Series Wrap Up
Over the past couple of weeks I penned a series of articles regarding General Electric's (GE) various business segments and their theoretical standalone values. In order, the pieces were: Home And Business Solutions, Transportation, Healthcare, Energy Management, Power And Water, Oil & Gas, Aviation and finally, Capital. In this piece, I'll take a look at the implied valuation of the entire company and some potential impacts of having the company split up as my articles theorized.
Below are the standalone valuations I calculated based upon the data in my articles:
Capital - $89 billion
Aviation - $72.5 billion
Power And Water - $65 billion
Healthcare - $38 billion
Oil & Gas - $26.3 billion
Transportation - $18.6 billion
Home And Business Solutions - $3.8 billion
Energy Management - $1 billion
As you can see, there is quite the discrepancy between the relative valuations of GE's business segments according to my calculations. In addition it's easy to see that GE is spending large amounts of effort on H&BS and EM without much payoff. Both of those businesses offer very low margins and thus, don't contribute much to GE's profitability. However, management is spending time running those businesses; time I believe could be better spent on a different project.
What GE Could Do
Now, let's take a look at what I would like to see GE do based on the information I collected and summarized in my series of articles. First, Capital is on the mend and despite its shrinking revenue base, margins are powering ever higher and profitability is outstanding at this point. As Capital is too large to be sold I'd like to see a spinoff of the business with the new shares going to existing GE shareholders. Altria (MO) has done this over the years with its various businesses and it has worked out tremendously to the shareholders' advantage. GE should consider doing something similar with Capital in order to separate the banking and industrial businesses.
The Aviation and Power and Water segments are the cream of the crop in terms of the industrial business. Both have very strong margins and long term demand tailwinds. Aviation and Power and Water are likely to continue to grow in value and GE should hold them forever. The same goes for Healthcare, to a lesser extent as it is smaller, but the same kinds of demand tailwinds and margins exist for Healthcare. With our population of aging citizens growing higher and higher each day Healthcare is poised to take advantage of demographic changes for a very long time to come. Margins are great in this business and it will do nothing but continue to grow.
The Oil & Gas segment suffers from falling margins which is hurting profitability long term. The segment is growing by acquiring new businesses which is perfectly fine, but very expensive. However, GE is working hard to make sure it is the leader in this category and ensuring it is keeping pace with new technologies in order to capture long term sources of revenue.
Transportation is a relatively small but very strong line of business for GE. The segment is posting strong gains in both revenue and operating margin and as such, the value of this segment will continue to expand. In addition to world class products in this segment GE derives revenue from annuity-type service contracts that offer GE a long term, stable source of margin.
The HB&S and EM businesses both suffer from the same afflictions; stagnant revenues and low margins. Both of these businesses have seen massive declines in their respective standalone values, according to data I collected, because revenue growth is hard to come by and margins have been terrible. I would like to see GE sell both of these businesses outright and use the cash to either invest in a new business in one of the other segments or return it to shareholders via a buyback or dividend.
So what would happen to GE's consolidated results if the two ugly ducklings were sold? First, according to my valuations, GE would get roughly $5 billion for both businesses combined. The price would likely be different but $5 billion is close enough for this exercise. That would buy back ~184 million shares or pay a dividend of ~49 cents per common share. Either would be worthy additions to GE's total shareholder returns and of course, a combination could be used. Either way, shareholders would be much better off than simply holding these lagging distractions.
In addition, I calculate GE's consolidated operating margin to come in around 15.6% of revenues this year, as seen below.
If GE were to unload the HB&S and EM businesses it would see operating margin increase 150 basis points to 17.1% immediately. This is extremely attractive as GE's remaining businesses would likely be valued higher than they are today as the weakest among them was cast aside. I would love to see GE do something like this and I actually think it's plausible. In fact, shareholders should demand it as it has several benefits for shareholders.
What GE Should Do
Up to this point in the article I've been looking at what I think GE could do with its various businesses. That is, I think GE will hold all segments with the possible exception of the HB&S and EM segments. I believe GE could be coerced to sell those two segments eventually with shareholder pressure. However, what I'd like to see GE do and what I think should happen is GE breaking up the entire company. As I've profiled in my series, I think the sum of the individual parts is materially higher than the consolidated company. I fully understand there are intersegment relationships but those relationships could hold if GE's segments were broken up.
I believe that an announcement to break up the company and simply distributing the businesses' respective shares to existing GE shareholders would send the stock flying. While I'm not delusional in thinking this will happen tomorrow I do think GE is leaving tens of billions of dollars of shareholder value on the table by keeping underperforming businesses and keeping the company consolidated. Each of these businesses could function better with focused management and shareholders of their own to held accountable to instead of simply being lost in the shuffle in GE's consolidated results. In addition, shareholders could pick and choose which businesses they'd like to invest in instead of having to choose the conglomerate or nothing. It would be an arduous process for sure but Altria has proven the process works and it would enrich the executives themselves as well.
Even if GE wants to keep the company consolidated it should still sell the HB&S and EM businesses because they are both poor fits for GE's long term profitability. Both suffer from stagnant or declining revenue and very low margins. By simply selling those two businesses GE could not only improve consolidated operating margins by 150 basis points immediately but also offer shareholders a sizable buyback of shares or a 49 cent dividend per common share. A poll of shareholders would undoubtedly favor this option to simply holding on to lagging businesses that serve only to stifle profitability and distract management.
If I had my jollies GE would break up the entire company into eight pieces (or six if HB&S and EM were sold off). My calculations put the value of this breakup at roughly $40 billion higher than the current market valuation but with a few years' time we could see the value of those businesses soar much as we did with the former Altria companies. That is the model GE should use to unload these businesses to shareholders and I'd love to see it. If GE is looking for value creation, all it needs to do is break up the company. As good as GE is right now it could be so much better as separate entities.