GE at a Crossroads: Business Model Becoming Obsolete

Last week, GE (GE) Money India decided to shut down 50% of its branch network, effectively abandoning lofty plans to aggressively expand its $1.1 billion retail lending portfolio; the company’s management did not disclose data on forecasted loan delinquencies in an environment where huge segments of India’s middle class are confronting, for the first time in India’s history, the evils of leverage on family balance sheets. Almost simultaneously, GE's India unit announced that it was relying on the prospects of selling windmills, steam turbines and diesel locomotives to meet its 2010 revenue target of $8 billion.

Is India a precursor of GE’s future in the sense that GE’s internationally diversified business model is fast become obsolete?

This week, Fitch cut it ratings outlook for Thailand’s Bank of Ayudhya, in which General Electric holds a 33% stake, due to heightened political risk; the bank’s share price has, in any event, declined significantly in the wake of the political turmoil in the country. Twenty thousand General Electric workers in the United Kingdom were recently warned about forthcoming retrenchments due to worsening economic conditions. Given the sharp falls in oil prices, it is highly unlikely that GE’s $8 billion joint venture with the Abu Dhabi Investment Agency (Mubadala Development), announced in July, will make any contributions to improve 2007 revenues ($5 billion) from the Middle East.

The list of “qualitatively compromised” non-US assets goes on and on; General Electric operates in more than 100 countries. What is abundantly clear is that the company is betting on a significant turnaround in the global economy in late 2009. If that turnaround is delayed, General Electric simply cannot meet revenue benchmarks in its latest guidance reports. But, more critically, will stability, if and when it materializes, within the global business spectrum come at an exceedingly high price for numerous post-WW II multinational business models in terms of a long overdue rationalization in both, disposable incomes and national growth rates in the emerging markets?

The emerging markets contributed 20% to GE’s 2007 revenues; in its report accompanying the 2007 financial statements, the company confidently predicts that emerging-market revenues will grow from $33 billion (in 2007) to $50 billion in 2010. But, upon closer scrutiny, that 50% increment falls squarely into the highly speculative category; on the contrary, management will find it a challenge preserving revenues close to the $25 billion mark in 2010. For example, the $8 billion India target appears grounded primarily on hope and optimism.

One the one hand, given well-known inefficiencies in the Indian bureaucratic machinery, there is absolutely no reason to believe that any major government-baced, energy-related projects will be implemented (as opposed to being announced) in the foreseeable future. On the other hand, the present government is not likely to be in power after mid-2009, and the coalition expected to take power in New Delhi has absolutely no credible green agenda whatsoever.

This is not the forum to enter into too much detail on several underlying economic emerging-market trends which, in the opinion of this writer, will thoroughly destroy the risk-reward parameters which have justified American investments in the emerging markets for nearly five decades. In the briefest of terms, access to government bailout facilities regardless, GE’ foreign investments must pressure its share price in the weeks and months ahead. And, in view of the highly uncertain impact on domestic asset values of Washington’s stimulus packages, no mathematical assessment of the company’s US business is possible at this point.

But look for renewed tensions between two ends of the valuation spectrum, between those who are convinced that GE’s multinational business model is no longer tenable (and requires deliberate contraction almost immediately) and those who continue to regard this global recession as a cyclical event with a life-span of 12-18 months. This writer will again start executing short General Electic trades Monday morning, with a comfortable first-half 2009 target of $10, and below.

Disclosure: Author holds a short position in GE

Comments

[tginomorebush:]

duh .......... sounds like he might be "short" ......... but at least honest ....... and no real points for his prediction ............. hope "shorty" burns

2008 Dec 07 08:35 AM

[Elli M:]

One should not neglect the huge investments of all the goverments in utilities/infrastructu... Once economy shows small signs of reblooming- investors , funds and pensions might relong GE
I would rather see the shutting down of non contributing lines-as a positive sign for proper opeartional navigation.

2008 Dec 07 09:08 AM

[Ishortyou:]

well, it is perceive that this is a global economic slow down if not recession, so all those businesses like GE that have that business model will have the same kind of headache, the ones that are doing so so under this global model are the food related companies like Yum Yum, McDonnalds and so on.

2008 Dec 07 10:31 AM

[arshile:]

Wow, this guy must be high, GE is THE most reliable well run company in the world. If they go to 10 The s&P will be cut in half too

2008 Dec 07 11:04 AM

[drone:]

GE recently announced a reorganisation of divisions and the appointment of several new vice presidents. This doesn't sound like a well run company. It sounds more like the auto industry comparison of a boat with nine people steering and one person paddling. GE is in decline with the Chinese one day producing cheaper, better wind mills and jet engines. The next big drop in this stock will come soon after the December dividend payment.

2008 Dec 07 12:09 PM

[Fam62c:]

I can't help but that think that, in the long run, GE would have been better concentrating on it's core technology and infrastructure businesses. Jack Welch went for the easy money when times were good and got deeply into the consumer credit business and GE is paying for that now. I can understand GE having a finance unit so customers can help finance locomotives, jet engines, steam tubines, wind turbines, etc. but I don't think that GE should be in the business of of providing unsecured credit to consumers to buy big-screen TV's, ipods, video game units, etc. Why would GE want to be in a position where they are at risk when Joe Sixpack defaults on his debt? Call me old fashioned but I think most companies are best when they stick with what they are good at. I would like to see GE get back to being GE and lose the entertainment and consumer credit businesses.

2008 Dec 07 12:14 PM

[Chetan S:]

Most of the most dire forecasts seem to be already priced in. In 2007 GE was trading at well over 40, now it is barely above the mid-teens.

The domestic infrastructure stimulus package being proposed by Obama is likely to benefit GE immensely. It is also risky to bet on current liquidity issues, which is the prime reason for sudden and violent contraction in global share price decline, to remain at these levels for an extended period of time.

The author seems to read too much into the near-term perturbations such as those in Thailand. These may not last more than a few days, let alone have a perceptible impact on earnings.

In my opinion, GE is a much safer bet in this market than most other equities. When the markets recover, GE stock will recover the fastest.

2008 Dec 07 12:14 PM

[Urbane Gori...:]

The author is correct. GE is an outdated business. Aside from being an overstuffed flabby business, it has too many divisions to deal with. You have a floundering financial division,a home appliance division that produces 2nd rate units, an aerospace division in this economic climate and an engineering division. When the economy picks up, and the rest of the world ramps up infrastructure, I can see the engineering division riding on that, but the rest? Doubtful. I think GE should consider splitting up. as soon as possible to unlock the value in each division.

Having said that, why bother with this mish-mash of a dinosaur. Why not buy focused companies that can deliver. Buy the best company out there (with no debt and a business moat) that meets the separate parts of GE. You will do much better when the economy rolls out.

Wouldn't it be better to own Boeing than the GE aerospace. How about Wells Fargo if you want a bank. ABB, Siemens or HAL if you want construction and engineering.... And well... Forget the household appliance part.

Happy motoring!!!

jegan ;-)

2008 Dec 07 01:00 PM

[MrBuzz:]

I take different view from most on GE. It has the best potential of any US corporation to improve and prosper. It is in many of the correct industries for our times. From railroads to jet engines and yes money.

The GE Money Bank on the international scope is good idea. It is needed in many nations where banking is either: crooked or non-existent. Or sometimes just not up to the times. If GE does not stick to the plan here. It will be future loss.

2008 Dec 07 04:19 PM

[mikeccall:]

Enjoy paying the 7-8% dividend for selling share short. Not smart.

2008 Dec 07 05:44 PM

[mikeccall:]

Enjoy paying the 7-8% dividend for selling the shares short. Not smart.

2008 Dec 07 05:44 PM

[Chemist29:]

What is GE's competitive advantage? Cost of capital. GE borrows money cheaper than even Berkshire Hathaway because of its credit ratings, this low cost of capital allows GE to finance companies buying of the big ticket items like locomotives, turbines, etc etc, thereby giving a steady revenue stream which supports the ratings. How is that a flawed model?

2008 Dec 07 08:29 PM

[longandshort:]

I would like a little more disclosure from this guy about his short position.
I'll bet he's got a couple of PUTs (maybe only one) for Jan and Feb...contracts under $1.00...gotta have a little more ba--s when you make strong bearish statements like this.
So he thinks GE should be priced just like GM ..how about saying something about GMs business model!

2008 Dec 08 01:36 AM

[GE Ranger:]

I would have to agree that GE still has a great deal of downside risk. What used to be unthinkable in this market has already come to pass. Regardless of what is currently "priced in" to the markets...there is still a long way to go before the losses and revenue erosion find a bottom.

Simply put...if the US consumer cuts their spending by 1/3 or even 1/2...we are speaking of 3-5 trillion of year on year reductions. There are not enough emerging countries, new products or fancy marketing campaigns that will be able to make up that amount over the course of 12 months.

Even though I'm not a big short fan, I do recognize the necessity of that force in a free market. Clearly the good should be rewarded and the weak weeded out...that's how economies thrive.

As far as GE goes, they dodged a huge bullet on their AAA rating when they announced yet another change in their structure....but specifically outlined their reduction on the dependence of GE Capital for earnings. The sad part of this announcement was that it would happen anyway...whether they planned for it or not.

The stock will at least retest the lows in the mid-12's, but probably will go a bit lower before bottoming out. By that time, perhaps the board will have a more objective view of the anemic performance of GE's leadership and set some new expectations. The shareholders have expressed their dissatisfaction for some time now...unfortunately, the timing of any change is now at the worst possible time (another consistent "core value" of leadership it appears). Well good luck out there....and good hunting.

2008 Dec 08 08:23 AM

[drone:]

Where does GE get its money from? It goes to the federal government, to you and me, on its knees, with its cup in hand and a scrap of paper with three letters written on it, AAA.


On Dec 07 08:29 PM Chemist29 wrote:

> What is GE's competitive advantage? Cost of capital. GE borrows money
> cheaper than even Berkshire Hathaway because of its credit ratings,
> this low cost of capital allows GE to finance companies buying of
> the big ticket items like locomotives, turbines, etc etc, thereby
> giving a steady revenue stream which supports the ratings. How is
> that a flawed model?

2008 Dec 08 08:38 AM

[Ed from Jus...:]

So he is short now if you folks will just rush to sell your GE shares, the market will drop and GE will go down and he will be so happy. I personally will continue to place my chips "all in" on GE and if they go down then the whole country will go down. We have to go with where we predict the market will be in 2 years, 5 years, etc. I say over 13 in 2 years, over 15 in five years. GE will hit $36 before it is over I bet on it.

2008 Dec 08 10:57 AM

[drone:]

This is the same line that Immelt fed us when he was on Mad Money in Septemberand where did that end up? Down about 15 points on the stock. Why? Because everybody knows it is bullshit. That antique scrap of paper with AAA written on it wouldn't fetch two bits at a Sotheby's auction.


On Dec 07 08:29 PM Chemist29 wrote:

> What is GE's competitive advantage? Cost of capital. GE borrows money
> cheaper than even Berkshire Hathaway because of its credit ratings,
> this low cost of capital allows GE to finance companies buying of
> the big ticket items like locomotives, turbines, etc etc, thereby
> giving a steady revenue stream which supports the ratings. How is
> that a flawed model?

2008 Dec 13 02:36 PM