Friday, April 27, 2007

CitiGroup Analyst Calls for GE Breakup

Last summer, I wrote this post regarding the reasons why GE should not exist in its current state as a conglomerate. As has happened with some other early predictions of mine, now others are coming late to this party.

Now a CitiGroup analyst has published a call for breaking up GE by spinning off its finance, real estate and media assets. He provided estimates of the value of each of the units apart from their current parent, such that the separated values sum to more than the current value of GE's stock.
Last August, I wrote,

"The days of Thomas Edison's end-to-end electrical system supply enterprise are long, long gone. I contend that each of these business units, and perhaps even more, at lower levels, could be spun off independently, to GE's investors' benefit. It's hard to believe that this collection of such different businesses can realistically derive value from being in a common corporate domicile, let alone generate excess returns because of that common home to pay for the lush compensation of the various senior executives.I can't see any downside to breaking up GE into its component businesses. Does anyone else?"

Clearly, I am no longer alone in this view, although I articulated it in detail eight months ago. Similarly to how Warren Buffett recently echoed my thoughts on Dell, discussed in this
post, and the business media took six months or more, last year, to echo my own views on GM and Ford, first posted in this blog in the fall of 2005, now there's the beginning of a drumbeat to dissolve GE into its more sensible, constituent parts.

For what it's worth, the CitiGroup piece merited an on-air acknowledgement and discussion by no less than David Faber, a CNBC reporter. CNBC, of course, is owned by GE, so Faber had to be, and was, very guarded in his remarks.

On the plus side, he explicitly acknowledged GE's dismal performance under Immelt. Then, he inexplicably, and with a straight face, intoned that 'some say' Immelt has actually performed even better than Welch at the helm of GE. I have absolutely no idea how Faber would justify this, and he didn't try.

However, he went on to essentially note that Immelt has said the company won't be split up, so, there. No matter what anyone else says, Jeff likes being paid tens of millions of dollars per year for not providing shareholders even as much as the better-diversified return that they could get in the S&P500, let alone a better actual return under his term as GE's CEO. However, Faber did end his piece by opining that, if the company's stock price doesn't begin to move, relative to the S&P, by year's end, Immelt's job and GE's structure could begin to be in danger. As I've noted in prior posts, I'd love to see a wolf pack of private equity groups do to GE what the European bank consortium is now attempting to do with ABN Ambro- buy it and break up the pieces to add more value among the hunting partners.

Earlier, on CNBC's Squawkbox program, Joe Kernen, one of the co-anchors, and typically very sensible, had read aloud the Citi analyst's estimated business unit values on an as-separated basis. He then asked, to paraphrase,

'well, if we know what the pieces should be worth alone, why is it necessary to split them off? why can't we just have GE's value reflect them?'

It's actually a fair question. Since the values are different, there must be reasons. Here are two that have occurred to me in the past.

First, astute observers realize that these units would behave differently, and probably more competitively and aggressively, if they had not corporate safety net, let alone had to vie internally for investment resources. Thus, on this basis, their different behavior and, probably, performance, would justify a different value.

Second, these units are currently saddled with a sort of corporate "tax" by Immelt and his royal court. Do you think Immelt actually adds value to any specific business unit personally? Doubtful. So, in essence, Immelt, his staff, headquarters operation, and all of the ponderous GE administrative overhead is paid by a tax on the operating earnings of the various GE units. Spin off a unit, and it instantly has more net income, and probably less meddling, time-wasting activities directed upward to the GE corporate staff.

For the record, here is a passage from Immelt's prepared remarks at GE's annual meeting this week, as reprinted in the Wall Street Journal,

"You can only believe one thing if you run GE or own GE stock: consistent earnings and cash flow growth, with expanding returns, increase shareowner value. This is a long-term investment. There are no short-term tricks.

The last few years have been frustrating for all of us. Your company has performed. Our five-year earnings growth rate of 11% matches our performance over the past 25 years. Our total shareholder return was 9% in 2006, 10% over the past three years and 2% over the past five years. But we have under performed the market.

Our challenge is one of historical valuation. GE's PE ratio was 31X in 2001, a 50% premium to the S&P 500. Today, our PE ratio is 17X, equal to the S&P 500. This is a function of a broader market sentiment away from "safer" mega-cap stocks and investors' desire to see GE perform consistently as we changed our portfolio.

We will continue to perform. We may have been over valued at 31X earnings, but we are not today. Our stock should reflect our double-digit earnings growth rate in the future. As we continue to execute, our valuation should improve as well. This is the best time to own GE stock.

I am compensated to meet with your expectations as long-term investors. Approximately 20% of my compensation is in base salary; 60% is at risk based on our financial performance; and 20% is at risk based on the stock price performance versus the S&P 500. I work without a contract. My objectives and compensation are set by our independent directors. My evaluation is transparent. You can read about it on page 41 of the annual report. I own 1.2 million shares of stock, including 100K shares I purchased in the open market over the past year. I will never sell a share of GE stock while I am CEO. Believe me, I am motivated."

Regarding Immelt's remarks, I would note the following.

His observation of GE's historic earnings growth rate being stable, while its stock price has stalled, simply points up Immelt's failure to understand that the game has changed in terms of investors' expectations. First, from my proprietary research, I would note that revenue growth, not earnings growth, is significantly related to concsistently superior total returns. Second, it's Immelt's job as CEO to figure out how to get total returns which exceed those of the market, not to excuse why earnings growth, and he, aren't getting the job done.

Second, Immelt is totally disingenuous in how he portrays his compensation. By expressing his compensation in percentage terms, he hides how much actual cash he has been paid by GE to date. I've covered this in various posts, most recently here, and the number is now at or north of $18MM. If Immelt explained this, than the '20%' figure, and his insistence that he is 'motivated' become pathetically hollow. Further the 80% of his compensation 'at risk' is, in reality, based upon terms he has proposed. The internal performance portion, 60%, is likely a sandbagged number. The 20% related to GE's stock price, in relation to the S&P, is, as I recall, rather complex, rather than simply requiring Immelt to consistently better the S&P's return over several years.

I'm left feeling a bit happier today, after hearing of the Citi analyst's call to begin dismembering GE. With time and continued lackluster leadership at GE, we might just see it be pursued and broken up within the next few years. Pity, though, that Immelt will get to keep what, by then, will be more than $20MM in cash, and probably more than $100MM in additional deferred compensation, all for doing basically nothing during his tenure to add value to GE for shareholders.

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