Just How Ugly Is GE’s Balance Sheet?

(Bloomberg Opinion) -- A reworked General Electric Co. deal says a lot about new CEO Larry Culp’s approach to a turnaround.

The embattled industrial conglomerate announced on Friday that it was updating the terms of its transportation unit’s pending merger with Wabtec Corp. GE will still receive a $2.9 billion cash payment up front, but it’s reducing the allocation of shares in the combined company to be spun off to its shareholders and keeping a bigger stake for itself. GE’s ownership in the new Wabtec will rise to 24.9 percent, compared with 9.9 percent previously. The net of this is that the deal will yield more cash that GE can use to chip away at its estimated $100 billion in net liabilities. GE says its stake in Wabtec is worth $3.4 billion at current prices, and it can sell that down subject to staggered lockup provisions.

It’s highly unusual to see companies revise deal terms so significantly this late in the game. The Wabtec deal was announced last May and at the time, the companies expected it to close in early 2019. GE is still expecting a February completion for the merger, but the fact that it’s ripping away equity rights from its own investors just a month beforehand is the strongest sign to date of just how desperate the company is for cash. In light of that, the locomotive business likely won’t be the only GE asset Culp tries to milk further.

Just How Ugly Is GE’s Balance Sheet?
Former CEO John Flannery carefully crafted the Wabtec transaction to provide a balance between giving GE the cash it needs and saving some upside for its aggrieved shareholders. He repeated this blueprint with his plans for the health-care unit: Flannery’s June proposal calls for the sale of a 20 percent stake in the business via the public markets, with the rest spun or split off to shareholders. Culp has already said he’s considering selling as much as a 49.9 percent stake in the health-care business instead. That’s the maximum amount GE can sell and still have the spinoff be tax-free to shareholders.

In the new Wabtec deal, the spinoff portion will be considered a taxable dividend, suggesting the interests of GE shareholders are increasingly taking a back seat to those of its creditors in the mind of the CEO. This suggests we could see a similar revision to the health-care business divestiture, with GE possibly scrapping the spinoff altogether. GE could follow a model similar to what Siemens AG did with the separation of its Healthineers business and retain a stake that it could sell down over time for more resources, helping to offset some of the sting of losing one of its best cash-flow generating businesses.

Just to take a step back, though, the Wabtec deal revision follows Culp’s decision to shrink GE’s quarterly dividend down to a mere penny per share and to accelerate the divestiture of the company’s majority stake in the merger of its oil-and-gas assets with Baker Hughes. He also sold GE’s stakes in Pivotal Software Inc. and NeoGenomics Inc. While I appreciate Culp’s sense of urgency in trying to alleviate GE’s debt burden and put the company on a healthier path, this race to find cash in every possible nook and cranny suggests the balance sheet is in an even uglier state than investors may be aware. That’s especially true for those shareholders who pushed GE’s stock up a whopping 16 percent this year through Thursday with little substantive news.

It seems likely that GE will now need to pump meaningfully more money into its GE Capital finance arm than the $3 billion it had earmarked. The biggest unknown is GE’s legacy long-term care insurance operations. All signs are pointing to the company’s initial estimate of a $15 billion reserve shortfall as not being nearly conservative enough. We should get more details on this when GE releases its fourth-quarter earnings next week, but Culp is already laying down telling — if troubling — guideposts. 

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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