GE Nuggets to Chew on From Its Annual Report

(Bloomberg Opinion) -- It might surprise you to learn that General Electric Co.’s mammoth 172-page annual report was actually on the shorter side, as far as these things go. The filing had the fewest number of pages since GE’s 10-K report for 2008, but what this year’s data dump lacked in sheer scale, it made up for in added transparency. Most notable were the added disclosures on GE’s insurance liabilities. The company once again avoided adding materially to the $15 billion reserve shortfall in its legacy long-term care insurance operations that it disclosed last January, but GE’s assumptions for that business look far from conservative and it may only be setting itself up for a string of negative surprises in the future. A more sober outlook for investment yields and the rate at which insurance claimants get healthier could force the company to put up as much as $12 billion in additional reserves. 

Also of note, GE specifically called out an economic slowdown in China among the risk factors for its business, a change from the previous year. One of the troubling things about GE’s unraveling is that it’s occurred at a time when most industrial companies and the economy at large are doing quite well; that may soon change. GE also flagged increased costs in its health-care business due to U.S. tariffs on equipment and components imported from China and said it’s working to mitigate that by moving operations elsewhere. I point this out because after a series of industrial earnings rounds where nary a conference call passed without a mention of tariffs, GE hasn’t talked as much about the issue because it’s been so consumed with bigger problems. As a side note, a study by the Institute of International Finance found that the trade war has put the U.S. on pace for $40 billion a year in lost exports, with American exporters winding up harder hit than their Chinese counterparts. 

In other news, GE wasn’t so great at doing deals under former CEO Jeff Immelt. In November, current CEO Larry Culp kickstarted the unwinding of the company’s stake in the merger of its energy assets with Baker Hughes, selling a chunk of stock at what was at the time the lowest stock price since the deal was completed. GE booked a pre-tax loss in equity of $2.2 billion from that. Once GE’s stake in Baker Hughes drops below 50 percent (it’s 50.4 percent currently), the company will have to deconsolidate the segment from its results and recognize the difference between the fair value of the remaining interest and what it paid for it. Baker Hughes shares have rebounded somewhat since the stake sale, but if they’re in the $23 range they were in at the end of January when GE sells more, the company could be looking at an impairment of $8.4 billion. GE also disclosed that Silver Lake paid $400 million for a 90 percent stake in its ServiceMax field-technician software business in a deal announced last year. The implied valuation for the entire entity is roughly half the $915 million GE paid for ServiceMax in 2017. The company expects to record a pre-tax gain of $200 million in the first quarter of 2019 on the Silver Lake deal, seemingly because it had previously taken a writedown on the ServiceMax transaction as part of the $22 billion goodwill charge it booked in its power unit last year.

The 10-K filing is also a good time to remind ourselves of intricate connections between the industrial parent and GE Capital. In 2018, GE Capital supported $10.1 billion of GE industrial orders, primarily in renewable energy, power and health care, down from $14.4 billion in 2017. GE Capital acquired 64 aircraft with GE-made engines in 2018 from third parties to lease to others and paid GE Aviation $400 million for spare engines and parts. GE Capital also has a $1.2 billion net book value of engines that it leases back to GE Aviation. This just underscores how complicated and potentially painful it is to unwind the industrial-financial hybrid that Jack Welch created and Jeff Immelt milked for maximum benefits. Many investors hope GE Capital eventually no longer exists, but that scenario would force a meaningful rethink of the way GE does business. Along those lines, GE brokered a deal in January with MUFG Union Bank, N.A. to sell a supply-chain finance program that allowed the industrial operations to tap into GE Capital’s liquidity to settle supplier invoices early and take advantage of early-pay discounts. GE suppliers can transition to an MUFG-run program over the next 18 to 24 months, but GE cautioned that its cash flow could be adversely affected if some choose not to.

PENNY FOR YOUR THOUGHTS
A group of banks led by JPMorgan Chase & Co. and Barclays Plc this week launched the first part of a $10 billion financing package for Brookfield Asset Management Inc.’s acquisition of Johnson Controls International Plc’s battery business. It’s the largest deal to hit the leveraged-finance market since September, when lenders put together a $13.5 billion package for Blackstone Group LP’s takeover of Thomson Reuters Corp.’s financial data unit, and it’s a key test of investors’ appetite for deals that were underwritten in much more borrower-friendly times, according to Bloomberg News’s Laura Benitez and Davide Scigliuzzo. The private equity buyers of the Johnson Controls division may end up sourcing more funds via secured bonds rather than the leveraged-loan market, following Dun & Bradstreet and others’ lead in redirecting their focus to the bond market. Apart from the broader macroeconomic and lending implications, the outcome of the Johnson Controls deal could have implications for private equity buyers’ ability to compete for large businesses sold in any future round of industrial asset sales – and by extension, companies’ willingness to explore those divestitures.

DEALS, ACTIVISTS AND CORPORATE GOVERNANCE UPDATE
GE  this week put plans for an initial public offering of its health-care unit on ice and instead announced it would sell its biopharmaceutical business to Danaher Corp. for $21 billion in cash plus the assumption of $400 million in pension liabilities. Danaher appears to have gotten the better deal: the purchase price is 17 times the GE business's expected 2019 Ebitda, a discount to comparable peers, according to Bloomberg Intelligence analyst Karen Ubelhart. Danaher's shares climbed 8.5 percent on news of the deal, an almost unheard-of gain for a buyer. But the sale offers GE the certainty of cash, while an IPO would have left the company subject to the whims of the market. A rocky December helped drive global volume of IPOs and share placements in January and February 60 percent lower than the same period a year ago, notes my Bloomberg Opinion colleague Chris Hughes. In GE’s case, trading an IPO for Danaher’s cash shows CEO Culp is putting creditors first. It’s the right thing to do in the face of GE’s giant debt load, but it meant Culp had to sacrifice one of the company’s faster-growing, most promising assets. The decision to keep the core imaging operations in the fold suggests GE needs that business’s cash flow to offset the ongoing downturn in the power market and possible drags at GE Capital.

Wabco Holdings Inc., a maker of driver-assistance and vehicle-safety systems for trucks, is in talks to sell itself to ZF Friedrichshafen AG. This would be ZF’s largest deal since acquiring TRW Automotive Holdings Corp. for $12.9 billion in 2015. Wabco and ZF reportedly were in advanced negotiations for a deal in 2017, but there’s reason to think a transaction may come to fruition this time around. The shift toward self-driving and electric cars plays right into Wabco’s wheelhouse. ZF knows it needs to adapt and evolve from its transmission background, vowing last year to invest 12 billion euros ($14 billion) over the next five years on autonomous and electric vehicle technology. Wabco’s own hefty R&D budget had been weighing on its profits and with ZF already giving the green light to increased spending, it may be better off as part of that larger enterprise. The sticking point may be valuation. Analysts are estimating a purchase price in the range of $8 billion to $9 billion. You can argue such a premium is justified because Wabco’s technology focus should drive sales growth even as the truck markets slow. But it’s always risky to strike deals at the peak.

Terex Corp. agreed to sell its Demag mobile cranes business to Tadano Ltd. for $215 million. The asset had been an earnings drag for Terex, but offloading it removes the opportunity for a recovery in that business and raises questions about the longer-term strategic direction of the company’s remaining crane assets, says Robert W. Baird & Co. analyst Mircea Dobre. That’s especially true for the tower and rough-terrain crane products that it moved into its not-particularly-core-sounding “corporate and other” segment. The divestiture follows the 2017 disposals of its backhoe loader and dumper business to Mecalac and the material-handling and ports division to Konecranes Oyj. That $1.4 billion port-equipment deal replaced plans for a full-blown merger between Terex and Konecranes after a competing bid from China’s Zoomlion Heavy Industry Science and Technology Co. complicated discussions. Zoomlion later walked away, accusing Terex of having inflated valuation expectations, while the target questioned its financing abilities.  

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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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