The light dims at General Electric
Once the world's largest company, GE's disastrous exposure to the banking crisis is now a major threat to its future. Stephen Foley reports
Thursday 26 February 2009
Thomas Edison will be turning in his grave. On his invention of the electric lightbulb and other innovations sits one of the world's biggest, most historic and best respected companies. For the humble lightbulb, through cookers and fridges, to jet engines, medical scanners and nuclear reactors, it is famous throughout the globe for the tradition of inventiveness infused by its legendary founder.
If an American owns just one share, chances are it will be General Electric. It is the only member of the Dow Jones Industrial Average to have been a member of that index for all its 113 years. Millions rely on its stock for its dividend income; the company's bonds are the bedrock of any conservative pension plan; its chief executive – Jeff Immelt now, like Jack Welch before him – is a kind of business guru for the nation.
And yet there is a cancer at the company's heart. From beginnings in the Great Depression, when GE started offering loans to customers so they could afford its appliances, its finance arm has grown to the point that it accounted for more than half its bottom-line profit in 2007. Thanks to the solidity of the rest of the business, GE was able to raise cheap debt that it lent out to businesses, property speculators, homeowners and credit card borrowers the world over.
There was nothing inventive about that particular money-go-round. Sadly, there is nothing surprising about the pain that GE is currently suffering, now the credit bubble has burst. As GE Capital undergoes an intensive dose of chemotherapy to bring it back under control, GE is sicker than ever.
Mr Immelt is struggling to hold together the competing interests of bondholders, shareholders and GE's own businesses, which had hoped to make big investments in profitable new areas such as wind turbines and other renewable energy projects. It looks like something is going to have to give.
For the past week, analysts on Wall Street have been combing through GE's annual report and coming to the conclusion that the collapse in GE Capital's earnings will force the parent company to cut its dividend – a seismic event for a company with an army of small shareholders – or face losing the gold-plated AAA credit rating on its bonds. One analyst, Deutsche Bank's Nigel Coe, even suggested the parent company may have to pump more money into GE Capital to keep it solvent, something head office denied. The cost of insuring GE's bonds against default soared to more than even Citigroup's, and the shares plunged into the single digits, down to about $9 apiece, for the first time in 13 years.
"GE is such a popular share because the company is so diverse, it reflects the economy globally and investing in GE is like investing in the market as a whole," Daniel Holland, an analyst at Morningstar in Chicago, says. "Of course, a lot of the profits for GE, like a lot of the profits in the world, were generated by its financial companies, and it looks like GE had a little too much to drink at the party."
In April last year, GE shocked the stock market with a profit warning, less than a month after Mr Immelt had given an up-beat presentation to invest-ors. The culprit then, as now, was the spiralling losses on commercial property held by the finance division, and the incident led analysts to question whether head office had a proper grip on the problems at GE Capital.
Inevitably, those problems have only got worse, and analysts are increasingly fearful about a full-on meltdown of the commercial property market this year, as mortgages come up for refinancing and some of the world's biggest buildings might end up having to be sold. Meanwhile, GE Capital is still sitting on personal loans and residential mortgages from the UK, France, Australia and elsewhere, whose future profitability is uncertain.
What you can say in GE's defence is that it did not plant the sort of timebomb under its finance division that sat under many of the world's biggest banks and insurers, which chased after complicated mortgage derivatives and credit default swaps and now find themselves with billions of dollars in losses that they are still struggling to understand. Nonetheless, it is scrambling to bring the business back down to size and labouring under the intense problems in the credit markets, where a lot of its short-term funding came from. It has had to avail itself of the insurance provided by the federal government so it can refinance GE Capital's borrowings; GE used a $15bn fund raising from Warren Buffett and new shareholders last year to plump up a cash cushion; and the dividend that GE Capital used to remit to the parent company has been slashed.
The company's problems don't stop there: there's a hole opening up at the head office pension fund, whose collapsing portfolio of stock market in-vestments has turned a $14bn surplus into a $7bn deficit, and the low-margin consumer and industrial division is still within the company (after failing to find a buyer last year), threatening to drag earnings lower. "Deterioration in GE Capital's business or a further capital injection could strain cash flow and make it difficult to sustain the dividend," says Stephen O'Neil, an analyst at Hilliard Lyons. "GE's board had previously signed off on management's plan to maintain the dividend through 2009. However, after approving the April dividend, it then indicated it will review payments in the second half of the year."
With the Obama administration's economic stimulus plan promising investment in the infrastructure for renewable energy, a business that GE is shooting to dominate, there could be big opportunities for growth, if only the conglomerate had the cash to invest in manufacturing. The black hole at GE Capital means it may have to forego some of the opportunities, with knock-on consequences for earn-ings growth.
Or alternatively, there is the bond rating that could be jettisoned, al-though a bout of speculation about a GE downgrade in 2005 sparked turmoil in the credit markets, making such a move potentially even more explosive than a dividend cut.
Morningstar's Mr Holland, though, questioned the value of maintaining the AAA rating at all costs, if the financial markets are ignoring it anyway.
"GE issued a number of bonds in January at about a 7 per cent interest rate. That compares to about 5 per cent on a 30-year mortgage so, goofily, the company is being asked to pay more than an individual buying a house. Let's put it this way: there's not a lot of respect."
Global giant: GE's many parts
2008 revenues: $38.6bn (2007: $30.7bn)
2008 profit: $6.1bn (2007: $4.8bn)
From oil wells to wind turbines, GE's energy infrastructure business spans the globe and spans the ways that we produce energy. Also included in the division is equipment for water treatment.
2008 revenues: $46.3bn (2007: $42.8bn)
2008 profit: $8.2bn (2007: $7.8bn)
Includes many of GE's fastest growing businesses, from manufacturing of medical scanners and testing equipment, to cutting-edge aircraft engines.
2008 revenues: $67.0bn (2007: $66.3bn)
2008 profit: $8.6bn (2007: $12.2bn)
During the credit market boom, GE Capital grew to be the group's most profitable division, offering comm- ercial loans, mortgages, insurance, credit cards and other personal loans, all around the globe.
2008 revenues: $17.0bn (2007: $15.4bn)
2008 profit: $3.1bn (2007: $3.1bn)
GE is also one of the world's leading media and entertainment companies, spanning film, television, news, sports and special events.
Consumer & Industrial
2008 revenues: $11.7bn (2007: $12.7bn)
2008 profit: $365m (2007: $1.0bn)
From its familiar light bulbs, washing machines and toasters to the latest advancements in consumer technology, the historic core of the business has shrivelled in importance as the rest of the conglomerate has grown.
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