GE Finally Slays the Beast That Jack Welch Built
(Bloomberg Opinion) -- General Electric Co. is finally ditching its conglomerate structure, ending an era of corporate sprawl that even in the best of times never made much sense and in the worst of times brought the company to the brink of destruction.
The $120 billion industrial giant will split into three companies: The health-care division will be spun off in early 2023, followed by an amalgamation of GE’s gas and wind turbine businesses and its remaining digital assets in 2024. Those divestitures will leave the remaining company focused on jet engines. Nothing about GE is ever simple, though: The company is still funding the surprise $15 billion reserve shortfall in its legacy long-term care insurance business that it disclosed in early 2018, and those assets will remain with the aviation operations. That liability is no longer the unpredictable money suck it once was, but it does muck up the story a bit — at least until GE can figure out how to pay someone to take this headache off its hands. Even so, with three separate smaller companies, there will be much less room to hide unwelcome surprises like the insurance funding gap and the earnings statements will be inherently less messy, hopefully bringing an end to a long legacy of obfuscation. It has been a trying road, but GE at long last has a pathway to an identity bordering on normal, thanks to the deft decision-making by Chief Executive Officer Larry Culp.
Culp intends to stick around through the divestitures and will lead the remaining aviation company. His current contract runs through at least 2024 with an option for a one-year extension. The health-care spinoff will be run by incoming unit CEO Peter Arduini and the standalone energy operations will be overseen by the current power division CEO Scott Strazik.
Some big question marks remain. The capital structure for each of the GE entities will be determined “later,” as will their brand names and full leadership structures. For a company with GE’s history, scale and liabilities, those details are important. Untangling the industrial behemoth will result in one-time separation, transition and operational costs of about $2 billion. For context, that is a little less than half of what GE expects to generate in free cash flow this year. Followers of the company may remember that former CEO John Flannery had previously laid out a plan to spin off the health-care business in 2018. Culp scrapped that scheme — in no small part because the company needed the health-care unit’s steady stream of cash flow to manage its mountain of debt and give it cover to turn around the struggling power unit.
The health-care business is less of a make-or-break asset than it once was: GE has since raised enough money to reduce its gross debt by more than $75 billion by the end of this year, most notably through the divestitures of its biopharma business and GECAS jet-leasing operations. Meanwhile, the power unit has eked out a small operating profit for two consecutive quarters and is expected to start generating positive free cash flow in 2022, if not sooner. GE said on Tuesday that it expected the combined aviation and energy businesses to generate a high single-digit cash flow margin by 2023 with or without contributions from the health-care unit, underscoring the operational improvements Culp has made. But even before the recent periods of crisis, both the power and aviation divisions benefited from the ability to tap into the cash-flow power of the rest of the company to finance expensive development programs that often stretch for years and weather their more volatile operating environments.
The power unit is no longer threatening to sink the company, but with so much of the business still linked to fossil fuels, its long-term future is less than lustrous. GE warned last month that the renewable energy unit was unlikely to post a profit by its 2022 target and would burn cash this year. Of the three businesses, the energy entity will need to carry the least amount of debt, Culp said Tuesday on a call with investors to discuss the breakup plan. The jet engine business will recover from the pandemic slump, but that same slump underscores why it was helpful to have the health-care assets around. The aviation unit is also under pressure to prove it can still generate pre-pandemic levels of cash flow and profits without selling spare jet engines to the GECAS lessor arm or other off-balance sheet subsidiaries at a high margin.
“In our view, almost every business that has come out of GE and seen the light of day in a public market setting has disappointed, while some have underperformed materially as stand alone, a function we think of more meaningful and useful disclosure,” JPMorgan Chase & Co. analyst Steve Tusa wrote in an October report analyzing a potential breakup. Is this time different? Can all these businesses be successful and command a higher valuation as independent entities? We’re about to find out.
Read more: Covid Is Casting Conglomerates in a New Light
In an interview last year, Culp said the pandemic had caused some investors to rethink their dislike of conglomerates. “I’ve seen a bit of a shift with investors, some of whom were on that ‘Spin it all’ bandwagon, to ‘What about a little bit more balance, a little bit more thinking through the cycle?’” he said. This breakup plan would appear to fall more into former camp than the latter. And yet this was truly the only way that the GE saga could end. Despite Culp’s best efforts to move the company toward a more decentralized operating structure that incentivized accountability (and he made more progress than most expected), GE still represented the worst of the conglomerate genre. It was just too complicated for its own good. Culp’s predecessor, Flannery, knew this; so, too, did former CEO Jeff Immelt, who took over for the true originator of the mess, Jack Welch. But they were both ultimately thwarted by the very complexity they were trying to solve — and some rather poor judgment calls on their part.
Culp will be remembered as the CEO who shrunk the 129-year-old industrial leviathan to a fraction of its former self, but he will also be remembered as the one who gave GE a fighting chance of being relevant in the modern economy.
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.
©2021 Bloomberg L.P.