GE Is Set To Expand Its Power Business With Alstom Acquisition

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General Electric (NYSE:GE) is set to take over French company Alstom’s gas and steam turbine businesses after the latter’s board chose GE’s revised bid over a competing joint bid from Siemens and Mitsubishi Heavy Industries. The French government has also supported this bid after disapproving the company’s previous bid, which sought to completely absorb Alstom’s power and grid businesses. In April, GE offered to buy Alstom’s power and grid businesses for an enterprise value of $13.5 billion. Combined with the $3.4 billion net cash held by these businesses, GE sought to take over Alstom’s power and grid businesses for a total sum of $16.9 billion. [1] But the French government disapproved the offer, citing concerns related to loss of jobs from France and dissolution of an iconic French brand. Over the next two months, Alstom received competing joint bid from Siemens and Mitsubishi Heavy Industries. But Saturday, June 21, Alstom’s board unanimously chose GE’s revised bid after GE CEO, Jeff Immelt, met with the French president Francois Hollande and also addressed the French parliament to resolve their concerns related to, among other things, loss of jobs from France as a result of this deal.

Here we highlight the key features of GE’s revised bid that we figure helped propel the Alstom board as well as the French government to vote in its favor. We also analyze the gains that GE will likely extract from this deal in the coming years. We currently have a stock price estimate of $26.20 for GE, marginally below its current market price.

See our complete analysis of GE here

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What Propelled The French Government To Support GE’s Revised Bid?

The revised offer from GE proposes to not completely absorb Alstom’s power and grid businesses. Instead, GE will only buyout Alstom’s gas turbine business and its steam turbine business which lies outside of France. Though these two businesses constitute the bulk of Alstom’s overall power business, the remaining portion of the company’s power business and its entire grid business will be rearranged to form joint ventures (JVs), in which GE will hold 50% stake and Alstom will continue to hold the remaining stake. We figure this unique structure that enables Alstom to hold onto significant parts of its power and grid businesses, even after acquisition of its core assets by GE, helped the French government come on board.

Under the earlier bid, GE was seeking to buyout Alstom’s entire power and grid businesses, which constitute about 70% of its top line. That would have left Alstom with only its transport business which constitutes the remaining 30% of its top line. Such a diminished Alstom was not acceptable to the French government which had bailed out the company a decade ago.

GE Still Benefits From The New Deal

Though GE would have preferred to completely buyout Alstom’s power and grid businesses, we figure the new structure will also be beneficial to the company.

In our opinion, GE’s key gain from this deal is the complete acquisition of Alstom’s gas turbine business, which will enable GE to scale up its own power business. Scale is an important factor in the global power sector as the world is continuing to add power generation capacity at a rapid pace. According to figures cited by GE, approximately 3,400 GW of power generation capacity will be added worldwide over the next decade. [2] Greater scale will enable GE to bag a greater share of this rapid growth in the global power generation capacity. Additionally, more than 50% of this global power generation capacity (about 1,600 GW) will be gas and steam turbine based. [3] GE is already a world leader in production and maintenance of gas turbines, but lacks in the steam turbine space. Alstom will fill this gap well in GE’s portfolio, as its steam turbines are not only highly advanced but also have a large installed base in Europe. Acquisition of Alstom’s steam turbine business (that lies outside of France) will also help GE expand its presence in the coal-fired power plant market, which is growing rapidly in many regions of the world, especially China and Africa. Together, the gas and steam turbine businesses of Alstom constitute the bulk of its overall power business, which had $15 billion in sales and $1.4 billion in income from operations in fiscal 2013, which ended on September 30, 2013. [1]

In comparison, GE’s power business constitutes the bulk of its power & water segment, which had revenues of $24.7 billion and operating profit of nearly $5 billion last year. So, the gas and steam turbine businesses of Alstom will add significant scale to GE’s existing power business. These businesses of Alstom are also profit making and have many existing long term maintenance contracts with power plant operators across the world. The importance of Alstom’s gas turbine business can also be gauged from the fact that GE and Alstom’s German competitor, Siemens, had also bid to fully acquire this business while proposing to form JVs with Alstom’s other businesses.

The remaining portion of Alstom’s power business, consisting of manufacture of equipment for power plants based on wind, hydro and nuclear energy, will be rearranged to form two JVs in which GE will hold 50% stake each. The first JV will include Alstom’s offshore-wind and hydro energy businesses, while the second JV will include Alstom’s production and servicing of equipment for nuclear power plants and Alstom’s steam turbine business for applications based in France. In the second JV, the French government will have a veto over issues related to security and technology of nuclear plants. We will have to wait and see if this veto power obstructs GE’s gains from this JV, in the future.

Separately, Alstom’s grid business, which had revenues of $5.2 billion and income from operations of $0.3 billion last fiscal year, will also be reconstituted to form a JV in which GE will hold a 50% stake. [1] Alstom’s grid business provides equipment and services for the build out of power grids. We figure like its power business, Alstom’s grid business also has huge growth potential, as the developing countries are likely to continue expanding their grid infrastructures through the next two to three decades. For instance, China’s per capita electricity consumption even after nearly two decades of rapid capacity addition is about a fourth of the U.S.. While India’s per capita electricity consumption is less than a tenth of the U.S.. [4] Thus, as these major developing countries add electricity generation capacities in the coming years, they will also need to expand their grid infrastructures, creating growth opportunities for Alstom’s grid business.

Next Steps & Other Concessions Which GE Had To Make To Get Alstom’s Core Assets

Overall, this new deal with GE will require Alstom to invest $3.5 billion in the new JVs. And, GE’s net cash outlay will be about $10 billion for its purchase of Alstom’s gas turbine business and its stake in the new JVs. [5] The deal will also need to be approved by Alstom shareholders, who in our opinion will likely vote in favor. As the company’s board has already unanimously approved the deal and the French government also supports it. The opinion of the French government matters since in mid-May, it enacted special laws which would have enabled it to block the deal. This development forced GE to bargain with the French government. The bargain resulted in, among other concessions, the possibility of the French government becoming the largest shareholder in Alstom. On Sunday, June 22, the French government reached an agreement with Alstom’s largest shareholder, Bouygues, to purchase upto 20% stake in Alstom. We figure the government is intent on becoming the largest shareholder in Alstom so as to more closely monitor this transaction which will see half of Alstom’s strategic nuclear business pass into GE’s hands. To have a government as a partner is definitely not ideal from GE’s perspective, as it could bring its own set of challenges in the future. But, we figure the enormous gains to be had from acquiring Alstom’s gas turbine business compelled GE to accept these terms. After the deal, GE will also have to sell its rail-signalling business to Alstom for $825 million to strengthen the latter’s transport business, which produces France’s iconic bullet trains, the TGVs. [5]

On its part, GE maintains that this acquisition, which will likely close in 2015, will add to its earnings in the first year itself, and will also bring synergies of around $1.2 billion annually by the year five. [5] We figure the acquisition also fits well with GE’s overall shift towards its industrial roots. Alstom’s industrial businesses will help GE achieve its target of generating 70% of its overall earnings from industrial businesses. As part of this shift away from finance businesses, GE will also divest its North American retail financing unit later this year.

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Notes:
  1. GE offers $13.5 billion enterprise value to acquire Alstom Thermal, Renewables, and Grid businesses, April 30 2014, www.ge.com [] [] []
  2. GE-Alstom alliance graphics, June 21 2014, www.ge.com []
  3. Alstom board chooses GE offer, June 21 2014, www.ge.com []
  4. List of countries by electricity consumption, April 30 2014, www.wikipedia.com []
  5. Alstom board chooses GE offer, June 21 2014, www.ge.com [] [] []