?"

BALONEY ! The fact that the govt is guaranteeing some weak financial institutions is forcing the strong ones, like GE, to tap government guarantee program in order to level the playing field - GE cannot compete for debt issuance with players who have a govt guarantee behind them. If this guarantee program did not exist, GE would not need it. This is the inevitable result of the govt's misbegotten piecemeal approach to this crisis.

2008 Nov 14 11:18 AM

[Dr A J:]

I am positive on GE,if one believes the U.S. will recover from this crisis,GE will recover with it.The media and short sellers love talking the markets down,doom and gloom.I love a good short squeeze,hopefully sooner than later.With all the major players in the world working toward a solution, it's going to happen.

2008 Nov 14 11:40 AM

[kurt walter:]

GE Capital begging for taxpayer bailout money. Not a good sign for GE. How come Buffett gets GE preferred at 10% and investors weren't given the same opportunity? Instead, they want taxpayer money. All of these companies need to dilute shareholders with common and preferred shares offered to investors, who will take the risk/reward. Going to the taxpayer is not right.

2008 Nov 14 02:22 PM

[distinguish...:]

My comment i aimed at the primary author.
Seems to me GE's Immelt has sold off the real link for most people with GE : the appliance and lightbulb sector. I am very suspicious that Immelt did this to generate money to cover his fanny over crazy expenditures that were thought to be big fast money (such as securitized mortgage loans) makers to support the usual 2nd half 20thC profit sharing bonanza for the management!
Now i'm wondering if the move to tap the federal bailout pot is another management move to shore up 'winnings' so as to float more profit sharing bonanzae for upper management! I'm beginning to think O'Reilly is right when he says Immelt is ruining the company.
Bye, from the Distinguished Fellow.

2008 Nov 15 12:44 AM

[MiddleOfRoader:]

GE is a good story for late in 2010 or 2011 or 2012 ... ???? when GDP begins growing again. Not so good for now when GDP is shrinking.

Buy if you are someone who can put it away and not look at the share price for the next two years and just be content with whatever dividends the company pays.

2008 Nov 15 01:19 AM

[bearfund:]

You ask whether companies relying on government handouts should be allowed to pay dividends. What, sir, do you think is the point of these handouts? A corporation receiving one can do three things with it: pay it out in dividends, buy T-bills with it, or "invest" it in some new or existing business. If it pays out, the thousands or millions of shareholders, many of them pensioners, will have a little more money to spend. If it "invests" it, thousands of employees will take home money they otherwise wouldn't have. If they buy T-bills with it, their balance sheet looks better but the money itself goes right back where it came from and does nothing.

You ask me, GE (like many other public companies) is simply acting as a conduit for getting printed and/or borrowed money into the hands of individuals who will spend it, quite probably on things they don't need. Which of course is exactly what the government wants: an economy leveraged to the hilt needs so-called discretionary spending to keep growing at a rate faster than the rate of interest it has to pay on its ever-growing debts. If that doesn't happen, it collapses. There is no practical difference in economic effects, especially for a company so widely held by conservative, traditional individual investors, between paying dividends and employing unproductive surplus labour. We can leave the political distinction to the politicians.

2008 Nov 16 01:45 AM