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Thursday, December 18, 2008


GE's Woes

A Post Script on Elliot Waves (would that be a PS Elliot? sorry for that one) - I would think most devotees would say that we are in Wave 3 of a bear market supercycle where Wave 1 started in 2000 when the tech bubble burst. They would discount the Dow record in last year's bull rally since NASDAQ and the general market never fully recovered. As for the rally we have just had, it's just a corrective bear market rally within the longer wave 3 (down). If that makes you feel worse, it's supposed to.


Really unsettling to see the bad news and economic strain impacting GE but this blog has commented a number of times about the fact that GE has lived off a long held reputation as a well managed company that it deserved back in the 60's and 70's (the Strategic Business Unit days), but hasn't deserved for a decade or more. When you allow managers to move around learning various businesses (but never expert in the one they are managing) and allow neophyte statisticians (black belts) to run the company, it should be no surprise that things have to catch up to you eventually. On the financial side, GE has long had a culture of "making the quarter," whatever it takes, so there is a mad dash by the accountants in the last few weeks of each quarter to scrounge up "net income" that for some reason never seems to come out of the recurring operations of the company. On top of all this, the culture has a strong bias for financial and operations leaders and against marketing. In fact, there is very little understanding of the marketing function and what differentiates it from sales.

It's fashionable to criticize Jeff Immelt for all this and put him on termination watch, but it's really the once revered Jack Welch, perhaps America's most overrated business executive, who tilted the culture in these directions. To Immelt's credit, he has tried to shift things a bit, devaluing six sigma and emphasizing businesses with real potential while deemphasizing GE Capital. But this company is an aircraft carrier - it has a huge turning radius and I doubt Jeff can complete the maneuver - he will have to displace too much water.

a couple of moves I really liked this week - one was the withdrawal of quarterly guidance (and maybe all earnings guidance), putting the analysts on their own as I think all publicly owned companies should do. In GE's case, this may have the additional salutary effect of taking the heat off of the business CFO's a little bit at quarterly close so they don't do stupid human accounting tricks just to make a forecasted number. The second smart move was foregoing the usual dividend increase. That took some guts, but too bad Jeff couldn't find the courage to do what he really needed to do in this environment - reduce the dividend, perhaps in half. If the rumors are true that GE is short of cash that it needs to do some of its usual things - like make aquisitions and extend financing to customers, then the dividend is a waste of a precious resource.


Last night, I had the very good fortune to visit Birdland and see Freddy Cole, Nat King Cole's younger brother. Cole led a very competent quartet through a set of wonderful songs that featured him on the piano and singing. Cole does not have anything like the vocal chops his brother had, but he puts across a song in a winning way, cabaret style, sometimes half talking, but somehow always keeping the melody intact. All in all, there could hardly be a more pleasant hour and a half for me to spend than to hear Mr. Cole's combo in my favorite venue. He appears on the Birdland bandstand through Saturday night.


Still buying into this stinky market, though now and then we do see signs of life. The Fed is pulling out all the stops, although the conservatives' hysteria concerning Bernanke's plan to buy Treasuries at the longer end seems a little out of order. Isn't this just another variation of what used to be called open market operations?

Anyway, I bought 1100 more shares of Books a Million (BAMM) for my IRA Monday at
1.90. Yesterday, IRA added 800 shares of Limco Piedmont (LIMC) at the bargain price of 2.85. Of course it closed lower than that today.

Redwave doesn't quite have this right ... Capital, until recently, did not need to be reduced ... rather the industrial side of GE's businesses did not measure up. Appliances and Motors should have been sold a long time ago. True, maybe Jack should have done that but CLEARLY Immelt absolutely should have done it.
Jack NEVER should have been allowed to participate in the selection process for his successor. I blame the weak board for that and blame the board and Jack for promoting Immelt.
Today, Capital has to be downsized because the business model doesn't work ... not enough $ from GE Industrial and problems in funding from the credit market.

Hail Freedonia!!
Rufus T. Firefly
Please see the article below from the NY Times. Jack should have demanded transparency but failed miserably. Immelt only continued the failure.
the next thing Immelt will do is ... cut the dividend and no one will know anymore about Capital or really why the dividend is being cut.
Like the offensive lineman he once was, he should be cut. his lack of stewardship of the once great American companies should cost him his job.

Hail Fredonia!!
Rufus T. Firefly

December 7, 2008
Darkness and Light at GE Capital

GENERAL ELECTRIC’S shareholders have taken quite a pummeling lately, largely because of uncertainty at the GE Capital Corporation, the enormous and often impenetrable financial services unit that has generated more than half the company’s profits in recent years.

Investors looking for more transparency about financial stresses facing their companies are fearful of troubles lurking inside the “black box” that is GE Capital.

Last Tuesday, General Electric responded to these concerns and tried to provide clarity on the capital unit’s operations. Among the headlines are these: Turmoil in the credit markets is expected to drag down the unit’s earnings to $5 billion in 2009, well below the $9 billion it expects to generate this year. The parent will also incur an after-tax restructuring charge of at least $1 billion this year; 70 percent of this comes from GE Capital.

Amid this dour news, G.E. did confirm that it would keep paying its $1.24 dividend in 2009, yielding around 7 percent at the current stock price of $17.85, down more than 50 percent for the year.

“We are taking a number of tough, but prudent actions to make GE Capital safer, stronger and more secure during this financial crisis,” said Keith Sherin, vice chairman and chief financial officer of G.E.

No one is shocked that GE Capital, a company in the business of lending to both institutions and consumers, is under pressure. But some investors and analysts are surprised at the degree to which the unit appears to be undercapitalized and underreserved for future losses.

“Referring to GE Capital’s capital position as adequate, given its various risk exposures, seems more in line with G.E.’s catchphrase ‘Imagination at Work’ than grounded in credit crisis reality,” said Richard Hofmann, an analyst at CreditSights.

The credit crisis has brought wrenching change to the GE Capital business model. In the old days, it could use its parent’s triple-A credit rating to borrow at low cost and lend at considerably higher rates. Now, however, the frozen credit markets are putting the squeeze on that lucrative process.

“That ability has fallen off and now they are coming to the realization that a fair amount of their book no longer makes sense,” Mr. Hofmann said.

GE Capital is not a bank, of course. But to analyze its financial position as you would a bank’s is illuminating. For example, if you compare its nonperforming assets, loan charge-offs and reserves to those reported by major banks, you can see how it stacks up against other lenders.

Based on its nonperforming assets and loans it has charged off, GE Capital’s asset quality is squarely in the middle of a group of two dozen major banks. But examine its reserves and the company’s position takes a turn for the worse.

For example, GE Capital’s reserves as a percent of total loans are just over 1 percent; JPMorgan Chase’s are 2.9 percent; and Citigroup’s are 3.5 percent.

GE Capital’s reserves to nonperforming assets are around 0.6 percent, less than one-third the ratio at both U.S. Bancorp and JPMorgan. Finally, its reserves are about the same as its net loan charge-offs; at U.S. Bancorp the figure is 1.7 times charge-offs, at JPMorgan the reserves are double its charge-offs.

To be sure, GE Capital is much more of an international lender than these banks. And it is probably justified in setting aside smaller reserves because most of its lending is commercial and highly secured by valuable assets. Neither did the company dive into the kind of high-risk activities that its banking colleagues did — like originating collateralized debt obligations or selling credit-default swaps. It also isn’t saddled with junk bonds. While Mr. Hofmann gives GE Capital a lot of credit for opening up its books, he worries about the company’s exposure to residential mortgages in Britain and commercial real estate. He is also concerned that none of the $15 billion that G.E. has raised recently, including $3 billion from Warren E. Buffett, has gone to shore up the capital unit.

Russell Wilkerson, a G.E. spokesman, said that the company is evaluating an approximately $5 billion contribution to GE Capital, but that the plan is not formalized..

As such, Mr. Hofmann said, GE Capital’s tangible equity to assets is on the slim side: it stood at around 4.7 percent in the most recent quarter. Raising tangible equity to 6 percent — the level at which banks are considered well capitalized by their regulators — would require a $9 billion cash infusion.

Most banks are raising their capital ratios even higher, Mr. Hofmann said. Of course, GE Capital is a finance company, not a bank, so it need not adhere to these capital ratios.

Still, amid the worst credit cycle in decades, the company’s ratio of reserves to loans is still skimpy.

Back in 2002, for instance, GE Capital had a ratio of 2.44 percent. Last year it had dropped to 1.1 percent.

While the company is bolstering the ratio now, and will bring it up to 1.61 percent in 2009, large banks, on average, are already at 2.1 percent and building.

Mr. Hofmann said he thought GE Capital’s estimate for losses on its real estate portfolio was too rosy. His forecast is for losses of $6.8 billion in the portfolio, while G.E. says $900 million is more likely.

Mr. Wilkerson said: “The difference in the analysis is we are long-term holders of our real estate book; we don’t have to sell it.” And the company is not subject to mark-to-market accounting.

Nevertheless, Mr. Hofmann said a cash infusion of even more than $5 billion might be necessary to put GE Capital on solid footing.

“Our concern is they could be underestimating losses in parts of their book,” Mr. Hofmann said. “We believe the losses could exceed their forecasts and GE Capital could need more, well, capital.”
Firefly, your strategic insights are an important contribution to the blog discussion of GE. Some of my criticisms also go to management. GE's management culture is still a holdover from the Jack days, as Jeff's changes are taking (and should be expected to take) a long time to take hold. I am not sure he has the answers either, but the management culture makes it very hard for the company to get to the right answers.

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