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Saturday, 19 April 2014

Imagination at bay

Can General Electric keep the activists at bay?

Can General Electric keep activist investors at bay? If the gates at Apple, Microsoft and Procter & Gamble can be rattled, complacency just isn’t an option for any company, even and maybe especially a $270 billion conglomerate. While GE’s broad strategy looks more coherent than ever, the Connecticut giant still has two potential vulnerabilities: its finance arm and its longtime leader Jeffrey Immelt.

Corporate America has learned of late that size offers no immunity from the braying of ornery shareholders. A $320 billion market value didn’t shield Microsoft from the pressures of ValueAct Capital, which nabbed a board seat and accelerated the exit of Chief Executive Steve Ballmer. Even bigger Apple, and boss Tim Cook, have been targeted by both David Einhorn and Carl Icahn to return more cash to shareholders. A long-standing reputation as a consumer-products stalwart didn’t protect $220 billion P&G from the advances of Bill Ackman.

GE has so far kept clear. Its executives, however, seem to be cognizant of how quickly that could change. The engines-to-dishwashers manufacturer has been proactively restructuring in ways that could wisely head off rabble-rousers. GE is reducing its exposure to finance, and in recent years exited businesses like NBC Universal, deemed ancillary to a strategy focused on global infrastructure.

As a result, the existing configuration of GE’s industrial portfolio looks better positioned to take advantage of a middle-class future. That world, to put it simply, involves more people around the globe seeking better healthcare, traveling on jet planes and gaining access to clean water and abundant energy – from which they can run GE appliances.

So what would an activist investor go after at GE? The most obvious weak spot is GE Capital. During the financial crisis, the division’s balance sheet of some $550 billion overshadowed the world-class industrial businesses. The need to finance a large financial institution without a stable base of deposits stoked fears GE might even need to jettison valuable assets. GE Capital has since pared its balance sheet by almost a third.

There’s also more to come. In November, GE said it would begin the process of spinning off its consumer finance business, which carries some $59 billion of assets. Once the divestiture is completed, GE Capital will have a loan book of about $350 billion. That’s far below its peak. Yet it still puts GE Capital on a par with U.S. Bancorp and renders it among the country’s biggest financial institutions.

Some of this is easy to justify. About a quarter of GE Capital’s assets will be devoted to what it calls “GE Verticals” where it uses its balance sheet to help finance customer purchases of GE products. But it still envisions tying up more than half its assets in lending and leasing initiatives and some $50 billion in commercial real estate. To investors wanting a more focused, industrial GE, this could provide a potential soft spot.

Outside of capital allocation and portfolio management, the other typical target for activists is management. Chairman and Chief Executive Immelt can’t ignore the possibility of a broadside. Since taking over in 2001, GE’s total shareholder return has been flat compared to a doubling of the S&P 500 Index.

Immelt was passed a tough hand. His ascent coincided with the attacks of Sept. 11, 2001, and the subsequent economic downturn. He also led GE through the outburst of financial services, which brought earnings to a record high of $38 billion, or $2.21 a share, in 2007. The crisis erased those gains. A dozen years on, GE is slated to record $146 billion of revenue and earnings of $1.64 a share – just around 28 cents more than in 2001.

Of course, with hindsight it’s easy to argue that Immelt should have been more proactive at reducing the size of the financial business he inherited from his predecessor Jack Welch. What matters now is that Immelt has put the organization on a better trajectory.

It’s not impossible, though, to envision a new hard-nosed investor demanding a more aggressive reduction of GE’s exposure to financial services, a conflict that could escalate into a referendum on management. That would put Immelt in an uncomfortable spot. He has at least groomed many able successors. Don’t be surprised if one of them gets a shot at the job in the coming year.

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Context News

General Electric hosted an annual outlook meeting for investors on Dec. 18, with targets for industrial business earnings growth, margin expansion and other goals, including a previously announced 16 percent dividend increase in 2014.

GE’s finance unit, GE Capital, said on Nov. 15 it plans to spin off its North American consumer finance unit, which includes private-label credit cards, veterinary and healthcare finance and personal loans.

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