General Electric Company (NYSE:GE) continues to remake itself. On Monday, GE announced that it was making a $1.06 billion purchase from Thermo Fisher Scientific Inc. (NYSE:TMO), to acquire several of the latter's businesses to go into GE's life-sciences division. Thermo Fisher put these businesses up for sale last year in order to expedite European approval of its pending $13.8 billion acquisition of Life Technologies Corporation (NASDAQ:LIFE) which it agreed to buy last April.
The justification for GE's acquisition was explained by John Dineen, chief executive of GE Healthcare: "Life sciences is one of our strongest and fastest-growing business areas, driven by the world's demand for improved diagnostics and new, safer medicines."
The deal "helps GE with its stated ambition of moving into high-tech, high profit margin areas of the market."
According to the Wall Street Journal, this was the third biopharmaceutical acquisition for General Electric in the last three years.
Note that GE does not manufacture pharmaceuticals "but makes technologies and machines that produce drugs." It is a growing space, but Mr. Dineen stated that the area they are working in within the life-sciences space is a "small industry." Although GE might do additional deals in the future, given the size of the industry "assets don't come up for sale frequently."
The new assets acquired produced about $250 million in sales last year. This will be added to about $13 billion in revenues from the GE healthcare business over the first nine months of last year. Profits during the period from this area amount to only about $2 billion.
It is interesting to hear the justification for the acquisition. Life sciences "is one of our strongest and fastest-growing business areas," and the fact that this is a fast growing area worldwide. But, it is also a "small industry."
General Electric is in the midst of a re-structuring. And, it is a very diversified conglomerate. Yet, I still don't get a real sense of the picture it has of itself for the future.
It is doing some good things. For example, it is getting rid of a good portion of its finance subsidiary, GE Capital. Jeff Immelt, CEO of GE, would like to reduce GE's reliance on its finance wing from 45 percent, recently, to about 30 percent. At one time before the Great Recession hit, General Electric was earning well over 50 percent of all of its profits from GE Capital.
Standing alone, GE Capital would rank as the fifth largest commercial bank in the United States…that is how large the commitment GE made to finance in the past.
I applaud GE shedding its finance wing. This is a very good move.
But, I am not sure that GE has its strategy all together yet for the rest of the company and that is why I am worried about the rationale for the current acquisitions.
Before the Great Recession hit, GE was earning more than 15 percent on equity. This is an important measure for me. From 2003 through 2008, GE's return on equity varied between just under 20 percent to just above 15 percent. In 2008, the figure was 17.3 percent…quite respectable.
I focus on these numbers because I believe that a company that has a return on equity of 15 percent of more exhibits some kind of comparative advantage. And, if it continues to earn 15 percent or more for five or more years it has a sustainable competitive advantage. GE achieved this.
However, something was not quite right. Investors apparently did not believe that GE was using its retained earnings well…an important criteria for some value investors, like Warren Buffett, in their investing. As a consequence, GE stock went nowhere from 2002 through the middle of 2008. It basically flat lined. This can be taken as a sign…something that Microsoft (NASDAQ:MSFT) shareholders have been dealing with lately.
Then, the Great Recession really hit GE hard. Return on equity dropped to 9.7 percent in 2009 and, although it has moved upwards since, it still only reached 13.5 percent in 2013, and the stock once again flat lined…but at a lower range. The future performance of GE's return on equity does not look much better. Reducing the financial wing of the business is supposed to help this substantially. But, better overall performance will require more.
Investors do not seem to believe that GE…and Jeff Immelt…have a clear picture of where they are going in the future...how GE might return to an organization that has re-gained its competitive advantage.
For one thing, it is hard for any conglomerate to produce results over time that put it in the class of those organizations that achieve a competitive advantage. Historically, conglomerates have not been among our better corporate performers.
General Electric did it in the past by rigidly adhering to a strategy that only kept subsidiaries that earned at least a 15 percent return on equity and that had a leading market share within the markets where they operated. Especially when Jack Welch led GE, he was ruthless when it came to adhering to these standards. That was how the company as a whole was able to sustain an overall return on equity that indicated that the conglomerate was earning more than just its cost of capital.
At that time, GE emphasized that it would only get into industries that it could take a leadership position in performance, return on equity, and market share. And, this position needed to be sustained. GE would dispose of any firm that was not able to achieve this. Although GE did not adhere to this 100 percent, this objective was the driving force within the organization.
One does not sense anything like this in the current management. In the year 2000, GE was posting a 24 percent return on equity. Jack Welch left in 2001; ROE began to steadily decline.
My question is, can the current management of GE get its return on equity back over 15 percent and can it sustain this return over the next five to seven years. Unfortunately, I don't get any feel for the fact that GE is looking for something like this in their new acquisitions. We hear that life-sciences are "one of our strongest and fastest-growing business areas." However, it is a small industry.
Nice…but, are the retained earnings going to purchase these businesses covering their opportunity cost of capital. Should these funds be used elsewhere…like paying more dividends…or buying back GE stock. Looks like GE is going to be satisfied with a growing firm in a "small industry" where it cannot scale results.
Conglomerates, in my mind, don't have a good chance of succeeding anyway, especially in creating competitive advantages. To me, it is highly unusual if a management team can allocate capital to a bunch of unrelated businesses better than the financial markets can.
There are exceptions to this rule, but the tone of the announcements put out in transactions, like the one discussed in this post, does not lend much confidence to the possibility that GE, as it is currently being run, is an exception.