Debunking Ortel's GE Short Case

Ortel's GE grandstanding is brilliant -- in a way. Everything he says is true. He says GE over-expanded GEC; GE agrees, so no surprise there. Then Ortel gets a little more subtle by attacking GE's guidance, more or less, by asking why GE is not giving more market-crushing news. He implies GE is not gaining market share, but no one knows; if GE is gaining share, he can complain that GE did not disclose it, and if they are not he can say 'I warned you.' Ortel also threw in his opinion that GE would not even be operating without the government. Since GE has used one program once, he can say that, but it is a bit of a stretch.

The most annoying thing about Ortel's 'analysis' is that he does not present any new information; furthermore, Ortel should have fallen on his sword today, because in his previous interviews he attacked GE's sacred cash flow, which is healthy at current valuation. So while Ortel is scoring points with GE skeptics (stealing candy from babies right now), here are the boring facts:

GEC made $149M from operations. GE has no revenue from stimulus programs yet. GE's quite profitable service backlog is $122B, and total backlog $169B, probably more than annual revenue. GE's operating cash flow is on course to be less than .50x last year, an impressive-at-current-valuation $16B minimum, around 1.51 a share. EPS should be around 1.10 with the usual slightly stronger 2H; however, GE says GEC will earn $2B in 2H, and in my opinion, it is reasonable to assume several billion stimulus revenue in 2H.

So how does that square with Ortel's short case, $2 a share? GE's PEx and P/CFx are getting discounted from historical levels (16x and 10x) because of worries that GEC's real estate holdings will become less stable. 1.05 EPS and 1.32 cash are worst case; at a discounted 12x PE, and a discounted 7.5x for operating cash flow GE is minimum ~$10.50. As GEC's real estate stabilizes those ratios will rise. In other words, if short, you are betting that it is more likely GEC's debt will destabilize, because low revenues are already priced in. On the other hand, add 0.20 for GEC's expected profit and a few cents for stimulus profits and that minimum valuation goes up even more.

Many investors feel that GE screwed them with incorrect positive guidance, and GE definitely was greedy and short-sighted in regards to over-expanding GEC. Two words: cash flow. I cannot guess what the market will do but from my perspective GE looks like a better bet to finish the year around $17 because of cash flow. So Ortel, please keep pushing those shorts, I look forward to the squeezes.

Comments

[danS:]

Nice analysis. However you have to factor in uncertainty in the regulatory environment. Is GEC going to be forced to become a bank holding company ( most likely) and is GE going to be forced split off the GEC organization (fairly doubtful). Uncertainty concerning these two issues I believe are causing the market to discount the price of the stock and will prevent it from reaching the $17 stock price you discuss. If the latter occurs I think the drop in price is warranted. However if the former occurs I don't think it will have much of an effect on GE's long term performance and you can expect the price to reach the low 20's in the next 2 years.

Jul 19 02:22 PM

[10101:]

Shorting GE is like building a house on the beach at low tide, betting that, this time, the tide won't come back in. If you don't like GE as a company, buy something else, but don't expose yourself to potentially unlimited losses betting against the inevitable.

Jul 19 02:44 PM

[H. T. Love:]

On 4/19, here seekingalpha.com/autho...

I valued GE at $8-$10 because I gave lower PE to the non-GEC side of things, based on my view of the economy and it's effects on GE.

I'm sticking to my guns and will re-enter it in that range.

HardToLove

Jul 19 02:47 PM

[wendling_r:]

GE is forming an inverted head and shoulders buying formation. It has just completed the right shoulder of the formation. I am expecting the stock to move well above the $20.00 level before all is said and done.

For more information on how I determined my price range and my latest free report on GE and other stocks follow the link on this note. It also explains how the specialist system manipulates not only stocks like GE but the entire market place to their benefit.

The information is free and hopefully useful to those who are interested in how the market really works.

Richard W. Wendling

Jul 19 03:51 PM

[sethmcs:]

I am selling puts on GE and I take the shares on the way down. I was disappointed with 2Qtr report as was the market. July 13 puts expired in the money (they had a good shot of expiring out of the money if the report was better) so I acquired the shares at $11.85 ( $13.00 less premium $1.15) I sold Aug 12 puts at $1.15 if they expire in the money then I will buy the shares at $10.85. If GE keeps going down I will keep buying more otherwise I will profit from those who are afraid of GE going down. GE's dividend is safe and I'll get paid to wait. GEC is not going to fold and management is reducing leverage 5.6 to 1 verses 7 to 1. GEC has funded all of its short-term commercial paper debt for the next three quarters so a liquidity crisis is not going to happen. Downside risk is $7 to $8 upside $20 with business improvement over the next three quarters.

Jul 19 05:57 PM

[jstratt:]

Thanks for an excellent posting.

GE is selling at a fair price and should be a good long term holding. However if you pick your price and stick to it you may find a better price.

In either case excellent long term rewards likely await the investor. I sold all my GE 18-24 months ago at $35 average and bought it all back in 2009 at an average near $10. I want more GE as I believe they are in much better shape than last year at this time. To me it looks like they have substantially improved liquidity.

Jul 19 09:42 PM

[KIT:]

www.smartmoney.com/sto...

Buffett uses 6.5% as a EPS divisor when ten year is artificially low.
GE EPS is 1.62 so X 100 / 6.5 is $24.92

GE capital debt is killing the price.

BOOK per share is $9.56 not far of market price
DEBT is totally out of wack $31 per share

Time to separate GE capital into its own company and send it to TARP heaven. The remaining GE industrial wil do fine without it.

Jul 19 11:00 PM

[Wisdom vs. ...:]

GE's debt is deceiving b/c GEC sells bonds to pay GE; GEC's bond debt is still quite a bit lower than future receivables. On most of those contracts, GEC writes 70% of contracts as assets.

Bad: GEC is worried about G Britain real estate, which may sting a little if it does not improve. GEC paid too much for its US commercial real estate portfolio and admitted that we can forget about making a dime from that for five years. Good: The Buffet contract allows Buffet to buy GE shares at 22.50; I am assuming that means Buffet thinks the shares will be worth more than that before the contract expires

Jul 20 12:51 AM

[expat in China:]

I believe when Buffet made the contract to buy GE at $22.50 he wasnt thinking of the complete destruction of the consumer and or the rape to any real stimulas by the financial crises. Buffet made a bad bet trying to shore up the collapse of Oct 2008 with his buy America foray into GE and others it was too early!

The emerging market industrial players are eating away at GE product lines while GE struggles under consolidated debt, cost reductions and old industry divisions. GEC is widely exposed to commercial real estate debt that is does NOT mark to market and there fore DOES have inflated asset values on the balance sheet.

All great companies have a life cycle and Berkshire most likely had its peak.

I am short GE for the mid term and will never be long until GEC is capitalized and regulated, sold off or liquidated!

Jul 20 02:11 AM

[KIT:]

The financing needed to roll over a lot of the commercial debt coming due in the next few years is not available. Much of the company's commercial real estate equity is not worth what GE paid for it
news.alibaba.com/artic...


On Jul 20 12:51 AM Wisdom vs. Information wrote:

> GE's debt is deceiving b/c GEC sells bonds to pay GE; GEC's bond
> debt is still quite a bit lower than future receivables. On most
> of those contracts, GEC writes 70% of contracts as assets.
>
> Bad: GEC is worried about G Britain real estate, which may sting
> a little if it does not improve. GEC paid too much for its US commercial
> real estate portfolio and admitted that we can forget about making
> a dime from that for five years. Good: The Buffet contract allows
> Buffet to buy GE shares at 22.50; I am assuming that means Buffet
> thinks the shares will be worth more than that before the contract
> expires

Jul 20 03:38 AM

[Wisdom vs. ...:]

Cash flow does not lie. GE is not "struggling" at current valuation. Long term debt usually finances capital which hopefully generates future sales; GEC's long term debt is matched to contracted receivables, not hopes.

Jul 20 04:30 PM

[KIT:]

GE Capital’s loan-loss reserves as a percentage of finance receivables is 1.8 percent, among the worst in the financial-services industry www.bloomberg.com/apps...


On Jul 20 04:30 PM Wisdom vs. Information wrote:

> Cash flow does not lie. GE is not "struggling" at current valuation.
> Long term debt usually finances capital which hopefully generates
> future sales; GEC's long term debt is matched to contracted receivables,
> not hopes.

Jul 21 07:38 PM