The GE of the Future Remains an Open Question

(Bloomberg Opinion) -- Another General Electric Co. earnings presentation has come and gone, and we still don’t have answers to key questions around open-ended insurance liabilities or the future cash flow and structure of the company. After posting a $300 million deficit in the first nine months of the year, GE generated a greater-than-anticipated $4.9 billion in adjusted industrial free cash flow in the fourth quarter. The company was also able to cross one liability off its list of unknown horrors by announcing a $1.5 billion settlement with the U.S. Justice Department related to its WMC subprime mortgage business. That’s all fine and well, but it’s hard to contextualize those announcements in the absence of 2019 guidance and a more thorough update on whether the $15 billion GE has committed to shoring up its legacy long-term care insurance reserves will be sufficient.

Yes, the better-than-expected adjusted industrial free cash flow to close out the year creates a stronger base from which to calculate 2019 numbers, but that number is based on a cherry-picked definition that Culp’s predecessor John Flannery came up with in an attempt to satisfy investors’ demands for greater transparency. And it’s somewhat meaningless without any clarity on the cash-flow situation at GE Capital. I appreciate new CEO Larry Culp’s desire to avoid giving guidance he can’t stick to, but there was scope for him to set a very low bar, and his unwillingness to do so suggests the challenges in the power unit and GE Capital run deeper than the current share price would suggest. The pop in GE’s shares on this earnings news makes even less sense against the backdrop of the stock’s 20 percent rise leading up to earnings. That was largely on speculation about a potential sale of its GECAS jet-lessor unit at an alleged $40 billion valuation that seemed unlikely and now has been definitively ruled out by Culp.

On the topic of asset sales, Culp reiterated GE’s plan to sell as much as 49.9 percent of its health-care unit via an IPO but didn’t address the status of its previous proposal to spin or split off the remaining equity to existing shareholders. Read more here and here for my thoughts on that. GE this week also announced it’s shifting its grid and hybrid assets from the power unit into its renewable-energy division to ease customer access to “the most diverse and broadest” suite of products in the industry. This is about cost cuts and eliminating layers of management, but it also brought to mind the kind of language companies use when they want to position businesses to stand alone. Flannery’s argument for keeping renewables in the fold was that wind turbines share technological similarities to jet engines and gas turbines. That’s worth something, but rival Siemens AG still saw fit to turn its renewable-energy business into a separate publicly traded entity by merging it with Spain’s Gamesa Corp. in 2017. That combination – in which Siemens retains a 59 percent stake – hasn’t exactly been a smashing success amid growing competition, price pressure and governance issues, but it’s something to think about. On this question about the value of technological overlap, as part of our Bloomberg TV series on GE this week, I asked former GE executive Bob Nardelli if he thought the power and aviation units could be split up. Watch for his response.

YOU’RE UP, YOU’RE DOWN
There was a plethora of industrial earnings this week, and the general takeaway is that growth is cooling from the blistering pace set in 2018. For the time being, though, the slowdown seems relatively contained to a few trouble spots – namely China, Europe, electronics, autos and some housing. Honeywell International Inc.’s fourth-quarter results embody this dynamic: Its aerospace division continued its impressive growth with a 10 percent surge in organic revenue, echoing strong numbers from Boeing Co. and GE’s aviation unit earlier in the week. But sales at Honeywell’s building-technologies unit were up just 1 percent amid declining demand for air and water products in China. The post-earnings stock reactions have tended to be driven more by sentiment than the actual numbers: Caterpillar Inc. plunged 9.1 percent after its weak earnings outlook spooked investors, whereas shareholders took 3M Co.’s fourth guidance cut in a year in stride because this round of slashing wasn’t as bad as feared. The risk is that when the slowdown starts to broaden, the impact can be swift and ferocious. Commentary from bellwethers such as Stanley Black & Decker Inc. and FedEx Corp. suggests that shift may be closer than we might think. Honeywell CEO Darius Adamczyk said his company was preparing for an “uncertain economic environment” in 2019. As a side note, I wanted to flag the continued double-digit sales growth in Honeywell’s Intelligrated warehouse-automation business and Roper Technologies Inc.’s 9 percent organic revenue bump in the fourth quarter as proof that digital investments done right can pay off.

HOLLOW VICTORY
Caterpillar decided to include restructuring costs in its 2019 guidance, reversing a practice of stripping out these expenses that industrial analysts loved to hate. It’s making the move because restructuring costs are expected to fall to “normalized” levels this year; Caterpillar reported $386 million in such expenses in 2018, down from $1.3 billion in 2017. This moderation would appear to back up the idea that spikes in costs from firing people and closing factories are in fact one-time and not just a traditional cost of doing business in cyclical industries. But to believe that, you would have to agree with management that Caterpillar’s cost cuts have better positioned it to weather the effects of a downturn, whenever one should occur. Remember that “high watermark” comment signaling peak earnings that spooked the markets last year? That was based on an assumption that input costs would rise more than Caterpillar’s prices – which is what happened in the fourth quarter, despite a mid-year price increase – and a ramp-up in R&D spending and digital investments. So time will tell how much of its margin gains Caterpillar can retain. Broadly speaking, though, if Caterpillar can convince more industrial companies to stop stripping out restructuring expenses, I’m all for it.

DEALS, ACTIVISTS AND CORPORATE GOVERNANCE UPDATE
Apollo Global Management
is reportedly tapping outside investors and some of its own partners for additional equity contributions after banks struggled to find investors for the $275 million loan supporting its purchase of some of GE’s energy finance assets. Banks have reportedly been forced to offer discounts and improved terms to clear out a backlog of risky leveraged loans that became less desirable as economic worries mounted. Concessions like Apollo’s help clear the pileup and keep the buyout financing market functioning for future deals. But this further underscores the challenges Apollo or another private equity buyer would have faced in raising enough funds to purchase the GECAS jet-lessor unit.

Berry Global Group Inc. is contemplating spoiling Apollo’s $4.4 billion takeover of U.K. packaging company RPC Group Plc with a counterbid. This is a bit awkward because Berry used to be owned by Apollo, which bought the company in 2006 and then took it public in 2012. But we talked last week about how Apollo’s bid was on the low side and shareholders were squawking about being poorly compensated for a future turnaround. Apollo spent months on due diligence and has declared its offer final, which under British takeover rules limits its ability to raise its bid. My colleague Chris Hughes points out Apollo could have added a qualifying clause that would have allowed it to trump a counter-bidder; by choosing not to do so, it basically laid out the welcome mat for alternative suitors. That may not be such a bad thing if the price rises to uneconomical levels, Chris writes, and he’s skeptical of Berry’s ability to find cost savings to justify a meaningful higher bid.

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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