General Electric (GE) CEO Jeff Immelt suggested recently that GE is interested in exploring a possible IPO of its Consumer portion of the GE Capital business. The idea of spinoffs, IPOs, sales, etc are nothing new to GE Capital but Immelt was awfully specific in his latest comments about the Consumer business. This article will take a look at what GE's Consumer business may be worth to shareholders in the event that it was spun off into an IPO as an independent company.
First, the Consumer business is a $138 billion asset arm of GE Capital that consists of mainly credit card loans (60%) and Non-US residential mortgages (29%), Non-US auto loans (4%) and Other (7%). The specific breakdown in terms of receivables is below.
Portfolio Composition ($ millions)
Non-U.S. residential mortgages
Non-U.S. installment and revolving credit
U.S. installment and revolving credit
Total Consumer financing receivables, before allowance for losses
As you can see, this is a huge business by most standards as the receivables alone account for over $115 billion. From these assets, the Consumer business produced the following revenue, profit and return on assets for the past three years.
We see strong profits for this particular segment in each year but we also see declining revenues; the result of stagnant asset base and lower interest rates. However, in a banking sense, return on assets is very strong at 2.3% last year.
Given these numbers, we can produce an estimate of what GE's Consumer business might be worth on its own. First, considering that revenues are declining and profits have dropped quite significantly year over year, it wouldn't be fair to assign a huge multiple to this company. I think something on the order of 8 or 9 times earnings would be fair given failure-to-pay risks of things like credit cards and international auto loans. GE currently reserves roughly three percent of assets to cover Consumer loan losses so if those numbers became materially worse, it could wipe out the Consumer business' profit for a year. I don't think that is likely to happen but it is a risk with a receivables business like Consumer.
Now, assuming that GE gets an IPO value sufficient to imply 8 to 9 times earnings post-tax earnings (assuming a 35% tax rate, which is likely high), a value of $17 to $19 billion would be expected for the IPO. That sounds like a lot of money until you consider that the spun-off company would be producing so much in earnings. Like I said, 35% taxes is probably too high as GE has highly skilled tax accountants and lawyers that could likely help shareholders with that little matter.
GE would have some choices to make, should this spin off actually happen. First, GE could simply spin off the whole thing and wash its hands of the business. This would result in a 100% shareholder owned company that would be free to make decisions however it pleased. The other option is that GE retains an ownership stake and perhaps enough to still control it. I would prefer the first option as the partially spun-off company would likely be less attractive to potential shareholders. The reason is that GE would likely continue to run the business the same way it is now whereas independent management would be free to grow the business as it saw fit. Just my opinion, but I wouldn't be overly interested in this company if it were still GE-controlled.
Now, assuming that the new company was independent of GE control, it could reasonably be expected to pay 30% to 50% of its after-tax earnings in dividends to shareholders without any trouble. This would imply a potential yield of 3.5% to 5.8% for the new company given the valuation I discussed earlier. This is a dividend investor's dream and could spark buying interest in the new entity.
The value to GE shareholders would be potentially ~$18 billion to spend on growing the core business, buying back shares and paying dividends with the cash generated from the sale of the Consumer business. This could be an obvious boon to GE shareholders as the company has committed publicly to reducing share counts and this could be a big step towards doing just that. So am I a fan of the idea to spin the Consumer business off? You betcha.