The Tragedy of General Electric
For a century General Electric was one
of America’s most iconic corporations with roots going back to Thomas Edison
and J.P. Morgan. Yet over the past two decades it has shriveled up into a
shadow of its former self. Wall Street
Journal reporters Ted Mann and Thomas Gryta
vividly tell a deeply researched story of GE’s slow motion collapse that
began at the at the start of this century. Let me say at the outset that
several years ago I was a preliminary Loeb Awards judge for the best business
book of the year. Although they no longer offer an award for books, if they
did, this book would most assuredly be a finalist.
The seeds of GE’s demise starts with
their rock star CEO of the 1980’s and 1990’s, Jack Welch. Wall Street uniformly
admired the house that Jack built, but in many respects its foundation was
shaky. Specifically Welch created a “make the numbers” culture and he used the
ever growing GE Capital subsidiary to meet his quarterly earnings target by
coming up last minute financial transactions. Thus by 2000, 40% of GE’s earning
were coming finance; not generators, jet engines and appliances.
During that era GE kept a close watch on
the analysts who covered GE stock. Mann and Gryta’s comments on this process
ring true to me. It 1997 as Chief Equity Strategist for Salomon Brothers I
remover GE from the firm’s recommended list of stocks. Within minutes Russ
Leavitt, Salomon’s analyst covering GE, received a complaining call from
investor relations. He had to grovel before them by saying it wasn’t him, but
rather it was me.
Welch wanted to end his career with the
mega-acquisition of Honeywell. That would have created an even bigger electric
behemoth, reduced the role of GE Capital as a relative source of earnings and
in, my opinion, it would have created accounting opportunities to sweep under
the rug past mistakes via a special charge that analyst usually ignore. This
last proposition is mine, not the authors.
After a drawn out selection process,
Welch selects Jeff Immelt to be the new CEO. Those passed over include David
Cote who would soon run Honeywell, Bob Nardelli who would go on to Home Depot and Jim
McNerney who would run both 3M and Boeing. Yes, GE’s vaunted management had a
very deep bench. In picking Immelt Welch got probably the best salesperson in
the company. I met Immelt once at a charity function, and in a very short
conversation his sales personality came through and that experience was very
consistent with what you get from the book.
Unfortunately Immelt was not really
strong on finance; he didn’t really understand GE Capital and he was a deal
junkie with a penchant to overpay for acquisitions. He did that when he ran the
health care equipment division in the 1990s and would do that in spades later
with acquisitions in media, oilfield equipment and power generation when he ran
the whole company.
Immelt had the misfortune of starting to
run GE just a few days before 9/11 which signaled the end of the 1990’s boom
that so propelled the Welch era. The environment made it more difficult for GE
to reach its earnings targets and the passage of the Sarbanes-Oxley accounting
reforms in 2003 made it much harder to generate earnings with the stroke of a
pen. Thus Immelt had to rely more and more on GE Capital expanding its balance
sheet, so much so that by 2007 it accounted for half the company’s earnings.
Then in 2008 as the financial crisis hit with full force, GE could not roll
over its commercial paper and had to be bailed out by the Fed. With that GE
became known as a finance company that made industrial equipment and its
multiple suffered.
To get out of this fix, Immelt began to
slim down GE Capital and went on an ill-timed acquisition binge buying into
oilfield equipment at the top of the market and grossly overpaying for the French
generator company Alstom. The deal was predicated on cost synergies that the
French government wouldn’t allow, but Immelt when ahead anyway. Much of the
details on this transaction comes from the author’s version of “deep throat,” a
deal team member they identify as “Adam Smith.” To make things worse the
conventional power market was entering a secular decline as wind and solar were
gaining market share.
It is downhill from there. In order to
make their numbers the power division rejiggers its service contracts to
generate accounting earnings as opposed to cash earnings. It seems that GE was
utilizing something akin to gain on sale accounting for their service contracts
where they booked earnings upfront rather than over the life of the contract.
It this accounting that triggered a very negative analyst report from J.P.
Morgan’s Steven Tusa that opened up the gates of hell for GE.
Then, of a sudden, GE discovers it had a
long term care insurance problem that the executive team, the board and market
thought was behind them with the spin-off of Gentworth in 2004. Yet it was
there to the tune of $15 billion. That was the end of Immelt. In his place John
Flannery was appointed in 2018. He tried his best, but he was gone in 18
months. Then the board appointed Larry Culp, GE’s lead director and formerly a
very successful CEO at Danaher. He had his work cut out for him.
Perhaps what is most staggering is that
from 2004-2018 GE bought back $108 billion worth of stock as the market value
collapsed to $56 billion at this writing. All the while GE’s board was
mindlessly approving the share buybacks and Immelt’s acquisitions. You could
say that that it was complete abdication of authority while they were
collecting their $300k a year annual retainers. They weren’t the only ones who
missed the mark. I too owned shares of GE during most of Immelt’s reign as I
was blinded by the firm’s iconic image and reputation for good management.
As I said at the outset, Mann and Gyrta
have written an important book and should be read as a case study for
investment professionals and corporate managements alike. My one quibble would
be that an annotated stock chart would have been very helpful in visualizing
the history presented here.
For the full Amazon URL see: https://www.amazon.com/review/REM986Q7TZ4RO/ref=pe_1098610_137716200_cm_rv_eml_rv0_rv
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