By Bob Blandeburgo
Is General Electric Co. (NYSE: GE) poised to be the next U.S. player scuttled by the worldwide credit crisis?
Or is the onetime-bellwether conglomerate on track for a major corporate turnaround – the kind of rebound that will restore the company's global muscle while providing investors with a shot at double- or even triple-digit gains?
With a bold move it made yesterday (Tuesday), the Fairfield, CT-based GE is doing all it can to make that second scenario come true.
Since the global credit crisis, Wall Street gloom-and-doomers have continually predicted that GE's financial-markets exposure – courtesy of its massive GE Capital Corp. financing units – would cause the once-admired U.S. blue chip firm to share the same fates as American International Group Inc. (NYSE: AIG), Lehman Brothers Holdings Inc., or The Bear Stearns Cos. Inc., all one-time heavyweights whose exposure to "toxic" financial assets sealed their doom.
So GE yesterday opened GE Capital's books up to Wall Street, hoping the bold move would stifle investor fears that the financing would continue to struggle, or that it would need to be separated from is parent, as the Obama administration has suggested.
The upshot: While some investors and analysts weren't swayed – and believe the problems remain and that GE merely bought some time – others now believe the company has a new, and much-sharper strategic focus, one that could richly reward investors who have the courage to bet on GE now.
Even with the continued speculation that GE Capital still may require a cash infusion in the future, the changes that GE has already made are enough for the company's stock to double over the next three years, says Jack De Gan, chief investment officer of Harbor Advisory Corp., a Portsmouth, N.H.-based wealth-management firm.
"They are shrinking the balance sheet at GE Capital much faster than anticipated at the last 'deep-dive' meeting, which is, I think, the reason the shares are up," De Gan told CNBC-TV in an interview.
GE's shares rose 20 cents each, or 1.62%, to close at $12.52, although they traded as high as $12.70. De Gan's price prognostication isn't out of line; a double from here would take GE's stock up to about $25 – not far below their 52-week high of $30.39.
The Low-Flying High-Finance Unit
GE's finance unit, which once accounted for nearly half of the company's overall business, suffered an 80% drop in profit in the second quarter and has dragged the company's stock to its lowest level since the mid-1990s. Despite the hemorrhaging, its losses in areas such as real estate and consumer lending were relatively small.
GE is under pressure to separate its industrial unit from GE Capital, as outlined in a white paper on financial regulatory reform by the Obama administration.
"The loophole for special-purpose credit card banks creates an unwarranted gap in the separation of banking and commerce and creates a supervisory 'blind spot' because Federal Reserve supervision does not extend to the credit card bank holding company," the paper said.
But yesterday, in a Webcast that GE used to help tell its upbeat story to investors, GE revealed that its GE Capital financing arm no longer needs to raise additional capital in order to navigate the continuing fallout from the worst economic downturn in more than 60 years, and also said that this still-crucial business unit has stopped issuing commercial paper through the Federal Deposit Insurance Corp.'s Temporary Liquidity Guarantee Program (TLGP).
GE Capital Chief Executive Mike Neal, who appeared on the Webcast, told investors that the finance unit was operating just as detailed back in March. The projections outlined then were based on the U.S. Federal Reserve's "baseline" economic scenario, which were a key – though controversial – element of the much-discussed "bank stress tests" conducted by the Obama administration and the nation's central bank.
"We're fairly close to where we thought we would be with the base case," said Neal. "We don't see any need to raise external capital."
GE Capital is projected to earn $2 billion to $2.5 billion this year. The baseline scenario is the more conservative of two scenarios outlined by the Fed last spring as government officials performed federally mandated stress tests on the nation's largest banks. The scenario called for a maximum unemployment rate of 8.8% and a gross domestic product (GDP) contraction of 2% in 2009.
GE is trying to reduce the corporate importance of its financing arm, and is making progress. GE Capital's total assets were valued at $557 billion at the end of June, down from $600 billion last year, according to a presentation the company gave to investors. GE's goal is to reduce the division's total worth to about $400 billion in the future. The company is on track to have total investments down to $450 billion by the end its next fiscal year.
Does GE Need a Dance Partner?
Still, many analysts aren't convinced, particularly since the nation's unemployment rate hit 9.5% in June – meaning the assumptions the company used for its longer-term projections are all wrong.
Another analyst said GE is simply buying time for its financial unit, which will ultimately have to be spun off.
"This isn't any more about a decision: it's about when it's implemented," 's Nicholas P. Heymann told TheStreet.com.
Even De Gan, the bullish Harbor Advisory CIO, concedes some risk remains. The company's near-term future carries the most risk, because of GE Capital's real estate holdings, he said in the CNBC interview. GE right now has about $5 billion in unrealized losses that it expects to absorb through earnings over the next three years. If that market doesn't rebound, the company might not be able to follow through with its plan, he says.
But De Gan told interviewers that this risk appears to have already been factored into the current stock price. The bottom line: Someone who opts to make GE a multi-year investment could end up watching as the company's shares march back up toward the $30 level.
There is also speculation that GE is seeking an eventual partnership with a lender. A shrinking business would make GE Capital more attractive for banks looking to buy a stake in the division. Heymann expects GE to eventually partner with a large bank such as HSBC Holdings PLC (NYSE ADR: HBC).
GE Capital refutes any assertions about a possible partnership.
"I don't know what the scenario would be where we would entertain that," Chief Financial Officer Keith Sherin said in the Webcast.
"I'm not focused on that." CEO Neal added. "I don't think anybody here is."
Other analysts are more optimistic.
"The Treasury [Department's] suggestions are just that, so far, with new regulatory rules probably several iterations away from a final version," Sanford Bernstein's Winoker wrote in a recent report.
Winoker also noted that if GE were forced to break off its finance arm, it would have five years in which to do so.
News and Related Story Links:
Supervisory Capital Assessment Program – Baseline Scenario
GE Says Finance Arm Performing as Expected
- Money Morning:
Bank Stress Tests: The Results Are in; Now What?
GE Says Finance Arm On Track to Hit March Targets
GE Capital Not Seeking Equity Partner
- GE Capital:
Investor Meeting – July 28, 2009
- U.S. Treasury Department:
Financial Regulatory Reform
- The Wall Street Journal:
- The Street.com:
General Electric: Buying Time for Financial Unit.
GE Shares Could Double in 3 Years: Analyst.