My 2 Concerns About General Electric's Synchrony Spin-Off

Jul.30.14 | About: General Electric (GE)


General Electric intends to repurchase stock with the proceeds of the Synchrony share swap, and GE does not have a great track record of repurchasing stock.

This spin-off has an element of "throwing the baby out with the bathwater" to it, as the consumer private label credit card division is a sturdy cash cow.

These concerns are hopefully offset by the strong industrial business that is growing by 8% annually, and the slightly low dividend payout ratio that sets the stage for dividend growth.

Before I dive into this article, let me establish my frame of reference first: General Electric (NYSE:GE) is an excellent company with an industrial division that is growing by 8% annually, the company has a backlog of work to do that is in the hundreds of billions, and it is entirely reasonable that long-term shareholders will achieve a dividend growth rate in the range of 10% annually over the next five or so years as the company continues to increase its payout ratio steadily following the dividend cut during the financial crisis.

With that out of the way, I'd like to share with you two concerns I have about General Electric's upcoming plans to remove Synchrony Financial from the corporate umbrella, first in a 15% public offering and then in a stock swap that will follow sometime next year.

My first concern deals with the fact that General Electric plans to use a significant part of the proceeds to repurchase its own stock:

Proceeds from the public offering will remain with the new company and be used to build out its infrastructure as it prepares for the final break from GE, the company said in November…GE said it plans to make up for the spin-off's impact on earnings per share with cost cuts and efficiency gains at the industrial businesses as well as share buybacks.

It seems fair to worry about the fact that General Electric plans to use the proceeds from the share swap to buy back its stock, given that General Electric does not have a particularly impressive record when it comes to reducing its share count. GE does many things well, but it is no Exxon (NYSE:XOM), IBM (NYSE:IBM), or Wal-Mart (NYSE:WMT) when it comes to steadily declining share counts. In fact, the last time we saw GE taking great strides in reducing its share count came during the 2005-2007 stretch, when the total outstanding shares decreased from 10.48 billion to 9.99 billion, right before the financial crisis hit and GE had to balloon its share count back up to 10.66 billion because the company was buying back stock with money it should have been using to bolster its Tier 1 Capital Ratio at GE Financial.

We've had five years of economic growth and rising stock prices: Is this really the time that we want to receive news that General Electric intends to repurchase billions of dollars of company stock with Synchrony Financial proceeds from the swap? The danger with stock buybacks has always been that companies tend to repurchase stock when they are most flush with cash during good economic times (and with the higher stock prices to prove it), and this could be setting the stage for buyback mistiming.

The best counterargument to my concern? You could argue that General Electric is only trading at 15x current earnings, and therefore, you don't have the kind of apparent overvaluation that existed in 1999, 2000, and 2001 when General Electric was buying back its own stock despite an annual valuation that oscillated between 30x and 40x profits. So even if a correction and/or recession lurks on the horizon, a mistimed buyback does not carry the same risk it did fourteen years ago.

The other concern is whether General Electric is discarding the wrong asset from the GE Capital portfolio. This share swap will make General Electric 75% industrial and 25% financial once the Synchrony swap is finished, and while that's generally a good thing, it seems that GE may be axing off the most reliable branch of GE Capital. The consumer private label credit card division is going to pump out $2 billion in profits this year, and it wasn't the reason why GE ran into trouble back into 2008.

Rather, it was the fact that GE had a troubled real estate portfolio with toxic loans that became exposed right at the same time that GE Financial's Tier 1 Capital Ratio became dangerously low. Choosing to release Synchrony Financial, a reliable cash cow, smacks of throwing the baby out with the bathwater.

General Electric seems to be making it hard on shareholders by not just spinning the shares off outright, so that shareholders could continue to own an excellent industrial business and receive a cash cow financial company as well. Instead, the swap forces investors to decide between the two. The redeeming thing about General Electric is that the industrial business is so strong, with its 8% annual growth and hundred-billion dollar backlog, that it can afford to deliver satisfactory returns even in spite of a potential botched buyback or the release of a high-quality financial asset. General Electric is still a buy-and-hold stock, and will likely deliver great long-term returns, but the structure and plans of the Synchrony Financial spin-off adds a couple warts to what should otherwise be an unblemished recovery story from the financial crisis.

Disclosure: The author is long GE. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.