- GE is exiting the retail finance business, reducing GE Capital's profits from $7 billion to $5 billion.
- The media has been unclear in notifying the public that the spinoff takes the form of a share swap.
- GE will use the "share swap" proceeds to buy back 5% of all existing common stock.
On Thursday, General Electric (NYSE:GE) filed for an initial public offering of its retail finance operations. Most of the discussion on the topic, in my opinion, has been superficial and incomplete, giving investors only a vague idea of what is going. For instance, most news sources do not even indicate that GE's spinoff of its retail finance operations is not a traditional spinoff in which you receive a certain amount of new shares automatically, but rather, is effectively a share swap in which you must elect to forfeit GE shares in order to receive an ownership interest in the independent retail finance company.
Below, I have included eight questions and answers that I believe are important for current and prospective GE investors to know, and I hope it will be of some use to you in clearing up the confusion caused by vague information issued surrounding the spinoff news.
1. What exactly is General Electric spinning off? GE is getting rid of its private label credit card business. Right now, that business is known as "GE Capital Retail Finance." When it becomes a publicly traded company, it will change its name to "Synchrony Financial" and trade on the New York Stock Exchange under the symbol "SYF."
2. What does Synchrony Financial do? This is GE's private label credit card arm. They run credit cards for businesses like Gap, J.C. Penney, Wal-Mart, Amazon, and so on. In total, Synchrony has 62 million active accounts that finance almost $100 billion worth of sales. Synchrony posted $2 billion in earnings last year.
3. What are the "big picture" implications of this Synchrony spinoff from GE? The point of this spinoff is to continue to decrease GE's reliance on GE Capital. Right before the financial crisis hit, GE Capital was flirting with becoming the predominant source of profits for GE as a whole, contributing 47-49% of the company's earnings at the time. Immelt has stated that the long-term goal is for GE's earnings to be 70% industrial and 30% financial, and the removal of Synchrony Financial is the second big step that GE is taking in that direction after selling off Everbank Financial two years ago for $2.5 billion.
4. Wait, so that's it? After a crisis that temporarily crippled the company, GE is only reducing its financial exposure from 50% of the company to 30% of the company? Well, it's more complicated than that. It's not just the percentage of financial assets on GE's balance sheet that is changing, but the quality of financial assets is changing as well. The GE Capital that will exist in 2016 will be significantly different than the GE Capital that existed in 2007. That is because GE is shedding assets that experience big ups and downs in response to shifts in the broader economy. GE got rid of its risky home loan portfolio two years ago, and now it's getting exiting the consumer credit card business. The business performance with those types of businesses boom and crash along with the broader economy. Now, we need to think of the remaining GE Capital as more of an industrial lender, and the credit quality and demand with that division is more resilient in poor economic conditions.
5. So how many shares of Synchrony Financial do GE shareholders get? This is the tricky part, and has been a huge source of confusion for lay investors because what General Electric is doing hasn't been made clear to the investing public. This isn't a spinoff in the popular understanding of the word; it's not like Kraft shedding Mondelez and giving you a certain number of Mondelez shares for every Kraft share you own. Rather, the Synchrony spinoff is actually a share swap, or exchange of shares. It's essentially a separation of Synchrony from General Electric in which you are allowed to use your GE shares as a currency to buy Synchrony. In other words, you will choose how many GE shares you want to forfeit to build a position in Synchrony.
6. What will the absence of Synchrony from the balance sheet do to GE's profitability? It is going to cause GE Capital's profits to slide from $7 billion this year to $5 billion next year following the exit of Synchrony.
7. What are GE's plans to "plug in" the loss in profitability following Synchrony's separation? Officially, GE said that they will rely on cost cuts, efficiency gains, and buybacks to plug in the difference. But in reality, it's going to be the buyback that is going to be doing the heavy lifting. GE said that the plan is to use the expected funds generated from the share swap to buy back 500 million shares. Right now, GE has slightly above 10 billion shares outstanding. To put it bluntly, GE shareholders are removing Synchrony from the balance sheet and then reducing the number of the ownership pie by 5% so that each dollar of profit that GE generates in 2016 will only have to be divided between 9.5 billion shares instead of 10 billion shares.
8. If GE is going to do a share swap, why not just sell the Synchrony business to a competitor and use the proceeds to execute a buyback? Sometimes, it can be easy to forget how truly enormous GE Capital's operations are. GE Capital is so large that it would become the fifth-largest commercial bank in the country if it existed in its own right. Speaking specifically of Synchrony, it generated $10 billion in net interest income over the past twelve months. The only institutions big enough to buy Synchrony would probably run into anti-trust problems. Letting Synchrony stand on its own is the only practical way to remove the private credit card company from GE's balance sheet.
Because we are just at the filing stage, the specific terms of what you must give up to acquire Synchrony shares are yet to come. From a strategic point of view, this spinoff is well-timed because we are at the top of the business cycle, a time in which consumer credit operations typically fetch the highest valuations (that is to say, people are a lot more willing to pay 10-15x profits for a credit label issuer in good times, compared to a 2008-2009 type of situation in which you'd be lucky to get a third of that amount). Additionally, this could allow General Electric the opportunity to trade at 20x profits in normal economic environments, as its high-quality industrial operations would become the predominant source of profits and the remaining financial operations on GE's balance sheet will be even more recession resistant. Whatever their flaws preceding the crisis, GE management seems to be acting opportunistically and intelligently now.
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.