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Summary

  • In Alstom, General Electric is furthering its inorganic growth strategies, while targeting a deal that will (if true) bring immediate accretive benefits to shareholders.
  • Assuming that Alstom will accelerate GE's cash flow margins to return to the low teens, investor should want this deal to happen. All the signs are pointing that it will.
  • With future growth drivers in place, such as GE's strong industrial portfolio and energy infrastructure businesses, these shares should reach $32 in the next 12 to 18 months.

According to Bloomberg, industrial conglomerate General Electric (NYSE:GE) is in talks to acquire Alstom (OTCPK:AOMFF), a company that operates in the power generation and transport markets, for more than $13 billion. Although both companies have yet to confirm the deal, or whether talks have ever taken place, it is believed that within a week, an agreement will come.

Investors now want to know how this deal would benefit General Electric. Even more pressing, how will Alstom, in which French billionaire Martin Bouygues owns a 29% stake, be of any benefit to General Electric shareholders? Note, Bouygues was forced to absorb a $1.9 billion write-down on Alstom due to a 37% drop in its shares over the past year. But as I noted recently, General Electric CEO, Jeff Immelt is not dumb.

Despite undue criticism, he's proven many times over that you can't keep a good company down. He's been working diligently to get General Electric back to its core of industrial strength. And, if rumors are true, I have to trust that Immelt sees Alstom as a way to augment his company's industrial operations.

Recall, despite the recent talking points, General Electric has not performed as poorly as some critics would lead you to believe. GE is relying less and less on its poor-performing businesses like GE Capital. The company is now a more focused operation, which was proven in the most recent quarter.

To that end, in Alstom, General Electric is furthering its inorganic growth strategies, while targeting a deal that will (if true) bring immediate accretive benefits to shareholders. While GE will be placing a strong bet, given that Alstom will be its largest-ever acquisition, the wager is not without merit. And from my vantage point, it seem well thought-out, considering the rate at which Alstom's transport division has been winning orders.

In fact, if it were not for the economic slowdown in Europe, Alstom, which specializes in high-speed TGV trains, would not have lowered its profit guidance, which led to debt-rating downgrade by Moody's. But the slowdown in Europe and emerging markets can't last forever. The company's larger power equipment business should rebound. And this is what General Electric management understands.

Although the $13 billion suggests more than a 25% premium to Alstom's current value, GE understands that if it were not for the Alstom's poor luck, it would have been forced to pay more. And don't discount the possibility that rivals like Siemens (SI) or even Honeywell (NYSE:HON) may have also been interested in Alstom, particularly Siemens, which has had ambitions of growing its presence in areas like Asia and Latin America, and beyond.

For GE, following its recent 12% jump in industrial profits, along with the company's goal of extracting 70% earnings from industrial operations, paying $13 billion seems like a good investment. It fits into Immelt's strategy to focus more tightly on heavy industry. And when you consider that Alstom ranks third behind ABB Ltd. (NYSE:ABB) and Siemens in the power transmission gear market, GE would also be acquiring a stronger position against two rivals.

The way I see it, for a company with $89 billion in cash, spending less than 15% of that cash to further its strategy and outsmart rivals makes perfect sense. From an investment perspective, this stock remains cheap, at around $26 per share trading at a P/E of 21. And when you consider that the P/E drops to 14 on fiscal 2015 earnings estimates of $1.82, there is hardly a better value on the market. Assuming this deal does happen, I project Alstom-accretive benefits to yield an additional 2% to 3% in long-term cash flows.

As I said recently, with future growth drivers in place, such as GE's strong industrial portfolio and energy infrastructure businesses, these shares should reach $32 in the next 12 to 18 months. This is also assuming that Alstom will accelerate GE's cash flow margins to return to the low teens. Investor should want this deal to happen. All the signs are pointing that it will.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Business relationship disclosure: The article has been written by Wall Street Playbook's tech sector analyst. Wall Street Playbook is not receiving compensation for it (other than from Seeking Alpha). Wall Street Playbook has no business relationship with any company whose stock is mentioned in this article.

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