On 15 Nov. 2013, GE (GE) announced that it's all set to initiate an initial public offering ("IPO") of its North American retail finance business unit (Retail Finance) as a first step in a staged exit from that business.
The company intends to complete the IPO in late 2014, as it plans to file a registration statement in early 2014. The company wants to issue up to 20% of the equity of the retail finance unit in the IPO. It will use the cash proceeds to further augment the equity capital of the new entity that will take over the business. The company further intends to distribute the remaining interest in the retail finance unit to the eligible GE stockholders in exchange for shares of GE's common stock by 2015 through a tax-free, split-off transaction. The separation of the retail finance unit is subjected to the market conditions and regulatory/tax approvals.
This will be the biggest step of the company towards a future with minimal credit risk. The IPO and share exchange will significantly reduce the credit risk of the company through the curtailment of its large portfolio of financial assets and debt, which during the 2008-09 financial crisis threatened the financial stability of the company. Ever since then, the financial business has been considered as a potential threat to the company's financial stability despite the fact that its financial business is profitable. Its financial business contributed over 30% of its total segmental profits in the most recent reported quarter.
North American Retail Finance business: (normally referred as "U.S. installment and revolving credit")
The retail finance unit provides credit services, which enables consumers to make purchases through a range of flexible financial products including private label credit cards, Dual Card, all-tender loyalty, Flex Loans, and gift cards. The unit also provides payment solutions and care credit. The unit's assets primarily constitute (about 70%) of private level/duel cards. Most of its private label credit cards are issued by the retailers such as Pep Boys, La-Z-Boy Inc. (LZB), Wal-Mart Stores Inc. (WMT), etc.
Retail finance unit's financial assets: (Source: Latest form 10-Q)
The Retail Finance business held assets of over $53 billion at the end of the third quarter ended Sept. 30, 2013. The business constitutes about 20% ($53 billion) of the company's net financing receivables, which stood at $254 billion as on Sept. 30, 2013.
- Credit quality:
The assets of the retail finance unit primarily consist of the private-label credit. Most of the private-label credit card financing is unsecured financing and can only be used for the products and services sold by the retailer.
Internal ratings translated to approximate credit bureau equivalent score* (Source: Latest Form 10-Q)
681 or higher
614 or less
U.S. installment and revolving credit
*The company's internal credit scores imply a probability of default, which it consistently translates into three approximate credit bureau equivalent credit score categories, including:
So, about 14% of the unit's receivables were low quality, weak credits at the end of the last reported quarter.
Due to the restrictions in place under the listing rules, the company provided no guidance on the value of the business to be spun off. The valuation of the planned entity will depend on the amount of debt and equity capital that will be transferred to the entity. More debt will affect the valuations of the entity negatively. The business is very profitable with over $2 billion of profit in FY 2012 and similar profit is expected in FY 2013.
The new entity will be one of the world's biggest providers of private level credit with a much more focused management, as it will function as an independent lender. The amount raised by the IPO will further fuel the growth of the business. For competitors like American Express (AXP), Capital One (COF), Discover Financial (DFS), etc., the new entity will present a much bigger challenge because as a fully focused entity it will focus on the growth of the business rather than to control the size of the business.
So, the separation of the Retail Finance business will be great news for GE investors as it will unlock the valuations and most importantly the growth of the separated business.
Reasons behind the separation:
The company is very happy about the development as the management said at the investor meeting: (referring to the Retail Finance business)
Mr. Keith S. Sherin, chairman and CEO of GE Capital said, "This is the right business for GE to exit," He added: "a good time to exit this business."
The prime reason behind the separation is that the retail finance business does not gel well with the company's industrial business. It does not allow GE to get the true valuation that the company should get as a premier infrastructure company, which is a leading supplier of industrial goods for the industries such as aviation, power and water, energy management, oil and gas, transportation and healthcare. So, the management has been under the constant pressure to spin-off the non-core financial business of the company to a separate entity particularly after the 2008-09 financial crisis.
Another reason behind this spin-off is the focus. Ever since the 2008-09 financial crisis the company is focusing more on the growth of industrial business and downsizing of financial business. The company's financial business is big and complex with hundreds of billions of dollars of financial portfolio maintained by the support of the huge debt. The investors see this as a potential threat to the company's financial stability. So, the de-growth of the company's financial assets has been seen as a positive development for the company.
This negative focus has been the reason behind the muted growth of the financial business, as the investors are always concerned about the huge size of its financial assets. After the planned separation the new entity will not have any such pressure, and the new entity will be able to go after the growth more aggressively.
The creation of the new entity for the company's retail finance unit will be a great and long awaited development for investors, as this will lead to the multiple benefits for the company and investors:
- With this spin-off the company's consolidated balance sheet will look much stronger, as it will reduce over $50 billion of financial assets and related debts from the balance sheet.
- This will reduce the company's credit risk considerably as most of the financial portfolio that will be going to the new entity is unsecured.
- This is an investor friendly spin-off as the company intends to issue the shares of new entity to the eligible GE stockholders in exchange for shares of GE's common stock.
- This spin-off will also unfold the growth in the separated financial business (as explained above).
For GE, it's the last step that will complete the transformation of GE Capital to a leaner and stronger company that can support its industrial business. As said by the management:
"This the final last step, the biggest step remaining in the transformation of the portfolio of GE Capital"
All in all, great news for the investors who are waiting, since long, for any such development. The IPO will be the first step of the company toward an exit from the retail finance business with due completion in 2015 when GE will give the shareholders the chance to exchange GE stock for the shares of the new entity. It will unfold the valuations of both businesses and hopefully will unfold a new growth story in Retail Finance business.
The best thing about the spin-off: The investors will be part of both businesses, as they will be able to participate in both businesses, directly.
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This article reflects the personal views of the author about the company and one must read the offer prospectus and consult its financial adviser before making any decision.