Back to the Future: GE’s Retooling into an Industrial Powerhouse
Signaling the end of a
chapter when financial risk was rife, General Electric has announced it’s
selling off the bulk of GE Capital, divesting out of the financial-services
market within the next two years. While many in the general public may still
think of GE as an industrial company that makes jet engines and CAT scan
machines, GE had in fact ballooned into a major player in the finance sector.
During the financial
crisis, GE took a huge hit, even getting a large government bailout. Afterward,
federal regulators enforced stricter guidelines for financial institutions that
they deemed too big to fail. GE fell into that category. While the significance
of such a move is not obvious to all, the massive slimming down of GE Capital
is one of the foremost examples of how the increased scrutiny of federal
regulators is forcing big financial institutions to take a hard look at
themselves.
With the shedding of
GE Capital, the manufacturing giant is returning to its industrial roots, say
Wharton experts. “GE is the largest single diversified conglomerate and it’s
now moving in a new direction,”
What’s
the Deal?
GE Capital includes
real-estate assets spanning the globe, a $74 billion U.S. commercial lending
and leasing business and a $16 billion sponsor finance unit, which lends money
for private-equity buyouts.
The idea of a sale has
“been under discussion for a long time. It was better for GE to wait to get a
good price and it’s been worth the wait,” says Useem, who is also director of
Wharton’s Center for Leadership and Change Management. He adds that GE’s board
of directors include John J. Brennan, former CEO at Vanguard, who brought the
discerning perspective of an
institutional investor.
In an interview with
CNBC, Jeffrey Immelt, GE’s chairman and CEO said, “The wholesale financial
model is tougher and we’re disadvantaged from the banks.… It’s the perfect
market to sell financial assets. There’s slow growth, low-interest rates, lots
of equity, people searching for yield.” Private equity firms and banks are
looking for wholesale financing opportunities, itching for higher returns with
low loan-to-deposit ratios.
Lawrence Hrebiniak, Wharton emeritus management professor,
notes, it was “a whole different world in the 1980s and 1990s. Going forward,
Immelt has realized that GE, being of large financial size, is very risky and
the financial crisis has shown that.”
In one of the first
deals announced, Blackstone, the largest real-estate private equity firm in the
U.S., and Wells Fargo agreed to buy GE Capital’s properties in an exclusive
$26.5 billion deal. Most of GE Capital’s real-estate assets include office
buildings, rental homes and shopping malls around the world. In a fast-moving
campaign, code-named “Hubble,” JPMorgan Chase shepherded the deal along in six
weeks of frenzied meetings. John Percival, a retired finance professor at Wharton and executive education
consultant, says Immelt was “waiting for the right buyers to pay the right
price. Things have gotten better in real estate markets and it seemed like the
time is right.”
“It makes sense to
sell [the real estate] all at once to a major firm like Blackstone,” adds Susan
Wachter, a Wharton real estate professor. “No one has better access to global
capital than Blackstone. With a very large deal like this, the transaction
costs of selling piece by piece would be high. GE Capital probably didn’t want
to get into different competitions with having people second-guess if they’re
getting assets at the right price.”
And there’s no better
time than now. Wachter adds, “The market is very strong. GE is selling at a
time with low interest rates and high asset prices.” The Feds are expected to
raise interest rates by the end of the year.
Moreover, there’s been
“big applause from large equity stockholders with a pop in share prices” after
the announcement, says Useem. When the deal was publicly announced, GE’s stock
jumped up almost 11% to $28.51 a share, the highest level since the financial
crisis. The company plans on returning a total of $90 billion to shareholders,
including $50 billion in stock buybacks as well as bringing $36 billion in cash
back from foreign accounts, incurring a $6 billion tax penalty. Hrebiniak adds,
“Investors are happy now. Since Immelt took over in 2001, share prices have
fallen by 38%.”
Going
Back to Basics
In shedding its
finance arm, Useem notes, GE is returning to its roots, when the company was
founded by Thomas Edison to manufacture the lightbulbs he invented. GE only
started getting into the business of loaning money so people could buy the
company’s household appliances during the Depression.
When the industrial
company first began to expand its financial services in the 1980s, it did so to
bolster profits as it faced fierce competition from manufacturers, especially
in Asia. “Management decided GE was going to be more of a service company
instead of sticking to stodgy manufacturing,” Percival explained. “GE had a
services industry, but it was all associated with GE products. They expanded
into other financial services that went beyond GE products. They got into
movies, theme parks, broadcasting and all sorts of other things” that faced
less competition than manufacturing.
GE Capital had an enviable
triple-A credit rating, higher than most banks, which meant that it could
borrow more money at cheaper rates than many other financial institutions
around. And since GE wasn’t exactly a bank, and not subject to federal
regulatory standards, it became more of a shadow bank. This in turn, translated
into hefty profits for the entire company, contributing up to 60% of GE’s
earnings in its heyday. “It sounded like a wonderful marriage,” Percival notes.
“They had a manufacturing business with strong balance sheets — steady but low
profits. And a financial services business that would provide growth potential.
It worked wonderfully for a long time. However, in a marriage, when one party
grows and the other becomes stagnant, the marriage becomes dysfunctional.”
Lucrative profits
don’t come so easily anymore for those in the financial market. In the last
quarterly earnings report, GE Capital brought in 25% of the company’s earnings.
“GE Capital has been fairly profitable. You might wonder why they want to get
rid of a profitable unit, but the company wants to be seen as an industrial
company. There are too many questions about risks and too many government
regulations,” explains Hrebiniak.
Moreover, under the
2010 Dodd-Frank Wall Street reform legislation, GE has been designated as a
“Systematically Important Financial Institution,” or Sifi. This means that the
government deems GE Capital too big to fail — therefore, it must retain a large
amount of capital on its balance sheets, which could reduce profits. GE then
falls under the scrutiny of the Financial Stability Oversight
Council (FSOC), which forces the company to comply with tighter
regulations.
“GE Capital is a
victim of Dodd-Frank, which increased oversight of large financial
institutions. Immelt wants out from under Dodd-Frank and for the government to
leave GE alone,” says Hrebiniak.
When the 2008
financial crisis hit, the company got a bailout of $139 billion in
government-guaranteed debt, after GE Capital grew into one of the biggest
mortgage insurers in America, dabbled in subprime mortgages and involved itself
in other risky short-term deals. With the sale of the majority of GE Capital,
the company is expected to get out from under the onerous Sifi designation by
next year. Percival notes that Immelt “never had the same feeling about the
financial services business that previous management had. Even if he didn’t get
the Sifi categorization, he would’ve reduced the size of GE Capital
substantially.”
Other non-banks, like
MetLife and Prudential Financial, are also categorized as Sifi. Currently,
MetLife is arguing against the designation in federal court. However, other
institutions are more hemmed in than GE, which has a robust manufacturing unit
to fall back on. MetLife’s options are limited, says Hrebiniak. “GE has lot on
the industrial side. They have something to go to.… MetLife is basically
insurance. What are they going to do? They certainly can’t divest into jet
engines.”
If it isn’t able to
shake off the designation, MetLife may also try to break up. Credit Suisse
analysts suggest separating the international unit from the domestic business,
according to The Wall Street Journal.
Back
to the Future
Unlike other financial
organizations, GE only has to remake itself into what it once was. “It’s an interesting
story about a company that came full circle,” says Percival.
Immelt said in The
New York Times that he wants GE to be seen as an “industrial company …
with more growth, more focus and less risk.” By 2018, he wants more than 90% of
the company’s earnings to come from its industrial products and services. The
company will maintain a small financial services arm, but only for loans to buy
its own products, like the old days.
“Last year, the
industrial sector contributed 58% of GE’s earnings. Immelt wants domination in
the industrial sector again,” Hrebiniak says. “He wants to bring the company
back to the days of invention … back to the future, if you will, with products
that you can touch and feel. He’s betting on the future of industrials with greater
margins and greater returns. This will increase the valuation of the company.”
In the past six years,
GE has started up 20 new plants and hired 16,000 new employees. GE plans to
invest $5 billion into the oil and gas sector annually. Meanwhile, GE is negotiating
a deal to buy the Alstom energy business, based in France, for $14 billion as
it negotiates with the European Commission’s competition concerns.
GE will focus on the
growth areas that it already has a vested interest in. “Health care is a growing
business all over the world. Emerging economies have a growing energy sector,”
notes Percival. “He’s putting all the eggs in the industrial basket,” adds
Hrebiniak.
http://knowledge.wharton.upenn.edu/article/back-to-the-future-ges-retooling-into-an-industrial-powerhouse/
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