- GE's Alstom deal makes both strategic and economic sense.
- Alstom’s energy business could be fetched at a fair price, has ample strategic overlap, and could be immediately accretive.
- The deal requires French blessing.
Following its impressive quarterly results and a week of transatlantic media reports, General Electric (NYSE:GE) announced on April 30th that it has submitted a binding offer to acquire Alstom SA's energy businesses (thermal, renewable power, and grid assets) for an equity value of $16.9 billion. The businesses appear to be coming with net cash of $3.5 billion, leading to an enterprise value of $13.5 billion. The acquisition will be funded with $9.5 billion of cash and $4 billion of debt (to be paid down over five years). The deal is expected to close in 2015.
As an analyst with Citigroup recently wrote in his note, the deal makes both strategic and economic sense. General Electric bears should particularly be persuaded that this deal, as a game-changing acquisition, accelerates GE's ongoing portfolio transformation and should drive further rerating/multiple expansion.
GE's investors have also voiced their support for the deal, as the stock surged in price after the news broke out. The deal is consistent with CEO Jeff Immelt's remarks on the 1Q14 conference call on what would constitute an attractive deal. Alstom's energy business could be fetched at a fair price, has ample strategic overlap, and could be immediately accretive. Investors who have been demanding a higher portion of industrial earnings should be particularly happy, as the Alstom acquisition would shift the industrial share of earnings in 2016 to 75%.
If the deal is completed, GE expects $1.2 billion in cost synergies over the next 5 years. Moreover, GE referred to the initial target as conservative, and the company could realize more in cost synergies. In order to drive cost synergies of $1.2 billion, the company will spend $900 million on restructuring efforts over 5 years. General Electric expects the deal to be EPS accretive in year-1 by $0.04-$0.06, and by $0.08-$0.10 in year-2 (2016). Over a period of 3 years, the deal is expected to provide the company $4 billion of incremental cumulative profit.
As mentioned earlier, the deal would be funded by $9.5 billion of cash and $4.0 of debt. General Electric's $13.7 billion cash balance and unlevered industrial balance sheet provides the company with ample financial capacity to fund the deal. GE projects $90 billion of capital allocation capacity through 2016. The company plans to return the majority of it to shareholders through dividends and buybacks, and a larger acquisition would not disrupt its ability to continue with active share buybacks and annual dividend increases.
Although Alstom is a French company, investors must remember that it only has a fraction of its employees in France. It is a truly global company, which sells in the same regions and to the same customers as General Electric already does. The synergies should be huge.
GE Pays Nothing for Future Growth
Looking at the current trends and order books, adding coal exposure, alternative energy and grid capabilities may seem counter-intuitive to many. Moreover, many would say that Alstom is a depressed asset in highly out-of-favor end markets. But that is exactly the point. GE has to pay nothing for the future growth of these assets. The installed base alone is worth what GE is paying for Alstom's assets. However, with this deal, GE gets a free call option of these markets bottoming and global secular trends in power returning to above depressed levels. Moreover, with a mix of coal, gas, and alternative, the conglomerate can now supply the full spectrum.
French Blessing Required
The matter of a U.S. company merging with a French global champion, operating in highly strategic industries would require some potential blessing by the French state. The high-profile and politically-charged nature of the negotiation increases the likelihood that GE would need to make certain political guarantees around employment security and the manufacturing base before completing an acquisition. GE recently mentioned in a statement that the company's CEO, Jeff Immelt, was in France recently to meet with Prime Minister Francois Hollande and Economic Minister Arnaud Montebourg to "discuss potential GE investments in France."
According to latest reports, the French government said it would oppose GE's bid in its current form. France wants GE to alter the terms of its proposed offer, saying it would reject a pure and simple acquisition that would lead to the demise of Alstom. France's economy minister, Arnaud Montebourg, said in a letter to Immelt:
While it is natural that GE would be interested in Alstom's energy business, the government would like to examine with you the means of achieving a balanced partnership, rejecting a pure and simple acquisition, which would lead to Alstom's disappearing and being broken up.
Responding to the letter, GE said that the deal is good for Alstom and France, and that the company is open to further negotiations:
We appreciate the engagement of the French government. We believe our proposal is good for France, for Alstom and for GE. As our letter to President Hollande stressed, we are open to continuing dialogue.
Although the Alstom's Board has unanimously endorsed GE's offer, The French government has the power to block takeovers of French companies citing strategic reasons. According to some analysts, if the deal was to be approved, it is quite likely that GE might be asked to dispose of some of Alstom's nuclear power assets, keeping in mind France's dependence on nuclear technology and domestic interests in the industry. Both Jeff Immelt and Patrick Kron, the CEO of Alstom, were confident during a joint press conference held last week that the deal would be completed.
Alstom has appointed a committee of independent directors to review this binding offer from GE. The committee is expected to reach a conclusion by June 2. In the meantime, the French company may consider unsolicited alternative proposals. A competing bid by Siemens (SI), which is currently conducting a 4-week due diligence, may be in the works. A competing bid by Siemens would likely make the deal more expensive and cause the process to drag on for several weeks. The politically-charged transaction should continue to grab headlines over the coming weeks.
Before the news of GE's bid for Alstom's energy businesses came out, the company reported impressive 1Q14 results. With 8% organic growth, 50bps margin expansion, and progress in the cost-out Simplification Initiative. General Electric started 2014 strongly. The company reported 1Q14 adjusted EPS of $0.33, beating consensus estimates of $0.32 by one cent. This was a fairly clean quarter, with an industrial tax rate of 6% and GE Capital tax rate of 9%.
Industrial margins expansion of 50bps was particularly strong, as the market was expecting flat margins. The strong start to 2014 should help the company distance itself from the disappointing results of last quarter and boost confidence in the company's 2014 operating framework.
Simplification Initiative Making Progress
General Electric, through its cost savings Simplification Initiative, aims to reduce its sales, general, and administrative (SG&A) expenses as a percent of sales to 12% by 2016 from 17.5% in 2012. The company accelerated its cost reduction initiatives and made structural costs out of $250 million in 1Q14. These actions should increase investors' confidence in the company's ability to achieve target of $1.0 billion + of cost reductions in 2014.
I'm long on GE. Alstom's acquisition does exactly what investors have been demanding for a long time. It adds to the global infrastructure part of GE's thesis and marginalizes the remainder of GE Capital. It sets the groundwork for the company to position itself as a pure play global infrastructure company. That is exactly what the company needs to do. General Electric needs to focus on being a premier global infrastructure company if it wants to raise investor interest and regain the glory of the past. GE needs to exit all non-core, non-competitively advantaged businesses. The market has responded positively to the news of the Alstom acquisition, but that does not mean GE should stop its re-focusing efforts. Spin-offs, sales, joint-ventures for non-core assets should continue.
Investors have long demanded GE trim down its financial arm. Exiting its lending business entirely would be the best strategy, as it is unlikely the investors would ever pay a premium for its financial business. However, as the company successfully spins off its North American Retail Finance business, brings down the size of GE Capital and becomes more of a pure-play industrial stock, GE should see further multiple expansion. The company does not have sustainable competitive advantages in lending, and investors are likely to value GE as a pure-play global infrastructure company more highly than in its current form.