GE Finally Enters the Zone of the Unknown

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

Comments

[kevin dempsey:]

IM A GE SHAREHOLDER THAT WONT BE SELLING I DONT WANT THE DIVIDEND CUT AS A OWNER IM RIGHT AND YOUR WRONG.

ALSO WHO EXACTLY DOES GE COMPETE WITH ON MAKING LOANS?

ALL THE BANKS HAVE FAR LOWER RATINGS THAN GE

THUS GE WILL ALWAYS MAKE MORE $$$ AND BE MORE COMPETITIVE THAN THEIR COMPETITIORS WHO ALL TODAY GOT A DOWNGRADE FROM S/P

$10 good luck your gonna need it K.D.

2008 Dec 19 09:09 AM

[investor88:]

Support short position in GE for possible price below usd10 based on the sound analysis above by Rakesh. [Does not seem logical to pay dividend when you need govt aid to survive? ].

2008 Dec 19 09:25 AM

[CHARGER:]

Necessary Confidence factor, so frequently sought by those who see this as a key to recovery, certainly has been earned by General Electric in their strong technology pipeline , their selection of businesss, and their active channel for selected corporate lending and there five year achievement pattern. I enjoy that confidence and am willing to own these shares. My more recent concern has been the SWAPS "casino of the unknown".
However , I am comforted in that the Analysts, though angerred by their professional impact of aborted quarterly reports HAVE NOT GIVEN THIS ANY WEWIGHT

2008 Dec 19 10:43 AM

[bluegillfish:]

So nobody believes GE is worthy of the already negative S&P rating? What a joke when a shorter starts speaking for "everybody", he really is just "praying".
I love the dividend, investor 88, maybe if you had some money you could buy a stock like GE and actually collect a dividend. But, guess you are too busy gambleing with your meger money to be an investor.

2008 Dec 19 10:51 AM

[k45:]

When GE bond yields are 2% higher than AA rated companies, obviously the market has lost all respect for S&P/Moody's ratings.

2008 Dec 19 10:55 AM

[MarkGillCPA:]

Let me get this straight. Your short GE because the debt has a 1 in 3 chance of begin downgraded, yet you state in your article that the debt is already trading as though it were rated lower than AAA. Looks like the market has already discounted your downgrade. So what's your advantage? The only way you can justify a short position now is if your EPS analysis is coming in much lower than everyone else. But you make no mention of what you think EPS will be in 2009 or 2010. The time to short GE was when it was trading for $40 last year, not now when it's trading at 16.50. Sure, I could see it retest that $12.58 November low, and that could give you a 20% gain on a short position (minus having to pay one of those dividend payments while you wait). But the corporate bond market is beginning to thaw, EPS estimates for 09 have already been lowered numberous times to $1.42, which appears reasonable. And right or wrong, GE has committed to the $1.24 dividend for next year, which will provide a floor for the stock. Are you really going to try to push a short position to 7 times next year's earingins? GE could just as easily trade to 20. And if GE does fall back to that 12.58 low, I'll be looking to load up the truck. Good luck with that short.

2008 Dec 19 11:14 AM

[helplessobs...:]

Mark has it right, the short signal was last year when the stock for no evident reason tanked from 42 to 32. You are late to the party and the road kill is pretty rancid and a bit toxic.

2008 Dec 19 12:08 PM

[PROXIMO:]

GE Lovers, AKA members of the Flat Earth Society, enjoy that dividend on your way to $8 a share.

2008 Dec 19 10:10 PM

[jepittman:]

First let me say I am no fan of GE. IMO it has long been a hedge fund in drag. However I am tending to agree that the time to short for significant gains has passed. A $10 share price indicates a dividend yield of 12.4%, which I see as far too pessimistic given the company's apparant determination to pay the dividend. Even enduring times when the dividend is not earned does not mean the board of directors will not pay it. After all, dividends are payed with cash, not earnings. Only the prospect of a recession lasting beyond 2010 would force a reevaluation of GE's dividend commitment. With the Federal Reserve's massive reflation policy and a sustained fiscal stimulus package imminent from the Obama administration I cannot see the recession lasting beyond 2009. To me this means the dividend can be sustained until a recovery arrives.

2008 Dec 20 11:32 AM

[PROXIMO:]

You say Rakesh will make 20% on GE if it retests the lows. FYI---The author has disclosed he is short GE several times in this blog over the past 3 months. He is already up over the 20% on his short, and more than that if he began shorting before he began writing here in SEEKING ALHA.


On Dec 19 11:14 AM MarkGillCPA wrote:

> Let me get this straight. Your short GE because the debt has a 1
> in 3 chance of begin downgraded, yet you state in your article that
> the debt is already trading as though it were rated lower than AAA.
> Looks like the market has already discounted your downgrade. So
> what's your advantage? The only way you can justify a short position
> now is if your EPS analysis is coming in much lower than everyone
> else. But you make no mention of what you think EPS will be in 2009
> or 2010. The time to short GE was when it was trading for $40 last
> year, not now when it's trading at 16.50. Sure, I could see it retest
> that $12.58 November low, and that could give you a 20% gain on a
> short position (minus having to pay one of those dividend payments
> while you wait). But the corporate bond market is beginning to thaw,
> EPS estimates for 09 have already been lowered numberous times to
> $1.42, which appears reasonable. And right or wrong, GE has committed
> to the $1.24 dividend for next year, which will provide a floor for
> the stock. Are you really going to try to push a short position
> to 7 times next year's earingins? GE could just as easily trade
> to 20. And if GE does fall back to that 12.58 low, I'll be looking
> to load up the truck. Good luck with that short.

2008 Dec 20 03:35 PM

[dawase@gmai...:]

Back when things were more normal GE traded in the 40s with the Capital arm providing 40% of the earnings. Even if GEC is a complete wipeout, the stock seems still undervalued. Take 40. Knock off 40% for GEC. Takes you to 24. Knock another 25% off because of the global crisis. Puts you at $18.

If you really want to get into the numbers from GEC, they're levered at around 7:1, so if you're looking to make the argument that they're a "hedge fund" or "like a bank", I think you've missed the critical metric. They have no exposure to residential RE although they do have commercial RE. That probably won't help them in '09 although all the talk of a collapse in Commercial RE may be overdone in light of the Fed dropping rates so precipitously.

At the end of the day, GE makes things. That's pretty rare in the US these days. Not only do they make stuff, but they make stuff that's in all the right markets - health care, power, alt energy, etc.

The major problems in my book are three-fold:

1. There's a definitive credibility gap. Immelt really botched the announcements over the last 4-5 months. It's going to be a while, if ever, before people trust him.

2. GEC has a BIG pile of debt that needs to be rolled in '09. Something along the lines of $70B. Between the potential down-grade, the current pricing on GEC debt, and the state of the credit markets, it could get messy.

3. Along the same lines, GE has been trying to dump assets over the last year and, last I checked, has had some difficulty finding buyers. It has likely only gotten harder and asset values are definitely down.

As an aside, anyone that thinks the S&P announcement counts for anything obviously missed the fact that the ratings agencies have been completely asleep at the wheel if not negligent for the last 5 years or so. The announcement was like an equity analyst downgrading a stock to a neutral after it falls 60%. The debt is already trading at sub-AAA yields. Hardly a newsflash.

I'm long the stock as I have been for about 10 years, but I halved my position in the mid-twenties and will look to add the shares back at a significant discount to my sale price some time in the first half of '09 as we get some clarity on the debt problem and whether Immelt is going to survive. I say this with the caveat that there are probably 5-10 other equities I'm watching that are ahead of GE on my list of "want to own" depending on valuations.

2008 Dec 22 02:13 AM

[drone:]

Reading this article, thinking about GE, a 60's song comes into my head. The chorus goes like this,

Break down, take down, you're busted.

2008 Dec 22 04:37 PM

[L Boyd:]

I certainly agree with MarkGill. While it is easy, using hindsight, to say the time to short was $40, I think the point (at least that I'd make) is that there are a lot of more attractive short candidates than GE right now. This is still a relatively solid, well-diversified company. While it is quite possible that the share price could dip to the ~$10 range, I'd say its much more likely to hover in the mid-teens for the next year or so.

2008 Dec 23 05:47 PM