The hedge funds have been nipping away at the heels of managements that they feel should be doing a better job in some way or another, looking for solid if moderate returns on leveraged positions. I offer them the ultimate reward: a stock that should double or even triple if appropriate actions were taken, General Electric (GE). While this would probably be the fight of their lives, there are massive potential rewards that go with it. As well, it would be very a very positive development for American capital markets.
There are three phases in the life of a conglomerate: the growth phase, characterized by a rapid growth rate and a correspondingly high price/book value; the sleepy phase where things sort of go dormant; and finally the pulling apart phase where it turns out that the sum of the parts is worth a lot more than the encased whole. Having lived through and watched with great interest, the birth, growth, sleep and death of a number of conglomerates during my career, I can tell you that the death phase is the most interesting because those hidden values can be liberated so quickly once the rending phase gets under way.
Companies such as Gulf and Western Industries and more recently, Canada’s Canadian Pacific Limited, were once conglomerates that were ultimately broken up. The gains that both groups of stocks made during and following the breakups were excellent. It is a tenet of our own analytical methodology that once companies that have been cloistered get unfettered access to the capital markets, they have a tendency to blossom and using history as a guide, they do indeed. There is no reason to expect that the elements of GE would behave any differently if they were free from the shelter of an overarching corporate structure.
Part of the SAC stock advisory service assembles price structure charts, showing, as I do above, the price/(adjusted) book of GE over the past 25 years. During the growth phase, the price/adjusted book was always 2 times or better, rising to 10 times at the peak of its expansion phase in 2000. As growth slowed and then leveled out after 2004, the market valuation of the stock plunged, at one point in 2008-9 reaching a 40% discount to book. While it has modestly rebounded since then to a maximum of 1.5 times book – and is now slipping again – the intrinsic value of the company as structured has declined because its ROE is nothing to write home about and the stock market is losing interest.
Indeed, as can be easily seen from the graphic, there has been a marked slowing of the fundamental growth of the company from about 12-13% per annum between 1985 and 2005, down to just a little over 1% since that time. Compared to the underlying indices, comparative growth has slowed to a trickle, the book value of the Dow being up roughly 33% and that of the S&P closer to 40%, or 5.75% per annum, while the book value of GE has grown but 12%, or 1.33% per year. In other words, it is tough to blame the slowdown in the company on economic factors when others have managed to come through quite strongly, all things considered.
GE is now similar to a closed end mutual fund of boring stocks: it is trading at a discount and unless I miss my guess, a very substantial discount, to its true underlying market value. One just has to look at other stocks in the industries that GE is in, the valuations that they are currently selling at, consider the leadership that the individual GE companies may enjoy, to realize that there is probably a lot of very un-boring but locked-in value here. Current management seems incapable to releasing that value and in any case, may not be able to do so as the company is currently structured.
One might argue in response, perhaps there are “synergies” that would make the sum of the parts rended into individual pieces actually worth less than the whole. I am sure that there may be a few synergies to be found within that sprawling corporate structure, but all B-school management studies point to the reality that synergies are more often in the mind’s eye of managements, but are few and far between in reality. In any case, many of the companies within GE would have little or no cause to call upon their GE brethren as far as I am able to see.
Others might also argue that this could be a case where I am recommending the premature death of an “American” icon. It is highly doubtful. Of course, that is what GE management would have you believe – and given that Jack Welch himself is still alive, you can bet that he will be in the forefront of fending off any actions taken to pull apart his megalith. I also have no doubt that he would come down hard against anyone or any group that dares suggest such an action be undertaken, pulling out all the stops, tugging at all the heartstrings and flying the American flag if necessary, to prevent such an event during his lifetime. While Welch is very pound of his company, unfortunately, looking back over the past six years, the vibrancy is long gone. The great works at GE are all in the past and while what we see today is a moribund conglomerate which has ceased to create value as a conglomerate. The valuation evidence (in price to book terms) of the past 6 years shows clearly that the value creation phase in terms of creating both growth in book value and growth in market value through agglomeration is behind the company and the break-up phase should now get under way.
In what I thought was a thorough and thoughtful article on GE which recently appeared on Seeking Alpha, Charles (Chuck) Carnevale noted that:
“General Electric is developing numerous exciting advanced technologies. They include sustainable energy, advanced propulsion, nanotechnology, advanced electronic materials systems, molecular imaging and diagnostics and energy conversion. In biosciences, GE is working on methods for removing cancer, growing cells outside the human body and using molecular pathology to change the way we see disease. General Electric is also developing chemical technologies and materials to include the next generation battery for the hybrid age and advanced storage capabilities. In electrical technologies and systems, it is developing technologies, products and infrastructure for electric vehicle integration, integrated circuits that can withstand high temperatures and methods for reining in the sun to bring renewable energy onto the electric grid. In energy and propulsion, it is developing diesel engines and state of the art gas turbine technologies to reduce emissions and operate on a variety of fuels.”
They all sound like interesting developments, but my sense of things is that while all of these may hopefully redound to the benefit of GE shareholders, the impact on the share price of GE overall is likely to far less than the impact on the share prices of separate pieces because of the "cloistering effect" that has now taken hold. I should perhaps also add that none of these exciting events are showing up in the earnings estimates for the next couple of years at least and our own calculation of the intrinsic value of the company based on what we do see does not show anything like the rosy outlook for its stock price growth that Carnevale calculates. Indeed, looking out 18 months from now, I can detect no upside potential for the stock at current prices.
Now, if I were the GE management, what would I do and how might I respond to such a challenge? If it became clear that I was about to lose that fight to break the company up, I might propose that I break it up myself, sell the various current parts, but with the intent of using that cash so generated to buy something else “with more growth potential.” I might do that in order to keep control of that vast amount of financial resources tied up presently in the company and thereby maintain my position in the corporate pantheon. Alternatively, I might respond by agreeing to spin out some percentage of the individual elements to shareholders but keep overall control at the top.
But how might the shareholders make out in such a situation? Poorly, I would suggest, relative to being dealt out the shares in separate companies. There would be some nice cash generated through the sales of the assets but they might then be used to buy up expensive assets in today’s market, creating the potential of wasting market value. So the answer is no. The assets in GE need to be liberated to find their true market value, all of which should flow to shareholders, not held by current management as they have already proven that they are no longer "value-adders." The thing is too large and unwieldy today and substituting other assets for those currently held does not guarantee that anything beyond ego satisfaction would result. The world does not need a massive conglomerate consisting of a mishmash of businesses that only "hang together" in the eye of management. And a partial spinout is more likely to result in a Canadian Pacific outcome where that continued lack of freedom hampered the individual companies until they were ultimately spun out and could operate on their own.
The company needs to be examined independently, the parts assembled into independent units that make strong business sense and them given out to the current shareholders. In other words, what I am really looking for is to have the shares of the various enterprises within GE distributed to current shareholders with no strings attached. List those shares on the proper exchanges and let them run free: everyone will then win. If current CEO, Jeffrey Immelt, did that, whatever Jack Welch would think, to the capital markets, Immelt would retire a real hero.
What’s There to Be Sold?
Appliances, aviation, consumer products, electrical distribution, energy, healthcare, lighting, oil and gas, rail, software and services and water, are all parts of GE. Some companies in the same industries have pretty nice valuations in the stock market these days and there is no doubt that broken into pieces, the shares in the sum total of the GE group of companies would return a very pretty penny indeed once they were allowed to trade freely again in the market and have unfettered access to it as well.
All shareholders will emerge winners, if all of capital markets history is any guide. Shareholders should double or triple their money in a very reasonable amount of time. Wall Street would, of course, enjoy a massive payday. With a market cap of $195 billion, a breakup fee of 3% (+?) would generate nearly $6 billion in fees and perhaps more. Wall Street will be needed for the structuring of the resultant companies which come out from GE and the necessary due diligence will be required in the preliminary work which will be necessary to launch this ‘new’ set of enterprises. Overall, the capital markets of the United States will benefit through the increase in efficiency that will result.
If, as and when this conglomerate is broken up, there is still a lot to do in the field of corporate disassembling. I found, quite literally, hundreds of these things around the world. Once investors began looking closely at many of the others in this class, I would strongly suspect that there are dozens of GEs begging to be taken apart.
What Should You Do?
If you own the shares, get this piece around to every hedge fund and GE shareholders that you know. If the history of "de-conglomerating" is any guide, there is at least a double if not a triple in the total prices for all the parts over the current price of GE by itself. If you don’t own the shares, unless something positive like this occurs, an investment in GE is more or less dead money: little upside potential and a long wait before the company itself generates much excitement. It might bear watching, but certainly not investing in at current price levels.
Disclosure: I have no positions in any stocks mentioned and no plans to initiate any positions within the next 72 hours.
Additional disclosure: Neither I nor my clients have any position in the shares of GE. Indeed, things are so dull that we wouldn’t even bother to be short.