General Electric: How To View The GECAS News

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About: General Electric (GE)
by: WG Investment Research
Summary

It is being reported that Apollo is working on a deal to buy GE's jet leasing business (GECAS) for $40 billion.

I will dig into the numbers and provide my thoughts on the proposed "deal".

I am long General Electric and I plan to stay long the stock.

General Electric's (GE) stock has been a major disappointment over the last two years, as GE shares are down by approximately 73% over the same period of time when the S&P 500 (SPY) is up 24% (yes, that is 97 percentage points).

Chart GE data by YCharts

I recently described why I thought that the GE Healthcare IPO was meaningful news but, in my opinion, investors should be really excited about the fact that GE will be able to dispose of its jet leasing business, GE Capital Aviation Services (or GECAS), for billions of dollars. To this point, I will explain why the recent news should be viewed in a positive light.

A Potential GECAS Deal

It was reported that Apollo Global Management (APO) was considering bidding for GECAS, which is rumored to fetch a bid around $40B (I will get back to this number later). There have been rumblings about GE selling this promising business dating back to 2016 so I am not the least bit surprised about the potential Apollo deal. However, I was surprised about the $40B that is being reported.

About The Business

GECAS offers aircraft leasing, financing, services, consulting, and, according to the company, this business unit is the world's leading commercial aircraft and engine lessor & lender. And make no mistake about it, GECAS' numbers are impressive.

Source: GE Capital

It's no wonder that GECAS has been considered the crown jewel of GE Capital. Plus, GECAS does not just sound like a good business, this unit has reported strong operating results for years. For example, the unit has consistently reported annual profit of $1B over the last few years.

Source: Bloomberg

Additionally, the unit recently brought in approximately $5B in revenue and only accounted for 26% of total assets (i.e., it's a high margin business).

Source: 2017 10-K

The recent results are just as impressive.

Source: Q3 2018 10-Q

GECAS has only reported revenue of $3.6B so far in 2018 but let's also remember that Q4 is typically the strongest quarter for the company (and this unit).

Lastly, it should be noted that management has consistently highlighted the fact that GECAS greatly benefits from its global operations (from the 2017 10-K report):

A substantial portion of the benefit related to business operations subject to tax in countries where the tax on that income is lower than the U.S. statutory rate is derived from our GECAS aircraft leasing operations located in Ireland where the earnings are taxed at 12.5%.

No wonder Apollo is interested in this business, the tax benefits alone make GECAS an attractive acquisition.

About The Price

GECAS had $40.6B in assets as of September 30, 2018, and the unit reported net earnings of $271M (up 5% YoY).

Source: Q3 2018 Supplemental Report

I created the table below with the data from the supplemental reports for the last few quarters to show the trending of net earnings.

Q4 2018 (estimated) Q3 2018 Q2 2018 Q1 2018 Total
Net earnings $900 $271 $311 $283 $1,765
Q4 2017 Q3 2017 Q2 2017 Q1 2017
Net earnings $1,133 259 $369 $386 $2,147

The takeaway: it is hard getting back to the $40B number being floated for the deal strictly from an earnings perspective but, in my opinion, investors also need to factor in the liabilities that will be assumed by Apollo. Therefore, the $40B appears to be a reasonable figure that works out to a reasonable number from a profit standpoint (after factoring in the liabilities). My rough estimate is that GE will clear a little less than $10B (~5x net earnings) if this deal happens.

GE may not benefit greatly from the sale of GECAS in terms of profit but I believe that shrinking GE Capital and reducing its leverage is enough to proceed with the deal (remember, GE currently needs to focus on its credit rating and overall financial position).

Risks

The biggest risk, in my mind, is that the deal falls through. However, JPMorgan's analyst, Mr. Tusa, also raised the concern that GECAS may not fetch a great valuation due to the type of assets on its books.

Source: Bloomberg

This is a legitimate concern that should be monitored but, at the end of the day, selling GECAS seems like the most logical next step for Mr. Larry Culp, CEO, even if the right valuation is not achievable.

Bottom Line

Mr. Culp appears to be a cut artist and is already making great progress in his goals to streamline operations. GECAS is a great business but that should not hold the company back from restructuring and changing the narrative. Even if the deal only reduces debt by $40B (i.e., "little"-to-no profit from the transaction), it will likely be viewed as a win for Mr. Culp and team - e.g. the stock was up big after the potential deal was announced.

The GECAS sale (if it occurs), coupled with the spins (Transportation, Healthcare, & Baker Hughes), shows that this company is serious about creating a simpler business structure. This is needed. GE is definitely still a 3- to 5-year story, but I believe that the stock is a great long-term investment, if it meets your risk/return profile.

Disclaimer: This article is not a recommendation to buy or sell any stock mentioned. These are only my personal opinions. Every investor must do his/her own due diligence before making any investment decision.

Disclosure: I am/we are long GE. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.