GE Capital is an important segment for General Electric (GE) in terms of revenue generation. At the same time, it is also the segment in which most of the company's risks are concentrated. Lately, the company has pursued a number of strategies to reduce its dependence on GE Capital by increasing its exposure to other segments. This includes the acquisition of Lufkin Industries for $3.3 billion, for which analysts believe that GE paid a premium.
A spin-off of GE capital has also been considered by GE's management in the past. Jeffery Immmelt, Chairman and CEO of the company, has said that a company like GE should be open to some form of restructuring every ten to fifteen years. Therefore, it is evident that the company will perform some restructuring. However, a spin off might not happen any time soon.
How Much GE Capital Contributes?
For the first quarter of 2013, Aviation was the largest source of revenues and profits amongst the industrial business segments with $5.07 billion in revenues and $936 million in profits. However, GE Capital, the financial segment of GE's earnings reported first quarter revenues of $11.5 billion resulting in profits of $4.86 billion. GE Capital is sometimes considered a liability because of the negative impact it had during the financial meltdown of 2008. However, it should be remembered that the macroeconomic environment is much better now and the economy is making a recovery, which is resulting in a positive impact by this segment. The global economy is still suffering; however, most of the regions are making solid progress and the only region with substantial risk is Europe.
Looking into the acquisition of Lufkin Industries, we see that the premium paid by GE is not entirely inappropriate. There has been a substantial increase in shale gas drilling in the U.S. which has been largely profitable for the drilling businesses. Furthermore, very strong synergies are likely to be associated in this acquisition, making up for the large premium. The company's restructuring push in this acquisition is therefore aimed towards the oil and gas industries.
GE Reducing the Exposure to GE Capital
General Electric is already trying to reduce the size of GE Capital, and keeping in mind the recent developments in the European debt crisis; it is a correct decision as the European debt crisis will continue to have an impact on the global economy. Furthermore, the level of debt borne by the U.S. economy on its own, coupled with the fiscal stimulus measures, add, to the economic risks. In current circumstances, the company might have been tempted to spin off the segment. However, large contributions by GE Capital towards the total revenues and earnings made management think otherwise, in my opinion.
I agree with the stance of the management to some extent - it will not be wise to separate GE Capital when the segment has returned to becoming an important and profitable arm of the company. Meanwhile, shedding of the non-core assets all over the globe is a shrewd move as it will decrease the exposure of the company to some specific regions and allow the company to manage its portfolio efficiently. The strategy has already started to pay off and the segment has become profitable again. As a result, a restructure plan based on selling off riskier parts of GE Capital is likely to be most effective as it will reduce risks without substantially reducing the value of the company. This will in fact increase the relative market value of the company and is also likely to result in improved credit ratings.
While GE is still a long way from its $40 per share pre-recession value; I believe the company is on the right path to achieve that value again. The stock is currently trading at a P/E of 14.22 against the industry average of 19.85, and also offers a dividend yield of 3.49%, which can serve as an important factor while investors wait for the capital appreciation. At current levels, I believe GE is trading at a discount and there is substantial upside potential.
Furthermore, a spin-off is not an appropriate option at the moment, and the company should carry on its strategy to decrease the geographic diversification of GE Capital. The company has been involved in a number of strategic acquisitions and with the takeover of Lufkin Industries; GE is increasing exposure to the high-growth areas. GE's efforts to consolidate its industrial segment and return to the strength of the company are the basis of my positive stance towards the company. I believe there are enough growth opportunities for the company to justify the current valuation.