On Thursday, Standard & Poor’s said that there is a one-in-three chance that General Electric (GE) will lose its coveted “AAA” rating in the next two years. But, as far as the debt marketplace is concerned, the “implied” rating for General Electric has been well below “AAA” for many months now. And faith in the credit agencies is at an all-time low anyway.
S&P cut its outlook for General Electric, and for GE Capital, from stable to negative on the basis of deteriorating earnings through 2010. But that outlook downgrade was hardly necessary given that credit default swaps on General Electric are being priced at 420 basis points today (from about 130 bps this April), that non-government backed or funded General Electric debt is trading well outside the recent range identified by the CDX investment-grade index (i.e. 220-250 bps) and that it is extremely doubtful that GE’s outstanding commercial paper is fully backed by valid bank credit lines—a normal business requirement before the various bailout mechanisms came into play.
More specifically, an increasing number of investors are wondering why CEO Jeff Immelt is committing to pay a maintain the $1.24 per share annual dividend (equivalent to $13 billion-plus) for 2009 when the true extent of the global recession has yet to unfold and when the company is, for all practical purposes, retaining its “AAA” status via government assistance. In other words, is the transfer of tax-payer dollars to shareholder pockets, albeit in an indirect manner, setting a dangerous trend within the upper end of the American business spectrum, while placing “secondary” corporations at a serious competitive disadvantage?
Compounding GE’s multi-tiered debt matrix are the maturity-mismatch readings from GE’s financial statements. Solvency ratios have already been impacted by the dual reality of the emerging markets: declining asset values and diminished liquidity for investments. This reality has not yet been captured in GE’s financial statements; General Electric is or was relying on the emerging markets for roughly 20% of its earnings. It is also important to note that a good part of GE’s growth in this decade has come from hundreds of domestic and foreign acquisitions using General Electric stock or cheap commercial paper. Moreover, if GE’s management implements plans to protect GE’s superior credit rating through fresh capital in these highly uncertain times, the dilution factor for existing shareholders will be devastating.
So there is no doubt that Mr. Immelt is confronting one of corporate America’s biggest challenges: to keep intact the Buy America vision of Warren Buffett. A General Electric spokesman said yesterday that “we will execute our 2009 plan, we’ve been through this before, and we will get over this, and our difficulties have been factored into our ratings.” But the core problem for General Electric is that nobody is willing to take the reiteration of GE’s “AAA” rating by S&P at face value and few analysts are willing to concede that the rating agencies have factored in, or possess the ability to factor in, all the risks.
This writer continues to advocate shorting General Electric, with a price target below $10 by mid-2009. Those who wish further support for this short proposition are advised to review the latest SEC filings and corporate presentations with the required degree of detail. In particular, it is worth going through GE’s country-by-country exposure to better understand why the perils in GE’s “borrow short-invest long” strategy are demanding a contraction and realignment of GE’s business model, not a continuous adjustment in GE’s borrowing and capitalization profile in line with the contents of bailout packages, data on the economic and financial meltdown currently in progress, fundamental changes in the international debt matrix and, of course, analyst pressures.
Disclosure: Author holds a short position in GE