Tuesday, May 22, 2007

Jeff's GE: Discounted Closed End Fund

Exactly one week ago, my partner and I attended a talk given by MIT Franco Modigliani Professor of Finance and Economics, Stephen Ross. I wrote about it here.

One of Professor Ross' topics was the anomaly of closed-ended funds selling at discounts to their net asset value. Specifically, approximately 7.5% for financial funds. I wrote that Ross discovered,

It turns out that simply quantifying and modeling the effects of management fees on the value of income and asset value to a closed-end fund-holder explained the difference between the market price and NAV of such funds.

What, you may ask, does this have to do with Jeff Immelt's GE? Plenty.

Today's Wall Street Journal carries a short article on page C14, by the paper's guest columnist, the online website breakingviews.com. Usually, these pieces are pithy, regurgitating what's already been in current discussion in the business media.

This morning, however, it raises the question of what GE's plastics division sale says about the rest of the conglomerate's valuation. To quote from the article,

"GE's vaunted premium to the sum of its parts, as estimated by analysts, has pretty much disappeared. Moreover, the plastics sale suggests many of GE's assets may have more value than investors and analysts are giving the company credit for in their models.....Companies that trade at a discount to their parts are prime targets for activist investors. Mr. Immelt should consider spinning off businesses such as GE Money and NBC Universal, before uppity investors dictate a more-Draconian corporate strategy for him."

I couldn't have said it much better, although I wrote it first. Here. Last August. Only it's not about spinning units off, but simply breaking the whole company into its constituent, standalone, unrelated businesses.

You see, Jeff Immelt is, in reality, simply an overpaid closed-ended fund manager. GE's shares are, well, shares of a closed-ended fund. The fund has invested in, actually acquired, a collection of unrelated businesses- finance, power systems, plastics (now gone), entertainment, etc.

As Stephen Ross illustrated, closed-ended funds trade at a discount due to management fees. In financial funds, those fees are typically one percent of assets, plus some expenses. You may ask why closed-ended funds exist. I did. Perhaps they are holdovers from the days when brokerage fees were high, liquidity was in shorter supply, as was information, and the best way for many investors to diversify was to buy a diversified fund.

None of those conditions are true today. That's why GE is an anachronism, as currently structured. It has no current reason for being.

To drive this home, let me relate what I heard yesterday morning on CNBC, Jeff's private (GE-owned) network. While discussing the plastics unit sale, he took the opportunity to once more attempt to fend off calls for splitting up GE. In particular, he argued that NBC/Universal was now turning around, and that they had a great slate of network programming and films on the way.

This was just hilarious. Jeff Immelt, corporate titan, is also a seasoned entertainment exec, with a sure eye for the next big hits on both the small and large screens of the world.

If you believe that, I have a bridge in Brooklyn to sell you.

As I contended in this recent post, Immelt is actually the only GE CEO in modern times not to have put his own stamp on the company. In this post, I explained why that doesn't matter to Immelt. He's already received a stupendous payday for nearly six years of abject failure.

Now, putting together today's Journal piece with Professor Ross' findings on closed-ended funds, it's much easier to see why GE should be dismantled into its standalone pieces, exchanging one share of GE for shares in each of its units. The discounted value as a whole conglomerate won't go away. But the plastics unit sale will now signal to the private equity crowd that there's money to be made simply by gaining control of the firm and releasing unrealized value in a breakup.

This should be a most interesting year for GE and the private equity funds.

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