General Electric: Sum Of The Parts Analysis, Healthcare

Nov. 7.13 | About: General Electric (GE)

In Parts I and II of this series, I examined General Electric's (NYSE:GE) Home and Business Solutions business and the Transportation segment, respectively, assigning what I believe to be reasonable standalone values. In this piece, we'll take a look at the company's well-regarded Healthcare business in a similar analysis. GE's Healthcare business provides healthcare and information technologies, diagnostic tools, patient monitoring, disease research, drug research, and many various types of equipment such as imaging machines in addition to its robust service offerings. The company's Healthcare business is very well respected and the GE brand name carries with it a lot of value in the healthcare industry as a leader in the categories in which it competes.

Note: in order to save some space here, for an explanation of the methodology I'm using to value these businesses, please see Part I, Home and Business Solutions linked above.

To begin our analysis of the Healthcare business, I've shown the segment's results from the past six years below.

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As you can see, GE has had a very difficult time growing revenue in the Healthcare business since 2008. In fact, after suffering a substantial loss in revenue during the financial crisis, which has been a common theme so far, revenue in 2013 is expected to be only equal to that which was achieved before the crisis took its toll. However, this business still has much going for it even if revenue is largely stagnant.

If we take a look at the red line, segment operating profits, we can see that, despite large fluctuations in revenue, the Healthcare segment is actually quite reliable in the amount of profits it produces each year. In losing $1.5 billion in revenue year over year in 2009, operating profits fell just over $400 million. Since that time, operating profits have climbed back to a peak of nearly $3 billion in 2012 and my estimate of roughly $2.7 billion this year.

Astute readers will notice that although revenue has reclaimed the level reached in 2008, operating profits are not likely to do so. This is a problem generally as it means operating margins are falling. In fact, we see exactly that below.

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In looking at this chart we can clearly see that operating margins in the Healthcare business are actually pretty volatile. In 2008 the segment produced nearly 17% operating margins but this year that number is expected to be roughly 150 basis points lower on about the same amount of revenue. Before we overreact, consider the levels we are talking about here. GE's operating margins on Healthcare are in the mid to high teens. That is an astounding amount of profits on a very large revenue base of ~$17.5 billion annually.

So what does all of this mean for the segment's theoretical standalone value? GE's Healthcare business is really a unique business in its size and complexity so attempting to divine information from competitors isn't particularly useful. However, we know a few things about GE's Healthcare business that can help us assign a value to it. We know revenue is approximately $17.5 billion annually and is likely to stay around that level or slightly higher. We also know that Healthcare's operating margins are enormous at 15% to 17% annually. Finally, we know that, at the end of last year, Healthcare's order backlog was $15.4 billion, or just under an entire year's worth of revenue.

If we consider the full business and the long term demographic tailwinds for such a business, GE's Healthcare segment is extremely desirable. As a standalone entity, given these factors, this business would likely command an earnings multiple in the 18 to 20 range due to its strong fundamentals, in spite of the lack of outright revenue growth. Also, the company's operating margins are near the bottom end of what has been achieved over the past several years so it will be important to see what happens in 2014 with Healthcare margins. If they begin to creep up again, it could provide some significant upside to my valuation estimate.

Since we don't have net income per segment, I'll use the same 25% tax rate estimate I used in Part II and if I do that, the net income estimate for 2013 comes in right at $2 billion. If we use the earnings multiple range I just mentioned, the midpoint of that range would produce a standalone value for Healthcare of about $38 billion.

In Part I, I determined the Home and Business Solutions business to be worth about $3.8 billion. Part II saw a valuation of the company's Transportation segment of $18.6 billion and in this piece, I estimated the Healthcare business to be worth about $38 billion on its own. In subsequent pieces, we'll examine the remaining segments in GE's portfolio: Aviation, Energy Management, Power and Water, Oil and Gas and finally, GE Capital.

Disclosure: I am long GE. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.