General Electric: Thoughts On The 'Reworked' Wabtec Deal

Summary

• General Electric and Wabtec modified their asset merger agreement.
• I believe that both companies should be viewed a winners under the new agreement, but it is a different story for GE shareholders.
• I plan to stay long both General Electric and Wabtec, and I look forward to reading your thoughts about the new deal.
• This idea was discussed in more depth with members of my private investing community, Going Long With W.G.. Start your free trial today »

On January 25, 2019, General Electric (NYSE:GE) disclosed that it modified the terms of the asset merger agreement with Westinghouse Air Brake Tech. (WAB), or Wabtec. After this news hit the wire, GE shares were up almost 4.5% but WAB shareholders were not as lucky (WAB shares finished the trading day down slightly over 3.5%).

Data by YCharts

Shareholders of both companies will be materially impacted by the disclosed modifications to the deal but, in my mind, the market got it wrong, at least in the short-term. To me, WAB walked away with a great long-term deal (majority stake but will have to give up cash in the new future) but I believe that GE (the company) will also greatly benefit from the restructured agreement. As such, GE's management team slapped shareholders in the face by reworking a deal that now directly benefits others more than them (i.e., GE the company and Wabtec are the real winners) but I believe that the slap was a necessary evil.

A Win-Win (For The Companies)

Let's first review exactly how the deal changed:

Old Deal	Modified (or Re-Structured) Deal
WAB shareholders would have owned ~49.9% of the new entity	WAB shareholders will own ~50.8% of the new entity
GE (the company) would have owned ~9.9% of the new entity	GE (the company) will own ~24.9% of the new entity
GE shareholders would have owned ~40.2% of the new entity (and the transaction would have been a tax free spinoff)	GE shareholders will own ~24.3% of the new entity (the transaction will now be considered a taxable dividend)
GE (the company) will receive $2.9B in cash at closing	GE (the company) will receive $2.9B in cash at closing
Deal was expected to close in "early 2019"	Deal will close in Feb. 2019
-	WAB will issue 3.3M fewer shares to close the deal

Click to enlarge

Observations:

• WAB shareholders will now receive a majority stake (win for WAB)
• GE will receive cash upfront and will be able to monetize a larger position in the newly created entity (a big win for GE the company)
• GE shareholders will receive a smaller stake in the newly created entity (a punch in the throat for GE shareholders, if you consider the specifics of the old deal)
• The closing of the deal was pushed up (a win-win-win for GE, GE shareholders and Wabtec)

As you can tell by the observations and additional commentary, I believe that the newly restructured deal is a positive for both GE and Wabtec. However, in my mind, GE shareholders were the real "losers" in this situation if you look at how they would have directly benefited from the old deal. The shareholders would have owned more of the newly created entity under the old deal but let's also remember why GE is even proceeding with these type of asset sales/disposals. GE's new management team is currently trying to show the market that they are able to strengthen the company's balance sheet, while also repositioning it for the future. To do this, in my opinion, GE will need to focus on doing whatever it takes, to a certain extent, obviously, to put itself in a better financial position. This will go along way toward showing the market that the current financial concerns are overblown and that this storied conglomerate can weather any upcoming storms (i.e., an extended Power downturn, potential long-term care reserve builds, pension deficit position, and any SEC fines and/or judgments).

The real slap to the face, in my mind, was the fact that GE shareholders will now be taxed on the transaction. This does not impact me much, as most of my GE holdings are in tax deferred accounts, but I would have to imagine that many individuals are not happy about this change to the deal. The optics of the deal are bad.

The restructured deal, as much as it pains me to say, was in the best interest of the company so I believe that Mr. Larry Culp, CEO, made the right long-term call, even though shareholders can (and should) be viewed as losers under this new deal.

The Path Forward - What Is Good For GE, Is Good For Its Shareholders Too....Right?

Why did GE disregard shareholder's best interest and restructure the deal? It's simple, the new deal gives GE the company a ton of flexibility to monetize an asset/business that was already on the books, if management chooses to do so.

The deal gives GE $2.9B in cash at closing and an interest in the newly created entity that is currently valued at $3.4B (based on WAB share price at the time of the announcement). GE already said that they plan to sell down (i.e., monetize) the $3.4B interest so this transaction gives a company that is in need of capital, a significant amount of capital. The statement from the company's new[ish] CEO says a lot:

“Today’s announcement is a significant milestone in GE’s portfolio transformation. With the increase in GE’s stake in Wabtec, and increased proceeds as we sell down this stake, this transaction will further strengthen our balance sheet and support our de-leveraging plan,” said H. Lawrence Culp, Jr., Chairman and Chief Executive Officer of GE. “The combined business will be better positioned with an improved business mix and enhanced opportunities for faster innovation in key growth areas.”

Notice that "shareholders" were not mentioned in this statement by Mr. Culp. It's easy to look at the details of the old deal and think about how shareholders got shafted (and we did if you look at the direct impact of the transaction), but there is another way to think about it. GE the company is a real winner by getting cash quicker and a larger stake, but this should also eventually benefit current shareholders. How? As Mr. Culp described above, this transaction will go a long way toward strengthening the company's balance sheet and supporting the long-term strategy. Therefore, shareholders will benefit as the company benefits, or at least they should if management is able to do their job (something that has not happened over the past few years).

Think about this. How would you view the new deal if the old deal was never announced (this is definitely hard to do and it is just an exercise)? In my mind, I would be bullish about a transaction that gives me a decent stake in the newly created Transportation company (full disclosure: I already have plans to build a small position in the new company) but that gives GE the company a ton of financial flexibility at a time when it is really needed. If shareholders remember correctly, we did not get to directly benefit at all from the Synchrony Financial (SYF) deal a few years ago.

Lastly, let's not forget that the old deal was structured and announced while the old CEO, Mr. John Flannery, was at the helm. As such, I believe that the structure of the new deal may be how GE handles the other asset disposals in the future. I believe that this new path forward will eventually benefit shareholders, if Mr. Culp turns out to be the right guy for the job.

Bottom Line

For full disclosure, I am not happy about the fact that I will get a smaller stake in the newly created Transportation company. However, I believe that Mr. Culp did what was in the best interest of the company, which, again, pains me to say. Additionally, as a long-term GE shareholder, I was able to eventually put my emotions aside while reviewing the newly restructured deal and view it this way: the new deal is a win-win for Wabtec and GE (the company) and this will benefit me as a shareholder over the long-term because I will eventually have stakes in both of these entities. Wabtec will be able to issue 3.3M less shares for the transaction and GE will be able to pay down debt or utilize the capital in another manner so, at the end of the day, both companies will be better positioned for the future. To me, this sounds like a win for shareholders (yes, the taxable event development is indeed a slap in the face).

Pundits are already saying that GE restructured the deal because the company is "desperate" for cash, which may have some truth to it, but, as long-term GE shareholders, I believe that the newly structure deal should be viewed as a necessary evil.

I know how this will likely play out, but I look forward to hearing your thoughts on this "new deal".

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, WAB, SYF. 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.