General Electric (NYSE:GE) stock price plunged more than 11% yesterday after forensic accountant Harry Markopolos issued a report accusing the conglomerate of massive accounting fraud and predicted that it could go bankrupt soon. GE stock price is climbing 6.5% today but remains about 20% below its July 24 levels.
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Known for reporting Bernie Madoff’s Ponzi scheme to the federal government years before Madoff was caught, Markopolos’ has earned some credibility with The Street.
Yet, for multiple reasons, including Markopolos’ history and recent conduct, I’m very skeptical about his conclusions. For these reasons, I recommend that risk-tolerant investors buy General Electric stock on weakness.
Markopolos Can Make Money if the Street Believes His Story
According to CNBC, Markopolos said that a mid-sized, U.S.-based hedge fund had agreed to give him “a decent percentage of profits” that it would earn by betting on the decline of GE stock.
Let’s say that the hedge fund bet $100 million against GE stock, and that it, using put options, made $50 million on the trade. Let’s say that Markopolos’ percentage was 20%. He would then of course earn $10 million on the deal. That’s a pretty high sum for putting together a report and appearing on a few TV shows.
And, if Markopolos’ report had not been negative enough to push GE stock price down, it appears he would earn nothing on the deal. So, I’d say calling him pretty biased when it comes to GE stock would be a huge understatement.
My confidence in the accountant isn’t increased by his refusal to name the hedge fund that’s paying him or the exact percentage of their profit he’s getting. And in my opinion his statement that his report was “self-funded” could make some people mistakenly believe that he has no profit motive in this case. As somebody who scathingly criticized GE for a lack of transparency, Markopolos’ own lack of transparency is puzzling and disappointing.
Markopolos’ Past Prophecies Haven’t Come True
Markopolos, of course, was spot on about Madoff, but his warnings about insurance companies haven’t been nearly as prophetic. As CNBC noted, his case centers around GE’s long-term care insurance unit.
Interestingly, in an interview published by Business Insider in November 2016, Markopolos alleged that all sorts of fraud was rampant across the insurance sector.
“I have some large insurance fraud cases that I’m going to make public in 2017. And they’re going to be in the tens of billions of dollars each. … Basically the insurance industry is where the banking industry was in 2007,” he told Business Insider.
But over two years later, I can’t find any references to insurance fraud exposed by Markopolos. Does anybody else hear a wolf?
America Doesn’t Crack Down Hard on Illegal Conduct by Companies
In his report, Markopolos compared GE to two of the very few large American companies that collapsed due to illegal conduct: Enron and WorldCom.
But the reality is that the vast majority of large firms that violate the law do survive, and many thrive. For example, American International Group (NYSE:AIG), Bank of America (NYSE:BAC) and Goldman Sachs (NYSE:GS) were charged with committing fraud during the financial crisis. Toshiba (OTCMKTS:TOSBF) had its own accounting scandal in 2015. They all managed to survive and thrive since then. More recently, Wells Fargo (NYSE:WFC) has admitted to various fraudulent actions. Multiple hospital-chain owners have admitted to Medicare fraud. None of them have gone out of business, either. So even if GE did commit fraud or break laws, the chances of it disappearing are pretty low.
Most of GE’s Problems Involve a Subsidiary
As CNBC pointed out, most of Markopolos’ allegations of insolvency and lack of liquidity relate to GE’s long-term insurance business. He identifies Employers Reassurance Corporation as the source of much of the debt he says GE owes.
But ERAC is a subsidiary of GE, rather than part of the company itself. Interestingly, earlier this year, another GE subsidiary, sub-prime lender WMC Mortgage, went bankrupt. Although I’m not a legal or financial expert, I do think it’s fair to wonder why GE cannot get rid of most of its debt stemming from ERAC by simply having the unit declare bankruptcy. Apparently, bankruptcies by insurers are not unheard of or illegal.
Why Would Culp Join a Corrupt Company?
General Electric CEO Larry Culp is in an altogether different situation than the CEOs of Enron and WorldCom were. In the latter two cases, the long-time heads of the companies were involved in fraud for years.
Culp, by contrast, just joined GE at the end of last year. At that point, Markopolos alleges that GE had already started their fraudulent practices. By all accounts, Culp was tremendously respected for the turnaround he engineered while he was CEO of Danaher (NYSE:DHR).
If Markopolos’ accusations are true, Culp either did not examine GE’s financial situation prior to taking the job, didn’t understand its financial situation or knew that it was about to crash but, for some reason, didn’t care about wrecking his sterling managerial reputation. None of those scenarios seems very likely.
General Electric Stock’s Fundamentals Are Strengthening
Despite the bears’ insistence that GE stock is doomed and its fundamentals are collapsing, there are concrete signs that the company’s fundamentals are improving or are poised to improve.
The oracle of the GE stock bears, JPMorgan analyst Stephen Tusa, reported that GE’s second quarter was an operational miss and that the company’s fundamentals had worsened.
But, as I pointed out in a previous column, the gas power segment of GE’s Power unit jumped 27% in the first half of the year, and the company’s overall backlog jumped 11% year-over-year. Culp reported that GE Power would benefit from positive trends going forward, including strong demand for natural gas in Asia. Moreover, despite temporary problems, the company’s Aviation unit received a record $55 billion of orders at the Paris Air Show in June.
Meanwhile, Greentech reported earlier this month that U.S. wind energy development accelerated in the second quarter, which should boost GE’s renewable energy unit. Additionally, New York and New Jersey are going all-in on offshore wind, which also bodes well for GE.
Finally, Caterpillar (NYSE:CAT) reported that the orders of its power business surged 17% year-over-year. Woodward (NASDAQ:WWD), which sells parts to GE, said that its gas turbine business is improving. And Barclays analysts reported that U.S. power turbine orders jumped more than 12% year-over-year.
Based on all of those numbers and fundamental catalysts, I really can’t see how Tusa can state with confidence that GE’s fundamentals are worse. I also am not very confident at all about Markopolos’ charges, so I would recommend buying GE stock on weakness.
As of this writing, Larry Ramer was long GE.
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