What happened to General Electric Co. (NYSE: GE) – the company, its businesses, its employees, and its shareholders – is sickening.
There is a clear path of failure that GE was led down, and it’s easy to see exactly where the mistakes were made.
Here’s who killed GE and what to do if you own the stock (or want to profit from this icon’s fall)…
The Beginning of the End
John F. Welch, better known as Jack Welch, the man who some call god or guru or genius, ran GE from 1981 to 2001.
When he stepped down, he left the company in an extraordinarily rich position.
Jack, the chairman and CEO that Fortune magazine named Manager of the Century in 1999, at the end of his two-decade run, rewarded GE shareholders with a staggering 2,790% gain while the S&P 500 gained 710%.
His successor, Jeff Immelt, who took the reins of GE in June 2001, should have, would have, and could have broken up the conglomerate. But his ego was too big and his ambition too blind.
Immelt knew, despite Jack’s success at GE, the company wasn’t without its troubles or controversies.
Two things were obvious by the end of Welch’s reign. GE had gotten too big to manage, and Jack was “managing” its earnings.
I never trusted GE’s earnings numbers. How in the world, I always wondered, could GE’s earnings come out within a penny or two of where the company estimated, weeks and sometimes months before they were tallied?
That’s called managing your earnings, and not in the good way.
What Welch was doing was juggling the books to hit the earnings targets he set. While revenue and earnings would probably have ended up where they did in the end, along the way they would have been volatile and often disconcerting to analysts and shareholders.
But they weren’t. They were smoothed out for the sake of meeting or beating analysts’ estimates. They were being ratcheted upward in a smooth and orderly progression, for the most part.
Immelt knew that, and he continued the practice. In fact, anyone who was paying attention knew that.
That’s because the SEC charged GE with accounting fraud in 2009. It settled accusations of its “overly aggressive accounting” which was “false and misleading” for a whopping $50 million.
But it was too late. There’d be no more managed earnings because by then GE wasn’t earning anything like it used to.
Immelt continued to grow all the businesses GE was in, spending recklessly in the process.
When “Too Big to Fail” Isn’t Enough
Jack’s philosophy was that in each business the company was in, it had to be the leader or in the top three of its field.
Whether it was power generation, jet engines, oil and gas, aircraft leasing, commercial lending, retail lending, railroads, appliances, or lightbulbs, GE’s businesses were gigantic.
Too big, in fact. And in the case of GE Capital, they thought they were too big to fail.
But they did fail.
While some of GE’s businesses were struggling with their size, their economies of scale having reached the unenviable heights of diminishing returns because of their size and the cost to manage them, GE Capital imploded in the financial crisis.
Even that didn’t alert Jeff Immelt to what GE’s problems were. All the business units were too big to manage effectively under one roof.
It was too late for GE Capital. The once far-flung and incredibly successful unit, which generally accounted for as much as 50% of GE’s revenue, should have been packaged as a separate business, along with each of GE’s business units. It should have floated as a public company with GE, their nominal parent, retaining a significant share of each company’s equity as a holding company or investment fund.
But that didn’t happen. Despite most big conglomerates breaking themselves up or being broken up by failure, GE didn’t see its future that way.
Jeff Immelt’s ego was too big to dismantle the house that Jack built. He wanted the same acclaim as his predecessor.
We know now how miserably he failed.
Whether it was buying Alstom’s power generation business for $9.5 billion when GE’s own power generation businesses were struggling, or buying back the company’s shares to make the company’s earnings per share look better as actual earnings were falling off a cliff, the magic was dying.
GE’s Ghost of Christmas Future
Now GE’s running out of cash.
Immelt shouldn’t have spent $23.7 billion on share buybacks in 2015 and another $22 billion in 2016 as GE’s stock was falling, as its businesses were weakening, and as actual earnings were tanking.
All that money, which came from selling pieces of GE Capital and other businesses the company wanted to slim down, is gone. Vanished.
What’s not gone, however, are the pension obligations.
GE’s pension covers 231,000 retired employees and is supposed to support the 242,000 employees the company still employs. It’s 30% underfunded (that’s $31 billion short) at present.
Jeff should have put more than $2 billion into the fund during 2015-16 period when he was spending more than $45 billion on share buybacks.
So, what’s going to happen to GE now?
Probably not much. It’s going to have to break itself up and sell off the businesses. The trouble is all the businesses are too big and loaded with too much debt to be interesting to any buyers.
Private equity companies may want some of the pieces, but they’re going to steal them because they know they’re the only game in town.
The bad news for underwater shareholders is that the stock hasn’t seen a bottom. With no one to pay up for businesses, GE’s going to have to sell and the whole company’s equity will keep contracting.
If you still own GE, sell it. If you think it can survive, use some of the money you get from selling your stock to buy long-dated calls, which are cheap now.
If you’re a speculator, short it (and buy some calls in case miracles do happen).
What happened to GE is sickening. This is the end of an American icon. It never should have come to this, but unfortunately, GE isn’t the only iconic company that’s being mismanaged to death.
— Shah Gilani
Source: Money Morning