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One Sale Does Not a GE Turnaround Make

Brooke Sutherland

(Bloomberg Opinion) -- General Electric Co. investors may be getting ahead of themselves again. Shares of the company spiked this week following a Bloomberg News report that Apollo Global Management is meeting with lenders about a bid for all or part of its GECAS jet-leasing unit. On the one hand, a sale would be fresh evidence that CEO Larry Culp has taken the lessons of his predecessor John Flannery’s hesitation to heart and is willing to do what’s necessary to put GE on more stable footing. On the other, there are more questions than answers about a possible GECAS sale at this point, and it won’t solve everything.

GECAS has about $40 billion of assets, according to the company. But helicopter lessor Waypoint Leasing Holdings Ltd. filed for bankruptcy in November amid a drop in utilization, while rival aircraft lessors AerCap Holdings NV and Air Lease Corp. have declined 20 percent and 27 percent, respectively, from last year’s highs. That suggests a discount to asset value is warranted; JPMorgan Chase & Co.’s Steve Tusa estimates an enterprise value in the ballpark of $30 billion and Gordon Haskett’s John Inch has said $5 billion to $6 billion in after-tax proceeds are possible. GECAS’s underlying profitability absent tax benefits is a question mark, but it is actually earning money, unlike the rest of GE Capital. So while a deal would raise cash and help mitigate GE Capital’s debt load, a GECAS divestiture by itself won’t change the fact that what’s left behind is mostly a pile of undesirable assets and a potentially hefty additional liability tied to legacy long-term care insurance assets.

One theme that came up in my conversations on this topic with investors is surprise that Apollo, which has little experience in jet leasing, would be considering this kind of mammoth bet. I flagged that KKR & Co. was also wading into the jet-leasing industry, but the buyout firm’s $1 billion investment in Altavair AirFinance is of a much different scale and is focused initially on freighters. The spread of e-commerce makes the business case for freighters more solid than the one for passenger jets — particularly as the global economic outlook gets murkier. While a leveraged buyout would obviously entail debt, jet lessors need an investment-grade rating to operate cost-effectively. So you may end up with a situation where the amount of debt GE can transfer with GECAS is limited, or Apollo chooses instead to buy only a more manageable chunk, which would make a sale even less of a game changer.

ALL ABOARD 

Union Pacific Corp. this week hired a disciple of legendary cost-cutter Hunter Harrison as its new chief operating officer. Harrison’s “precision-railroading” strategy — which focuses on reducing the number of train cars and capital needed to run a railroad — drove heady profit improvements at Canadian Pacific Railway Ltd. and Canadian National Railway Co. He died in 2017, leaving a protege, James Foote, to complete a similar reboot at CSX Corp. Foote’s success has turned competitors into believers and made other Harrison disciples a hot commodity (Norfolk Southern Corp. also recently hired a former cohort of his as its vice president of transportation). The rush to implement Harrison’s blueprint has cast an uncomfortable spotlight on Warren Buffett’s BNSF Railway Co., whose executives have argued the tactics can hamstring growth and make it harder to respond to demand swings. I agree that operating efficiency isn’t everything; Canadian National and Canadian Pacific have higher rates of injuries, for example, and the changes can cause customer disruption and employee angst. BNSF has the benefit of being part of Buffett’s empire and could prove prescient in its resistance. That said, Buffett didn’t get to where he is by saying no thanks to higher profits.

IN A FUNK

Industrial-company earnings are starting to trickle in, and, as I outlined last week, the focus is on signs of margin pressure and slowing growth. Distributor MSC Industrial Direct Co.’s fiscal first quarter was fine, but uninspiring, with gross margins contracting about 55 basis points as rising costs took a toll. The company is projecting significant margin improvement in the back half of the year as a planned price increase takes root, but that risks being undercut by a slowdown in growth amid what CEO Erik Gershwind sees as “more uncertainty than a few months ago.” Similarly, Acuity Brands Inc. executives were vague about when its price increases would start to overcome the margin pressure from wage inflation and the trade war. To cap it off, American Airlines Group Inc. followed Delta Air Lines Inc. in paring its estimate for fourth-quarter revenue per each seat flown a mile, indicating competition is undermining the benefits from lower fuel costs as airlines struggle to raise fares. Expect this kind of CEO hesitation to continue as incremental signs of gloom overshadow what’s still a fairly healthy industrial economy. 

DEALS, ACTIVISTS AND CORPORATE GOVERNANCE

United Technologies Corp. is shelving a sale of its Chubb fire-safety and security business “due to the recent market volatility.” Bloomberg News reports bids from prospective buyers including Apax Partners and Eurazeo SE came in below the $3 billion United Technologies was seeking. This divestiture was separate from the company’s plan to break itself into three, with one business focused on jet engines and aerospace parts, another to be called Carrier and focused on climate control and related technologies and the last to house the Otis elevator unit. Recent enthusiasm around possible consolidation in the HVAC sector had made the Carrier business a candidate for divestiture instead of a spinoff. A failure to sell Chubb may complicate that idea, by making Carrier less of a pure play; Johnson Controls International Inc., for example, has a fairly robust fire-and-security lineup of its own. More broadly, the market volatility raises questions about the wisdom of the timing of United Technologies’ breakup. After years of resisting the idea, the odds are rising that a recession may occur during the company’s 18-month to two-year timeline for executing a split. 

Pentair Plc this week announced a $120 million takeover of residential water-treatment company Pelican Water Systems and a $160 million deal for Aquion, which sells water conditioners and drinking-water purifiers. This is exactly the kind of M&A activity investors should welcome: both are niche, bolt-on deals that will have a greater impact than they would have before the spinoff of Pentair’s nVent Electric Plc business in May. And the takeover valuations look reasonable at 3.2 and 2.2 times revenue, respectively. Of note, Pelican’s existing direct-to-consumer platform should give Pentair useful insight as it works to expand its e-commerce accessibility.

J.B. Hunt Transport Services Inc. agreed to buy New Jersey-based Cory 1st Choice Home Delivery for $100 million. First, it’s amusing to me that Cory crammed some advertising for itself into its company name. But mostly, this deal is interesting because it’s part of a trend. Cory specializes in last-mile delivery of big and bulky items such as a TV from Best Buy Co. or a sofa from Ethan Allen Interiors Inc. This delivery category has become more of a priority for trucking companies looking to capitalize on consumers’ growing willingness to buy furniture and appliances online. XPO Logistics Inc. and Ryder System Inc. have also made acquisitions to build out their e-commerce fulfillment capabilities, including last-mile delivery networks for large and bulky goods. Make sure to check out this great story from Bloomberg News’s Thomas Black. 

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To contact the author of this story: Brooke Sutherland at bsutherland7@bloomberg.net

To contact the editor responsible for this story: Beth Williams at bewilliams@bloomberg.net

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Brooke Sutherland is a Bloomberg Opinion columnist covering deals and industrial companies. She previously wrote an M&A column for Bloomberg News.

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