So, it comes to this—General Electric, once arguably the greatest of American companies, will cease to exist, at least as the industrial titan it once was.
After more than 20 years of decline, the company is entering the final stages of a process that has seen the General Electric of old slowly dismantled—the corporate powerhouse founded by Thomas Edison doesn't even make lightbulbs anymore—until just three parts remain. Soon, those units—GE's aviation, energy, and healthcare businesses—will be separated into individual companies, starting with GE Healthcare, which could be spun off in early 2023. It's a sad end for a giant humbled by missteps.
Every ending, however, is also a new beginning. Unencumbered by the past—and past mistakes—the three companies have the potential to compete more fiercely than the old cumbersome behemoth could. What's more, they should earn higher stock market valuations separately than they could as part of an unwieldy conglomerate.
For investors, it's time to stop thinking about what GE was and instead look ahead to what it will be. Once they exchange their GE shares for shares of the three separate companies, investors could start seeing some nice gains.
"People aren't focused enough on the new GE," says BofA Securities analyst Andrew Obin, who has a Buy rating on the shares (ticker: GE). "Investors are fighting the last war."
It's hard to blame them. Back in the 1980s and 1990s, GE stock returned more than 25% a year, on average. And $100 invested in the company at the start of the '80s turned into more than $9,000 over that two-decade span, more than triple $2,700 invested in the S&P 500 index. Performance like that gave management carte blanche to do whatever it wanted, and made CEO Jack Welch a star.
But by 2000, cracks were appearing. GE's debt had ballooned, its businesses were less efficient, and Welch picked the perfect time to leave. He was succeeded by Jeffrey Immelt, whose deal making grew GE Healthcare and led to some perilous developments: the expansion of GE Capital, which was battered by bad bets during the 2008-09 financial crisis, and the disastrous acquisition of the energy businesses of France's Alstom.
By the end of 2018, GE's market cap had tumbled to less than $70 billion from roughly $500 billion at the start of the Immelt era, and the company had long ago ceded its place as the largest industrial stock. GE's decline was particularly painful for shareholders, who lost 7% a year from 2000 to 2018, even as the S&P 500 returned 5% annually, on average, over the same span.
With confidence in General Electric shattered, investors have been unwilling to give management much credit for a turnaround plan, even though current CEO Larry Culp, who replaced Immelt's ousted successor, John Flannery, in 2018, has a solid one.
Culp set about shrinking GE Capital, infused life back into the company's management culture, and pared the corporation to a more manageable size. Among his accomplishments: the sale of GE's biopharma division to Danaher (DHR) for $21 billion, with proceeds used to pay down debt; the end of GE Capital as a separate entity, though about $36 billion in legacy assets remain on the books; and even opening up the conglomerate's famously opaque accounting.
The turnaround might have gone smoothly, too, if it hadn't been for Covid-19. The pandemic dramatically reduced the number of people on planes, hurting GE's aviation business, and kept people out of the doctor's office, except for only the most necessary procedures, a problem for GE Healthcare. Culp continued to cut costs and pay down debt, but the coronavirus continues to create headaches for him and the company. Ultimately, he and the board concluded that they had three great businesses that could be managed more effectively on their own.
It was time to break up General Electric.
On Nov. 9, 2021, GE announced a plan to split itself into aerospace, healthcare, and power-generation concerns. The market initially cheered, sending the stock up to more than $116 a share that day. But November was also the month in which the Federal Reserve started to really worry about inflation and make clear that interest rates could rise. That hurt the entire market, but GE even more—since the end of November, its stock is down about 22% while the S&P 500 is off 9% and S&P industrial stocks are, on average, down 5%.
But at $73 a share, General Electric appears to be trading for far less than the combined value of its three remaining pieces.
Take GE's aerospace unit, which makes engines for both Boeing's 737 MAX and the Airbus A321neo. In the decade before the pandemic, its sales climbed at a 6% average annual rate, generating $58 billion in cumulative earnings before interest, taxes, depreciation, and amortization, or Ebitda, with an average operating profit margin of almost 21%. Covid hurt—at $21.3 billion in 2021, sales were 35% below 2019's—but the division still generated $4 billion in Ebitda, on operating profit margins of nearly 14%.
A recovery is in the cards, however, especially with travel bouncing back. In fact, results at aerospace companies in general are expected to return to pre-Covid-levels by 2024. In the past, large aerospace supplier stocks, including Raytheon Technologies (RTX) and Safran (SAF.France), typically traded with an enterprise value to Ebitda ratio in line with the S&P 500's, or about 11 times 2024 estimates. If GE Aerospace, which is expected to generate Ebitda of $7.7 billion in 2024, were to command that valuation, it would be worth nearly $85 billion. That's still well below where it was just a few years ago, observes Neuberger Berman portfolio manager Evelyn Chow. "We used to talk about aviation at a $100 billion valuation," she says.
And the spinoff might not be the end of the saga for GE Aerospace, which is expected to be led by Culp. The aerospace and defense industries have a long history of mergers—Raytheon's combination with United Technologies' aerospace unit in 2020 is the most recent example—and an eventual merger with Lockheed Martin (LMT) or Honeywell International (HON) could make a lot of sense—and lead to an even higher valuation. "The dream combination was always GE Aviation and Honeywell aerospace," says T. Rowe Price portfolio manager Jason Adams. "Together, that would be [the] pre-eminent company in global aerospace."
GE's healthcare business, which makes diagnostic imaging equipment including MRIs and CT and ultrasound scanners, also looks set to thrive as an independent company—even if it hasn't been hitting on all cylinders recently.
Like aerospace, healthcare was hurt by the pandemic, as patients avoided going to the doctor for anything but the most serious illnesses. This year was supposed to be better, but GE Healthcare's profit margin fell to 12.3% in the first quarter from 16.2% a year earlier and about 19% before the pandemic.
Margins bounced back in the second quarter, however, and if that continues, they should get back to pre-Covid levels approaching 18% to 20% over the coming quarters. One reason: An independent GE Healthcare would be able to make small acquisitions to complement organic growth. "We may be discussing 50, 60 different companies routinely," says Peter Arduini, CEO of GE's healthcare unit, who says that it aims to be more agile when it's on its own.
Some bulls see similarities between the GE business and Danaher, where Culp was CEO from 2001 through 2014. GE Healthcare, however, is no Danaher. Its sales are growing by 3% to Danaher's 6%, and it has less recurring revenue, about 50% for GE versus 75% for Danaher.
A more pessimistic comparison would have it trading near nine times Ebitda, like Philips (PHG), which makes imaging and diagnostic equipment similar to GE's. Still, the GE unit's margins of 18% are nearly double Philips' about 9%.
The most realistic comparison might be to Siemens Healthineers (SHL.Germany). The oddly named company was boosting sales at 3% a year, on average, before the pandemic, about in line with GE Healthcare, while its profit margin was about 16%, just a touch lower than the GE business'. If the companies fetched similar valuations, GE Healthcare would be worth $50 billion to $60 billion. Siemens Healthineers is larger; it's valued at $70 billion.
If the future is relatively clear for GE Aerospace and GE Healthcare, it is less so for GE's power business. Its renewable-energy business, focused on building wind turbines, is losing money, while investors worry that its natural-gas equipment business will eventually disappear as governments curb the use of fossil fuels. About the only thing that's certain is the new company's name: GE Vernova. The latter word denotes green and new.
The wind business, in particular, is problematic, and not just for GE. Over the past 12 months, the dominant wind turbine makers—GE, Siemens Gamesa Renewable Energy (SGRE.Spain), and Vestas Wind Systems (VWS.Denmark)—have lost a combined $2.4 billion, despite good demand for renewable energy.
The problem, says Culp, is that "it's an immature industry." Wind technology is changing rapidly, with new-generation turbines arriving before the older ones achieve high enough production volume to truly drive costs down. Wind farms also take years to build—usually on fixed contracts—so inflation like today's can turn them into money losers. And erratic government investment-tax policies lead to boom-bust cycles.
To truly cash in on demand for alternative energy, the industry must better manage costs, slow the pace of new-product introductions, and negotiate contracts that pass through higher raw material costs. Until that happens, the business will earn roughly the same valuation as Siemens Gamesa and Vestas. They fetch about 1.25 times sales, making GE Renewables worth about $18 billion.
GE Power also makes huge—and hugely complex—natural-gas turbines for power companies. Investors haven't given that business much credit, either, as they look ahead to the twilight of fossil fuels. Russia's invasion of Ukraine is likely to stretch that process out, and even the end of natural gas won't make the business evaporate completely because the turbines can be modified to burn a mixture of hydrogen gas and natural gas, or even pure hydrogen.
"I certainly perceive less of this 'melting ice cube' on gas," says Neuberger's Chow, who runs a decarbonization strategy at the investment firm. "Especially after all the geopolitical conflict, transitional fuel is incredibly important."
Comparisons to Siemens Energy (ENR.Germany), which trades at about two times Ebitda, or Mitsubishi Heavy Industries (7011.Japan), which trades at seven times, seem to make sense. A multiple between the two—say five times—appears appropriate, given that GE Power has been producing the group's best operating profits over the past year. At that valuation, Power could be worth up to $10 billion. The new company, which would also include GE's digital and grid-technology businesses, could be worth $28 billion, or a little less than one times annual sales.
GE Vernova CEO Scott Strazik is certainly optimistic. "We're much more focused on taking the portfolio of businesses we have and strategically positioning [them] to lead in the energy transition," he says.
Add it all up and the three businesses could be worth roughly $160 billion—about double what an intact General Electric trades for now.
In figuring the likely combined value of a broken-up GE, its balance sheet must be taken into account. It's still somewhat ugly, but not as much as it used to be. GE's pension obligations, though huge at $95 billion, are 88% funded, based on generally accepted accounting principles. This means that GE won't have to make cash contributions to meet regulatory funding requirements, says accounting expert Robert Willens, who adds that GAAP standards tend to inflate the value of obligations.
Scarier are GE's liabilities for long-term-care insurance policies—which it stopped selling a decade and a half ago. General Electric took a $9.5 billion hit in 2017 because the premiums weren't covering the claims. It has now set aside $14.5 billion to cover future payouts. Still, it must put more aside. Alternatively, it could pay another company to take the liabilities off its books entirely. Either way, resolving the issue will be costly, but less so than it once would have been.
All told, GE's debt sits around $32 billion. Total cash, along with stock in oilfield services and equipment company Baker Hughes (BKR) and aircraft sales and leasing concern AerCap Holdings (AER), comes to almost $20 billion. That puts net debt at about $12 billion—less than two times the about $6.9 billion in Ebitda that GE earned over the past 12 months. The average industrial company's figure is 2.2 times. Overall, says Obin, "they did fix the balance sheet."
If all of GE's net debt and other liabilities are toted up, along with its assets and some money for duplicating corporate overhead, the market capitalization of the three units to be created should be $130 billion to $140 billion, or roughly $125 a share. That would be more than 70% above the $73 at which General Electric has been trading lately.
Of course, sum-of-the-parts valuations are more art than science, but other estimates also imply meaningful upside. Obin values the shares at $105, and Melius Research analyst Scott Davis, at $118.
Whatever the final value turns out to be, the breakup of GE is what its businesses need to enjoy a rebirth. If he were still around, Thomas Edison might not like it, but investors in the humbled giant should be pleased.