GE Toast?

We’ve gotten a lot of feedback about our recent posts on GE.  As usual, some readers applauded us.  Some said we were brain dead.  Some wanted us killed.

We also got some very smart responses.  We’ve excerpted some below.  Also please see the comments on the following posts:

  • Sorry, GE Shareholders, You Owe $525 Billion
  • The Man Who Destroyed GE
  • Even At $7, GE’s Not Cheap
  • The Three Ways GE Can Survive


Nationalise GE, run off GE Capital. IPO the industrial business and give that money back to taxpayers.

GE is done. Put a fork in it. The only thing that will keep it alive is Govt support that ;turns into another zombie. Derivatives, my friend. They didn’t teach you about derivatives in your “how to promote internet stocks with extra hype” class, did they? This is all you need to know:

1) I think you are correct in pointing out Jack Welch had a large hand in creating the mess at GECC.
– during Welch’s term, financial accounting standards were more loose and he could and did “manufacture” earnings through manipulations at GECC

– the amount of debt on the books at GECC were probably much higher than $300 billion at the time Welch left, at that time

– accounting for VIEs was much more lenient and GECC had comparatively more off-balance sheet exposure

– although not debt per se, the policy holder liabilities associated with Genworth and FGIC added to effective financial exposure

2) Your reference to mark-to-mark* accounting and general status of GECC is misleading and incomplete
– investment banks with trading assets have a large percentage of assets reported on a MTM basis – by comparison to GS or MS, your comment is legitimate

– commercial / retail banks with hold to maturity loans (and securities) still DO NOT use MTM for such assets – by comparison to WFC or USB, your comment is not accurate

– GECC is largely a hold to maturity lender, hence accounts for assets similarly to commercial banks

– on a tangible equity to capital basis, GECC is capitalised similarly to (actually better than) most commercial banks

– look on pages 52 and 53 the recently published 2008 annual report for details
– on a tangible equity to tangible assets basis, GECC is capitalised at ~3.85%, very much in line with large commercial banks
– OK, this is not a positive per se, but GECC is actually better positioned to absorb more losses than most banks

– excluding the non-US mortgage book, GECC also has established reserves comparable to commercial banks
– GECC has a much better diversity and generally better collateral position in their lending books

– yes GECC is troubled, but actually is positioned better than most US Banks

3) I agree that “muddle through” is the most likely strategy, however, GE has two other very viable strategies
  A) – split GECC into two components: 1) GE Equipment Finance (portion that finances GE made equipment), and 2) everything else (essentially GE Money)
– combine GE Equipment Finance with rest of GE, sell 20% in a public offering (essentially a rights offering)
– use proceeds to recapitalize GE Money, then spinoff GE recapitalized GE Money into separate, independent unit
– rest of company then becomes GE plus related equipment finance

– market value of parts is likely to be greatly enhanced, GE exposure to finance would drop precipitously
  B) – split GECC as above, place majority of capital into GE Money
– sell GE Money unit to someone like JPM or HSBC, sell price might be $0, i.e. take over the company and its allocated capital in exchange for absorbing future risk

– more enticing than most realise as GE Money has some leading positions in commercial middle market and global retail

– GE would return to its roots as a manufacturing company with a captive equipment finance unit

What the market and your analysis is missing, in my opinion, is that GE ex-GECC remains a phenomenally profitable, reasonably well positioned company.  The value of this part of the business greatly exceeds the current market price of the stock, again, in my opinion.  For disclosure, I own 7,000 shares of GE stock, 5,000 of which were purchased at ~$7 / share this week.
In my opinion, the press is doing the USA a disfavor suggesting all these entities are essentially going to fail / be nationalized.  During my years investing for JPM, I went through many credit cycles.  This is the most severe and losses on consumer debt will remain horrendous throughout 2009 at least.  But, diversified, well run entities like JPM, USB, WFC, PNC, GE and probably BAC will make it through the cycle and recover to their previously stellar places among global financial institutions.  Even Citigroup is likely to make it through, albeit with great dilution to common stockholders.  If you want to write critical pieces on companies like GE, please do more in-depth homework first.  I am not suggesting your work is bad, rather that America needs some positive news as well.  As an example, your work on GE could have presented a more balanced, brighter long term outlook.
* Having been a professional investor for ~ 30 years, I have mixed feelings about MTM accounting.  Yes, it can provide investors an “instantaneous” snapshot of liquidation value.  However, it’s a totally false snapshot because the markets are not sufficiently deep to sell every loan and security into the market all at once.  So, market prices always reflect some large dose of a “liquidity premium”.  Right now that liquidity premium is at an extreme due to: 1) the uncertainty regarding potential loss content in loans and to tight capital positions, 2) tight global capital conditions, and 3) risk policies that prevent many institutions from taking on risk during such a turbulent period.  In this context, transaction prices do not reflect “economic value”, defined here to be the present value of contractual cash flows weighted under varying risk scenarios (including severe stressed cases).  In a sense, amortized book accounting is designed to measure economic value.  Specifically, loss reserves should reflect potential life of loan losses under these various risk scenarios.  Banks that use for severe loss scenarios (take JPM and USB as examples) will carry larger loss reserves.Assume Z= GE, A is GE Capital and B and C are other divisions.

1) If Z=A+B+C and A=0; Z is not necessarily zero.  So the idea of “anything multiplied by zero” doesn’t apply in this case.  What if GE spins off one of those other divisions (i.e. the B or C) and monetizes their value?  Isn’t it conceivable that Z’s value would go up significantly over today’s fire-sale stock price?

2) Last I checked, $797 – $525 = $$272 which is GE’s assets minus debt, leaving $272.  Of course there are a lot of moving parts not included and I will concede that the tangible book value of the company is quite small.

Overall, I believe you guys are piling on and stoking fear which is playing out in the market.  This whole fiasco has really soured my view of the market.  I think there’s a lot of rumour-mongering and manipulating going as hedge funds “bear raid” some of these companies.  The fact is GE does not have to sell their assets at fire-sale prices.  In fact the balance sheet doesn’t even capture the franchise value of the company!  This is a world-class brand, with close to $200b in revenue, throwing off huge amounts of cash.  My belief is the chance of them defaulting on any debt is slimmer than slim.  The most mind-boggling part of this is you’re talking about a AAA-rated company being insolvent!  It’s unbelievable.

[In our defence, we’re not the only ones talking about it being insolvent.  And we think the really unbelievable part is that a company that many experts believe is insolvent is still rated AAA.]

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