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General Electric: From business icon to basket case

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Saturday, October 6, 2018 – Page B1

There's an old saying in investing: Don't try to catch a falling knife.

As if General Electric Co.

investors need to be reminded.

During the longest bull market in U.S. history - a nearly decade-long run that has seen the S&P 500 more than quadruple from its 2009 lows - GE has been a spectacular bust. Its shares now fetch less than one-third of their prefinancial crisis value, a crushing comedown for the industrial giant that was once the world's largest company and whose stock was widely viewed as a safe, bluechip investment.

Adding to GE's ignominy, the company has cut its dividend twice in the past decade, and another dividend cut now appears virtually certain. As if to add an exclamation point to GE's struggles, in June, it was kicked out of the Dow Jones Industrial Average, losing a prestigious position it had held since the Dow's founding 122 years ago. Never mind a falling knife: Investing in GE has been like trying to catch a falling fridge.

This week, the turmoil only intensified when GE announced that chair and chief executive John Flannery is leaving after little more than a year on the job, to be replaced by former Danaher Corp. CEO Lawrence Culp.

GE also warned that its cash flow and earnings in 2018 will fall short of previous guidance, citing weakness in its troubled GE Power business, which is facing a writedown of "substantially all" of its US$23-billion in goodwill.

"This is a slow-moving train wreck. To expect John Flannery to stop it and put the wheels back on the track in a year was unrealistic," Marshall Meyer, emeritus professor of management at the University of Pennsylvania's Wharton School, said in an interview.

For all the pain investors have already endured, GE is still nowhere close to being fixed.

"While the change in leadership brings the company a step closer to where it ultimately needs to go for a real reset, the reset itself, and how potentially bad it actually is, is still in front of them ... including a likely dividend cut and potential equity raise," Stephen Tusa, an analyst at JPMorgan Chase & Co., said in a note this week.

How did GE, a company that once symbolized the United States' industrial might, become such a mess?

Analysts and academics say GE's collapse reflects, to a large degree, a management culture that came to rely on mergers and acquisitions as the main engine of GE's growth. The focus on dealmaking led to a series of strategic missteps and ill-timed investments - many completed at or near market tops - that came back to haunt GE when the expected returns failed to materialize and assets were written down or sold off for less than GE paid.

Some observers lay most of the blame for GE's struggles at the feet of Jeffrey Immelt, who ran the company from 2001 until 2017.

But the roots of GE's struggles date back even further, to the era of Mr. Immelt's predecessor, Jack Welch, the larger-than-life CEO who oversaw massive growth in the company's finance arm, GE Capital.

Under Mr. Welch, GE expanded the finance unit at twice the rate of GE's other businesses, building it into a sprawling financial services empire that eventually came to encompass credit cards, mortgages, auto loans, equipment leasing and commercial real estate financing. GE Capital continued to grow rapidly under Mr.

Immelt, and by 2008, it had about US$700-billion of assets and was generating nearly half of GE's earnings.

Then came the credit crisis, which turned GE's main growth engine into a massive financial burden. With credit markets seizing up, GE did an emergency US$15-billion equity offering, including the sale of US$3-billion of preferred shares - bearing a princely yield of 10 per cent - to Warren Buffett's Berkshire Hathaway Inc. Less than five months months later, in February, 2009, GE cut its common share dividend for the first time since the Great Depression. (Berkshire no longer owns a stake in GE.)

The aggressive expansion of GE Capital - much of which has since been sold off - was far from the only GE investment that suffered from extraordinarily bad timing.

From 2010 to 2014, when the price of oil averaged about US$100 a barrel, GE made a series of acquisitions in the energy industry. Even after the price of oil collapsed, GE doubled-down on energy in 2016 by acquiring oilfield-services giant Baker Hughes Inc. and combining it with GE's oil and gas assets. The merged company suffered from a clash of cultures and quickly lost market share, and this past June, GE announced that it would sell off its stake as part of a broader effort to streamline GE's structure and reduce debt.

Yet another example of bad timing was GE's US$10.6-billion acquisition of Alstom SA's power business in 2015. In typical fashion for GE, the deal was consummated just as demand for gaspowered turbines - one of Alstom's key products - had begun to decline, hurt by the rise of renewable energy.

With Baker Hughes and GE's power division weighing heavily on its earnings, GE cut its dividend again in November, 2017, and announced plans to sell off US$20-billion of assets, including its storied locomotive and lightbulb businesses. The company had previously sold its appliance unit for US$5.6-billion to China's Haier Group, which continues to market appliances under the GE name.

GE made plenty of bad decisions, but "there is an element of really bad luck here. They happened to be in a bunch of industries at the wrong time," Wharton's Prof. Meyer said. "The combination of bad luck and poor choices takes a corporation that had been an icon for the U.S.A. into extremely perilous waters."

Can GE finally right itself? Or will it continue to sink? The appointment of Mr. Culp, GE's first outside CEO, is giving some investors hope. During his tenure from 2000 to 2014 at Danaher - a global manufacturer of diagnostic equipment, dentistry tools and other health-related technology products - revenue and market capitalization both rose fivefold.

"We believe that investor confidence in [Mr. Culp's] strategic vision and operating excellence should put a floor in GE's stock," RBC Capital Markets analyst Deane Dray said in a note to clients. "To be clear, there is still much to fix at GE, but the market can now have full confidence in the senior leader at the helm."

Reflecting investors' newfound optimism, GE rallied about 7 per cent on Monday after Mr. Culp's appointment as CEO. The shares extended their gains over the next four days. Investors are now awaiting details of how Mr. Culp plans to fix GE's extensive problems. It's not clear if he will press ahead with Mr. Flannery's breakup plan, which called for GE to focus on three businesses - jet engines, electric power generators and wind turbines - or if he will also retain other businesses such as GE Healthcare, given his experience at Danaher.

The new CEO will also have to address deepening troubles in GE's power division which, in addition to facing challenges from wind and solar, is grappling with an "oxidation issue" that led to a recent blade failure in one of its new gas-fired power turbines.

Several of the new turbines have been taken offline while GE tries to implement a fix.

Highlighting the many hurdles GE still faces, Standard & Poor's this week downgraded GE's debt by two notches, to triple-B-plus from A. GE's credit rating - which had enjoyed coveted triple-A status until the financial crisis hit - now sits just three notches above speculative or "junk" levels.

It's yet another reminder of how far GE has fallen, and, perhaps, a warning sign for investors who believe it's finally safe to grab hold of the knife.

Associated Graphic

A man walks past General Electric Co.'s global operations centre in San Pedro Garza Garcia, Mexico, in May, 2017.


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