Investors have deserted GE's stock over the last week like draft dodgers fleeing to Canada. The firm's shares fell more than 20% over the five trading days, and now sit near a multi-year low of just below $9, 25% of its 52-week high. Even though GE's financial services operation is only one of many parts of the company, its shares have done much worse over the last year than JPMorgan (JPM) or Goldman Sachs (GS). It is as if GE's large and healthy infrastructure business did not even exist.
The abridged description of the case against GE is simple. The assets of its financial unit, GECS, will suffer from high default rates as the recession undermines the ability of its business and consumer customers to pay their bills. A Deutsche Bank analyst recently wrote that GE Capital has zero value in contributing to the value of the company's stock. His argument is that the unrealized losses on the financial unit's balance sheet are greater than most investors understand. On top of the analyst's report, The Wall Street Journal reported that GE has significant exposure to the failing commercial real estate market. (Watch a GE advert shown during the Super Bowl.)
The company's attempt to improve the fortunes of its financial unit will not be without cost. As Morningstar says, "GE's decisions to wind down its non-U.S. portfolio and shift to higher-quality asset classes is welcome even though these decisions will likely pressure earnings going forward." GE makes the risks of its exposure to the real estate, tight credit markets, other financial firms clear in all of its public filings and readily admits that it may not be able to keep its "Triple-A" credit rating which would drive up its borrowing costs.
But, GE has stuck to its case that it has been careful to tell investors exactly what is going on inside the financial unit. Yesterday, the firm said, "We made $8.6B in financial services in 2008, and we have an excellent franchise that we are restructuring to perform in the current environment. Also, we have an "originate to hold" model that is highly collateralized, so we have a more conservative approach than the U.S. consumer banks."
It is valuable to look at the shares of GE through the eyes of common sense. The company has lost $300 billion of market capitalization in about a year. During the same period, Citigroup has lost $130 billion in market cap. Bank of America has lost $200 billion. Since GE's financial services business is not the majority of its revenue, the destruction of it market value seems extreme. Balance sheet jockeys would say that the trouble the market fears is hidden within GE's asset base and will jump out to eviscerate earnings soon. So far there is no sign that GE will implode because of the state of its financial services receivables or its debt.
GE still has a number of remarkable businesses. The sales at it energy infrastructure business has gone from $19.8 billion in 2004 to $38.5 billion last year. Revenue at GE's technology infrastructure business has gone from $30 billion to $46.3 billion over the same period. The profits at both these segments of GE have gone up at similar rates.
One of the easy knocks against GE is that it board has not kept CEO Jeff Immelt on a shorter leash. He should have been forced out of many of the company's consumer and industrial businesses more quickly. That criticism seems reasonable. Immelt has also hung on to NBCU, the company's entertainment unit. While it does not belong with the rest of GE's businesses, it performance has not harmed the parent. At its worst, it can be viewed as an expensive way to get good seats at the Olympics. Looked at in a better light it bought in $3.1 billion in segment profits in 2008.
GE is not the monstrosity that the stock market has made it out to be. It may cut its dividend or lose its precious credit rating. Its financial service businesses may post large loses. But, it should not trade like a money center bank that the federal government is about to nationalize.
Douglas A. McIntyre
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