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Summary

  • One segment has underperformed and may be divested. Buyers may be interested, but they'll need a steep discount.
  • Their latest big production does not add value to GE.
  • The product is late to market, solves no compelling customer need, and lasts long enough to eliminate reorders.

GE (NYSE:GE) has a long history of innovation, which is unfortunately matched by a long lead time from innovation to market. The company is attempting to improve on its profitability levels and respond to criticism that it has been unable to respond to the market quickly enough. To that end, the company has begun divesting segments that do not match management's view of the company. Everyone following the company knows about the consumer lending segment, but the appliance segment has gotten less attention. This piece is designed to help investors understand why the appliance segment has underperformed and why we expect that trend to continue. The new LED bulb GE is producing reflects the problems that have afflicted the segment.

The appliances segment has not been the darling of investors. As Asit Sharma points out, the appliance segment had an operating profit of less than 5%. One of the products currently in the pipeline is yet another LED bulb that can be controlled by a smartphone. What's wrong with that?

  1. It's an area several companies have invested in. Competition will reduce pricing power.
  2. There is pretty much no compelling need to have it.
  3. The LED bulb lifetime is long enough that customers have no reason to re-order.

We'll look at each of those issues a little more in depth.

Competition reduces pricing power

The wireless bulbs that GE is producing can be pre-ordered through Home Depot. The problem, as stated in that article, is that they won't ship until fall. Normally, a conclusion that a few months is too long to wait to save money would be met with fierce criticism. This isn't that normal situation. The product is a fad. Being late to market is missing the market entirely. It appears the market is already in full bloom. Here is a search for "wifi led bulb" on Amazon. There is page after page of products that meet the description.

The effects of competition are already clear. GE is reaching this market and already attempting to gain market share by cutting prices. GE might be right to cut prices and sell units, but cutting prices to unload inventory isn't the trademark of a high margin industry. As price competition becomes more intense, the margins may begin to resemble those in monopolistic competition rather than oligopoly. The problem with appliances was low margins. It looks like the new bulb won't be a savior there.

No compelling need was solved

Imagine the nightmare of working in this marketing department in a few years. What problem does the product solve? The original light bulb solved a problem. That was innovation. The new light bulb allows the consumer to turn on their lights. Most consumers already have a device for that: a "light switch." It is (usually) located on the wall of the same room as the light, which puts it within easy reach. Unlike the cell phone, it is very difficult to misplace the light switch.

Is it too much effort to physically move to the light switch? There is a product for that. It's called the clapper, and it was a great fad many years ago. Similar to the light switch, the clapper's remote is hard to misplace, even in the dark. For clarity sake: the clapper is turned on by clapping and the remote is your hands.

Imagine the potential customer. A product without a customer is not a business. Who will need their lights operated by phone? The younger generations are heavily reliant on their phones for everything. However, they are also a generation that has been mired in debt. As The Guardian reported last year, middle-class young 'will fare worse than their parents'. Are these theoretical young customers going to install these lights in their apartments and move them? Would you want to buy a light bulb that lasts 25 years when your lease lasts 6 to 12 months? Perhaps the younger people that moved back in with their parents will be a market, but how kindly will those parents respond to not being able to control some of the lights in their house? Are young home owners the ideal market? That is a small market that may be characterized by better than average financial decision making.

Will the baby boomers buy it? A few might. While the complete dependence on phones seems to be a generational issue, there are plenty of tech savvy mature adults. Of course, plenty is a relative term. These adults have also lived through the era of the clapper. If they bought into fads, they probably have one in storage somewhere. This group might buy into one issue that could be used to market the product: Safety. The ability to control your lights without being home would allow vacationing baby boomers to set their lights to turn on at different times. This could almost be considered a compelling need, but many baby boomers won't be able to afford those vacations. Vacations are a secondary priority to being able to retire in the first place. Remember the false-consensus effect: "In psychology, the false-consensus effect or false-consensus bias is a cognitive bias whereby a person tends to overestimate the extent to which their beliefs or opinions are typical of others." People that regularly read financial publications and prepare for retirement are a very small portion of society.

Do you own a wireless bulb? If you own a similar product, leave a comment about how it has worked out for you. Do you still use it? Do you love the features? If yours was damaged, would you buy it again? There are several options available, so anyone that truly wants this product may already have it.

The LED bulb lasts too long

For argument sake, I could be very wrong about the target market. Perhaps the target market exists in sufficient numbers to create meaningful sales. If that is the case, what is the life time value of a customer? It is whatever profit they can squeeze out of the first and only sale they will have. Consider a potential buyer of this bulb. He or she plans to buy the bulb as soon as it reaches Home Depot. A couple days before buying it they go to a car dealership and purchase a new car. That bulb is going to outlive their car. They may trade their car in not once, but twice before they need to buy another bulb. By virtue of the life of the product, the customer turnover is effectively one hundred percent. A customer that only orders half the bulbs they need on the first visit is akin to a customer at a restaurant choosing one course at a time. It isn't the same as having a continuing demand.

Even if the bulb works perfectly, the customer has no reason to purchase more. Advertising is generally expensed as incurred, but things like "brand loyalty" can provide a lasting value to the company. The cost of customer acquisition through marketing is dramatic. GE can avoid those costs by lowering prices and attempting to lure customers that were educated by other companies, but that brings that right back to the low margins that they wanted to escape.

This production is too late in the PLC (Product Life Cycle)

Just how late is this news? If you search for "wifi bulb" on home depot's website, you will get one hit. It is a product that was already discontinued. It isn't the exact same product, but it addressed the same "need." This fad may already be reaching the decline.

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Image Source

The problems disappear with the segment

If GE is able to divest the segment, these problems won't haunt GE any longer. However, potential buyers will have to price the risk. The price GE can get for its appliance division will depend on the projected future cash flows. Valuing the company with the segment requires estimating the value the company can obtain from divesting it. Even if appliances had a good fourth quarter before the divestiture, the segment may be unable to duplicate those results for future years.

There has been a strong case made for the company to be worth $35 per share. Based on that analysis, the company may be trading at a discount. The best way to unlock that value for shareholders may be to divest segments that no longer fit. Unfortunately, the market value of those segments will still have to account for the same problems that made the segment unattractive for GE. Our outlook for the stock as a whole is positive. However, buyers should beware of placing an attractive value on an unattractive segment. To sell off this department GE may need to accept selling it at a deeper discount than they want to let on.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.

Additional disclosure: The author maintains positions in mutual or index funds that have exposure to large cap US corporations. GE may be included in those funds. All statements are the opinions of the author and are only represented as opinions.

Source: GE Is Divesting, But Some Segments Aren't Worth Much