Wednesday, May 09, 2007

More On GE's Breakup: The Right Idea

Today's Wall Street Journal featured an article concerning GE's breakup. It's in the middle of the Money & Investing section's front page. The headline is a complimentary "For GE, No Lack of Ideas."

As I wrote recently, here, even as the Journal touches this potential third rail topic, it is doing so gingerly. Here are some of the more forgiving (of Immelt and GE) quotes:

But some shareholders and analysts argue that GE's sprawling businesses are better off together than apart. GE's big umbrella, these investors say, can balance differing product and economic cycles, while helping all its businesses financially. And that would boost the stock price over the longer term.

The "keep GE together" crowd appears to have a strong ally in Mr. Immelt, who has resisted past calls to sell NBC Universal. Mr. Immelt has repeatedly expressed his frustrations with GE's stock price, which is down 7% since he took over in September 2001, while the Dow Jones Industrial Average is up 35% over the past five years.

What's more, splitting off big pieces of GE could ultimately lower the entire company's valuation. If, for example, it divested itself of NBC Universal, the company would be even more heavily weighted toward financial-services businesses, which generally get lower valuations than the industrial units. In the first quarter, financial services already accounted for more than 60% of GE's profit.

What I noticed about the above-cited text was that no salient, sage investors were actually named as the 'some shareholders' who 'argue that GE's sprawling businesses are better off together.' Who are these shareholders- seasoned hedge fund managers, or your great aunt Hilda, who has held GE in her portfolio since 1980?

To say that GE CEO Immelt 'appears' to want to keep GE whole is an understatement. After six years presiding over this failed conglomerate, do you really think he's ready to throw in the towel and fire himself? Because that is the logical conclusion of beginning any divestiture, or the complete breakup into all its six constituent units.

I wrote about a GE breakup here, last August. Contrary to the sentiment expressed in the third paragraph I cited above from the Journal article, I think a split up would result in more value all around for shareholders. If one unit becomes valued as a financial service company, so be it. That's what it is. Shareholders would be free to sell shares of that spun off company.

Simply put, corporate diversification for cash flow smoothing has been a discredited management approach for creating consistently superior total returns for some time. My own proprietary research, which drives my equity portfolio selection of consistently superior large-cap companies, confirms this. Back some thirty or forty years ago, when trading equities was expensive and information and innovation were in shorter supply, it may have made sense for investors to hold shares of conglomerates. And, in the day, they existed- Gulf&Western, ITT, and Litton, to name just a few. But they are gone now. ITT still exists, but in nothing like the shape it had under Harold Geneen.

In fact, even GE went through such change in the past. Besides publicly available information, I have additional knowledge from my old mentor and boss at Chase Manhattan Bank. He worked for the CPO of GE as it moved between CEOs Fred Borch, Reg Jones, and Jack Welch.

Few today realize how Jones, of whom I have heard it said, "once a beanie (accountant), always a beanie,' stripped much of the strategic vision from GE that Borch had instilled through his business unit investments. Jones retooled the company to be a cash machine because, well, he was an accountant. He liked cash.

Welch, upon taking the helm from Jones, faced an unprecedented period of high inflation and a wide array of non-strategic businesses at GE. He rapidly cut and pruned the company's businesses, earning the now-forgotten moniker "neutron Jack." I can't believe it's so long ago that I probably need to explain the meaning of this nickname to younger readers. At the time, the neutron bomb was under development. Its salient characteristic was to 'kill the people but leave the buildings standing." You can figure out the reason for the nickname from that.

Today's large firms are usually focused on a particular product/market. Diversified conglomerates are pretty much a thing of the past. Mediocre analysts and fund managers might confuse large focused global firms, such as Intel, Cisco, or ExxonMobil, with yesteryear's broadly diversified giants. You should not. I don't think investors do, either. That's why GE's stock is in suspended animation. Everyone can diversify more cheaply today than they can by paying an enormous tax on operating earnings of GE's business units in order to keep them under one administrative regime.

What's ironic is how everyone seems to have forgotten GE's heritage of being subjected to wrenching change with each new CEO of the prior forty years, except for Immelt. He's the only one not to have actually made a big change in the firm, and it has stalled.

In the past, the company was led by CEOs who were unafraid to put a significant personal stamp upon the shape of GE. Immelt, however, eschewed that approach. Instead, he's pretty much kept the cards Welch left on the table. Too bad it's evidently not the right hand for today's business environment.

As I've argued in prior posts (which you may find by searching on the label 'GE,' and following links to even earlier posts), Immelt has been paid far too much for simply keeping Welch's seat warm, but not even managing to beat the S&P. How many of Immelt's own managers do you think he would keep for six years if they had his performance record?

Where's the business media's outrage at Immelt's egregious overcompensation? Oh, yes, that's right- GE is a big advertiser. Wouldn't want to offend a company that lines the coffers of so many print, network and cable media firms. Same with most of the financial service firms.

However, I firmly believe that, now, lurking somewhere in the shadows, are the private equity wolves. Perhaps they are beginning to form a pack and slowly circle the ailing, misled GE. It may take a private equity offer to loosen the business media's collective tongue on this matter, but don't expect too much until they are pretty sure that GE is well on the way to some sort of break up before they feel it's safe to agree with everyone else and proclaim the wisdom of a GE dissolution.

No comments: