General Electric: 20 Years of Value Destruction
In announcing General Electric’s split into three companies, GE Chairman and CEO H. Lawrence Culp Jr. stated, “By creating three industry-leading, global public companies, each can benefit from greater focus, tailored capital allocation, and strategic flexibility to drive long-term growth and value for customers, investors, and employees. We are putting our technology expertise, leadership and global reach to work to better serve our customers.” Stated frankly, the purpose of General Electric splitting into three companies was simply to create shareholder value. But did it even succeed?
Shareholder Value has been Destroyed
Ever since Jack Welch relinquished the helm of GE, the company has lost its soul: resorting to accounting tricks, buying back shares, reducing the importance of GE Capital and selling part of its healthcare business. In other words, GE failed miserably. Seventy-five percent of GE’s value was lost under former CEO Jeff Immelt’s leadership. The stock dropped from a peak of $499 in 2000 to $60 when he left.
Splitting the company into three entities was aimed at enhancing disgruntled shareholder value. Bankers absolutely loved it (they amassed $7.3 billion in fees from GE in twenty years). As a result of the split, Royal Bank of Canada announced a 20% increase in GE’s value. Shareholders did not like it. Instead of increasing in value, the GE stock ended up lower than the value the week of the announcement.
Managerial Greed
After a three-year probe into allegations of misconduct, it is unlikely that GE’s board will end up clawing back compensation from Mr. Immelt or other executives over GE ’s accounting issues (or Mr. Immelt’s use of a backup corporate jet). At his peak with GE, Mr. Immelt earned an annual salary of $22 million and more than $200 million in compensation during his tenure. The juxtaposition of Mr. Immelt’s salary with the drop in the stock price under his leadership from $400 to $60 is extraordinary.
GE shareholders rejected top executives’ compensation packages, including a payout of as much as $230 million to Mr. Culp, at the company’s annual shareholder meeting in May 2021. While the shareholder vote was non-binding, the move was a rare rebuke of a major corporation’s handling of its executive pay. It comes after GE laid off 20,000 workers last year.
The primary beneficiary of the GE split will be none other than Mr. Culp himself. The move from CEO to Chairman will trigger a payment between $400 and $1,300 million (between 4 and 13 million shares), after receiving one of the highest total compensations — $75 million — of any CEO. As usual, no disclosure of the personal benefits of a failed management was made.[1]
One of the main drives of GE under Mr. Immelt was digital transformation. It failed. “Immelt followed fads, they say, paying top dollar to acquire the hot businesses of the moment,” said Geoff Colvin, from Fortune.com. The Alstom acquisition was one of them. It prompted massive write-offs at GE Power.
“GE is a fable of what happens when managers try to run an industrial business like a financial business, and become too much in thrall to the headlong pursuit of shareholder value (which GE’s former chief executive Jack Welch, long an ardent exponent, later repudiated as ‘the dumbest idea in the world,’” wrote the editorial board of the Financial Times.[2]
A Board Failure
The Board of Directors of GE has always been one of the most prestigious. It was also one of the most complacent in the history of Corporate America. Each and every one of its members were the epitome of the corporate establishment that would never challenge the CEO. They recently started to wake up, but it may have been too late — they should have reacted to the failure of Mr. Immelt.
Now, the Board should think twice about the split of the Empire. Did they really exercise a serious due diligence about the consequences of this extraordinary move? Which criteria did they take into consideration other than the failed shareholder value pretended to be the motivation?
I, for one, consider that the weakest link of U.S. corporate governance is the nomination process, the composition, and the complacency of the Board of Directors. Having sat on numerous boards in Europe, America, and Asia, I can testify that retaliation against outspoken board members is not uncommon.
At GE, the falling stock price itself should have been the clearest warning signal to the board that the management had lost its way. Keeping a failing CEO for sixteen years is predominantly a board failure.
Manipulation of Accounting
Even Warren Buffett, in 2018, stated that GE accounting was not a model. The massaging of quarterly earnings was a piece of art, even under Mr. Welch. Shouldn’t one expect that KPMG, GE’s external auditors, would challenge some practices that only powerful large companies can get away with?
LTSAs (Long Term Service Agreements) are a large part of GE’s business model (sell low- or even negative-margin equipment, then generate long-term revenue from service agreements). This model is a cause of litigation with the US Department of Justice and the SEC — GE might have overestimated its expected revenues. GE paid a $200 million fine levied by the SEC in 2020, which stated:
GE misled investors by describing its GE Power profits without explaining that one-quarter of profits in 2016 and nearly half in the first three quarters of 2017 stemmed from reductions in its prior cost estimates. The order also finds that GE failed to tell investors that its reported increase in current industrial cash collections was coming at the expense of cash in future years and came primarily from internal receivable sales between GE Power and GE’s financial services business, GE Capital.[4]
Massive Share Buyback
The massive share buyback leveraged GE and happened at a price that was way above the depressed market price. It was manipulation, financed by debt.
This table shows how much value was lost through share buybacks. I have been advocating a new approach to the regulation of share buybacks in a Columbia Law School blog.[5]
Culture and Conduct
The split of GE will not change its conduct and culture.
The dismantling of the powerful holding company is a risky initiative. It is the only listed company of the Group, holding 100% of its main subsidiaries is a cultural revolution. Having worked under the GE umbrella for a few years as head of the international division of the now-defunct Kidder Peabody, I could see firsthand how powerful the GE company was. Creating three newly listed companies is going to be a governance challenge.
The next three years until the dismantling is finalized will be a challenge and a transformation, as each of the three businesses now realize they will have the opportunity to manage themselves independently from a center.
It looks like renewed independence. But questions remained unanswered.
GE Capital is the financial services division of GE, focused on serving customers and markets aligned with GE’s industrial businesses. From emerging markets to developed economies, our focused team of finance experts connect capital to infrastructure and deliver innovative financial solutions that help make the world work better.
Furthermore, as I argued at the end of 2018, debt reduction has been massive but pension liabilities and goodwill will need to be treated with care.
Based on those considerations, one can understand why shareholders are skeptical about the announcement. Needless to say, the split will be tax-free.
Will the conglomerate discount disappear?
The dismantling of GE raises the question of the discount that conglomerates — and, for that matter, closed-end investment funds and listed private equity companies — have been tackling.
In a study published by BCG, a counter argument was raised:
“Many investors believe that conglomerates as a whole are worth less than the sum of their parts. A review of historical stock market data shows that this ‘conglomerate discount’ applies about 55% of the time. This means, of course, that a little less than half the time the discount does not apply. More important, a select group of diversified companies trades at a premium.”[6]
We will have to wait until 2024 to find out whether GE was a discount or a premium conglomerate. The jury is out.
[1] https://www.marketwatch.com/story/ges-ceo-could-make-a-fortune-when-the-company-splits-into-3-11636638951
[2] https://www.ft.com/content/c8daf298-ef2e-11e8-8180-9cf212677a57
[3] http://fortune.com/longform/ge-decline-what-the-hell-happened/
[4] https://www.sec.gov/news/press-release/2020-312
[5] https://clsbluesky.law.columbia.edu/2019/04/29/do-share-buybacks-deserve-more-regulatory-scrutiny/
[6] https://www.bcg.com/publications/2017/corporate-strategy-value-creation-premium-conglomerates-sustain-suc
