General Electric's Downfall Was Easy to See
- By Rupert Hargreaves
Of all the companies that have fallen from grace over the past two decades, none is more indicative of the times we are in today than General Electric (GE).
Since the turn of the century, this company has wilted from being one of the world's largest conglomerates, dominating industry all over the world, to a company that is struggling to survive, with flagging sales and a ruined balance sheet.
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As General Electric has spluttered to a halt, other companies have overtaken this dying beast in leaps and bounds: Amazon (AMZN), Facebook (FB) and Microsoft (MSFT) are the new industrial giants of the 21st century.
But there's been more to General Electric's downfall than just technological change. This company is possibly one of the best examples of how complex businesses can become their own worst enemy and how overexpansion can be destructive for shareholders.
In August 2000, General Electric's market cap was $594 billion. Nearly two decades later, the company has lost nearly 90% of its value since this point. At the time of writing, the company's market capitalization is just $73 billion.
And it looks as if there is going to be more paying out for shareholders before the company manages to stage a recovery. Earlier this week, the new CEO Larry Culp told reporters on CNBC that the company is looking to sell assets with "urgency" to reduce its high debt.
"We have no higher priority right now than bringing leverage levels down," Culp told CNBC. "We have plenty of opportunity to do that through asset sales."
This is a staggering admission to make on national TV, as it hints that the company is considering a fire sale for its assets. Even if it is not, the very fact that management has told the world that the company is looking to sell assets quickly to reduce debt means it is likely to receive lower prices as buyers know General Electric is in a tight spot.
Problems clear
Looking at the conglomerate, two factors stand out as being behind its problems over the past two decades.
First of all, there is complexity. General Electric has so many different business arms and divisions that it is difficult to understand what goes where and what contributes to what. The company has made several significant acquisitions in recent years that have only added to the pain and piled on the debt.
The last significant deal in the Jeff Immelt era was General Electric's buyout of Alstom for $10 billion in 2014. The company had been hoping to use this deal to become the undisputed champion of power generation from natural gas, but it coincided with the collapse in oil and gas prices.
This deal in itself was not enough to break the company but combined with years of frivolous spending on highly prized acquisitions, it became the straw that broke the camel's back.
Here is the second factor: debt and cash flow. At the end of the third quarter, the company's debt was $114 billion, 3.7 times its equity.
Looking through the company's financials, it is clear that it has been spending more than it can afford for years. Until very recently, the company's dividend was gold-plated even though it should have been cut many years ago. Over the past five years, free cash flow from operations has totaled $45 billion, a respectable sum, but over the same period, the business has distributed $44 billion to investors via dividends, indicating capital spending (around $7 billion per annum). And acquisitions have been funded entirely with debt.
The red flags were on the wall for a while.
As the business tries to divest assets to clean up its balance sheet, its complexity is now becoming all too clear. Asset sales are taking too long and not raising enough cash to make a meaningful dent in the company's debt mountain.
Overall, this is yet another case study to investors of how dangerous debt can be, even for those companies that may seem to be too big to fail.
Disclosure: The author owns no share mentioned.
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David Herro and Bill Nygren Comment on General Electric
This article first appeared on GuruFocus.
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