By William Patalon III
Money Morning/The Money Map Report
General Electric Co. (GE) said yesterday (Wednesday) that it will sell "at least" $12 billion in common shares to investors, and another $3 billion in preferred stock to Warren Buffett's Berkshire Hathaway Inc. (BRK.A, BRK.B), making GE the latest U.S. giant that's been forced to raise capital in recent weeks.
The moves come as the conglomerate – whose GE Capital finance arm generates nearly half the company's revenue – has effectively seen itself reclassified as a financial-sector stock because of investor worries concerning GE's financing businesses. As a result, GE shares have been pounded.
Until last week, however, GE leaders had repeatedly maintained the company's finance arm was experiencing no real problems.
That changed last Thursday, when GE reduced its earnings expectations, ended its stock repurchase program, and announced it would hold its dividend steady through 2009, thus becoming another victim of the financial crisis. This will be the first time in 32 years that the company won't boost its dividend. GE cited "unprecedented weakness and volatility in the financial-services markets," and unveiled those startling protective measures to strengthen its capital and liquidity.
The company has been shedding consumer-oriented businesses and focusing its growth efforts on global industrial opportunities – particularly in China, where executives hope to double the company's business to $10 billion a year by the decade's end, Money Morning reported recently.
GE Chief Executive Officer Jeffrey R. Immelt ultimately wants to restructure GE in such a way that that its industrial business accounts for 60% of the company's earnings by the end of 2009. That would effectively reduce GE Capital's contribution to GE's bottom line by 13%, as financial services made up 53% of the company's 2007 profit.
GE shares closed yesterday at $24.50, down $1 each, or 3.92%. They were down as much as 10% at one point. The stock has plunged 42% from its 52-week high of $42.15 and is down by a full third so far this year.
Details of the Deal
Under the common-stock offering, underwriters will have a 30-day option to buy shares representing another 15% of the offering amount from GE to cover over-allotments, The Wall Street Journal reported. The company expects to announce the actual pricing of the stock offering before the market opens today (Thursday).
The $12 billion company officials are hoping to raise represents roughly 5% of GE's market value.
The near-term fate of GE Capital depends on two sensitive corners of the economy: commercial real estate and loans to midsize businesses. The fact that the credit crisis has put a crimp on the liquidity both those sectors need to operate, and is actually causing the economy to weaken, the ongoing financial crisis will hurt GE's earnings even more and increase the challenge the company faces in its attempt to sell some of its businesses.
Credit default swaps for GE Capital tightened dramatically once the company's stock-offering plans were announced yesterday, The Journal reported. It now costs $500,000 to protect $10 million of bonds for five years, down from $650,000 before the news, Phoenix Partners Group told The Journal. Debt-protection costs got as high as $740,000 earlier in the day as worries escalated about GE's ability to access the commercial-paper and corporate-debt markets, the newspaper report stated.
Under the offering, the underwriters will have a 30-day option to buy shares representing another 15% of the offering amount from GE to cover over-allotments. The company expects to announce the pricing of the deal prior to the market opening Thursday. At $12 billion, that is roughly 5% of the company's market capitalization.
Buffett's preferred stock deal with GE comes just a week after he made a $5 billion investment in Goldman Sachs Group Inc. (GS). In that deal, in addition to agreeing to buy $5 billion in perpetual preferred Goldman Sachs shares that pay 10% interest, Berkshire Hathaway receives warrants giving it the right to buy $5 billion worth of Goldman's common shares at any time over the next five years at a price of $115 per share.
Goldman Sachs shares closed at $134.50 yesterday, up $6.50 each, or 5.08%. Based on that closing price, Buffett has a potential paper profit of $847.83 million on those Goldman warrants.
"Goldman Sachs is an exceptional institution," Buffett said in a statement. "It has an unrivaled global franchise, a proven and deep management team and the intellectual and financial capital to continue its track record of outperformance."
Buffett's deal with GE calls for Berkshire to receive preferred shares that carry a 10% dividend and that are callable after three years. Berkshire also receives warrants to buy $3 billion common shares at $22.25 each. At yesterday's close, Buffett has a paper profit of $303.37 million on this investment.
In making his second major bargain-basement credit-crisis-related investment in a week, Buffett also took steps to express his confidence in the U.S. financial system. Indeed, in turning his attention to GE, Buffett issued a statement that said the company has "strong global brands and businesses with which I am quite familiar. I am confident that GE will continue to be successful in the years to come."
Immelt, the GE chairman and CEO, said the company's strategic repositioning moves and its capital-raising deals will make GE more nimble and will allow the firm "to execute on our liquidity plan even faster." Indeed, the investments from Buffett and the cash that will be raised from the common-stock sale will "give [GE] the opportunity to play offense in this market should conditions allow."
According to The Journal, Immelt reiterated the company's long-held commitment to its coveted "AAA" credit ratings and added that the company continues to "successfully meet our commercial-paper needs."
News and Related Story Links:
GE gets Buffett investment, offers common shares.
The Wall Street Journal:
GE Plans $12 Billion Stock Offering;
Berkshire to Buy Preferred Stock.
Money Morning News Analysis:
Berkshire Stake Brings Confidence and Credibility to Top China Electric Carmaker BYD.
Money Morning News Analysis:
Buffett's Goldman Deal Has Big Benefits, but What Else is Berkshire Up To?
Money Morning News Analysis:
GE Cuts Earnings Forecasts Amid U.S. Credit Turmoil, Shifts Focus to Industrial Businesses in China.
The Financial Times:
GE issues second profit warning of the year.
New Look General Electric Aims to Double its China Business by the Decade's End.
Credit Default Swaps.
Money Morning Special Investigation of the Credit Crisis (Part I):
The Real Reason for the Global Financial Crisis…the Story No One's Talking About.
Money Morning Special Investigation of the Credit Crisis (Part II):
The Credit Crisis and the Real Story Behind the Collapse of AIG.
Money Morning Special Investigation of the U.S. Credit Crisis (Part III):
How Complex Securities, Wall Street Protectionism and Myopic Regulation Caused a Near-Meltdown of the U.S. Banking System.
Money Morning Special Investigative Report:
Dear Hank: Here's How to End the Credit Crisis at No Cost to Taxpayers.
About the Author
Before he moved into the investment-research business in 2005, William (Bill) Patalon III spent 22 years as an award-winning financial reporter, columnist, and editor. Today he is the Executive Editor and Senior Research Analyst for Money Morning. With his latest project, Private Briefing, Bill takes you "behind the scenes" of his established investment news website for a closer look at the action. Members get all the expert analysis and exclusive scoops he can't publish... and some of the most valuable picks that turn up in Bill's closed-door sessions with editors and experts.