Understanding GE Capital’s Exit Plan

-15.37%
Downside
170
Market
144
Trefis
GE: General Electric logo
GE
General Electric

On April 10th, 2015, General Electric (NYSE:GE) announced it’s intention to exit out of most of GE Capital, to restructure its portfolio into more of a pure industrial company and moving away from its financial business. GE will be executing this plan by selling off majority assets held under GE Capital over the next twenty four months. The section of GE Capital that will remain at the end of this restructuring are those that directly relate to GE’s Industrial business. GE expects this decision to help the company achieve its long-term goals of growth.

Our current price estimate for GE is $27.81, approximately in line with its current market price.

GE’s Motivation To Divest Its Financial Business

GE along with GE Capital formed a unique business of being a large industrial as well as financial services company. At the end of 2014, GE Capital’s ending net investment was over $360 billion and it controlled assets worth approximately $500 billion. [1] [2] This made GE Capital the seventh-largest bank in the United States, a status which makes federal regulators view GE as a Systemically Important Financial Institution (SIFI). Consequently, GE was subject to tougher regulatory standards because a failure in GE Capital could impact the banking system in the United States. [3] Moving forward, GE wants to focus on its industrial business, and maintaining a large financial institution alongside in the form of GE Capital takes away from that focus.

In the aftermath of the recession, investors were seen shying away from GE shares due to the high risk and volatility associated with GE Capital. When financial institutions collapsed in the recession, GE Capital was among the institutions that the government had to bail out in order to prevent complete failure of the banking and finance structure in the country. Consequently, GE was pushed to slash down its dividends for the first time since 1938, a news that was not well received by its shareholders. [4] Even though GE Capital provided investors and shareholders exceptional return on value during better economic environment, they now perceive that GE Capital is responsible for making GE more risky and volatile than competing industrial firms such as United Technologies (NYSE:UTX).

GE expects that the divestiture of majority of GE Capital will help create more value for investors and shareholders in the future. GE’s industrial businesses tend to provide higher returns and with a smaller GE Capital supporting its industrial business, GE believes the company will achieve greater margins once the exit plan is complete. ((GE To Create Simpler, More Valuable Industrial Company By Selling Most GE Capital Assets, April 10th, 2015, General Electric))

Advantages and Disadvantages of Letting Go of GE Capital

The GE Capital exit decision comes with its advantages and disadvantages. On the positive side, at the other end of GE Capital’s exit, GE aims to derive 90% of its operating income from its industrial business. This is good news for both GE and its shareholders, as in recent times its industrial business has offered higher returns. In 2014, GE’s return on equity was 8.6%, which was lower than its cost of capital. It is anticipated that GE’s return on equity will be even lower this year. [5] The return on equity was particularly weighed down by GE Capital, and it is hence expected that letting go of GE Capital will breathe new life into the company and help increase its returns in the long-run. It will also free up capital within GE in the future, allowing the company to pursue acquisitions to enhance its industrial business. GE also announced a $50 billion share buyback of common stock, a news that has pleased its shareholders. Overall, the company expects to return more than $90 billion to investors through dividends, buyback and the Synchrony spin-off until 2018. ((GE To Create Simpler, More Valuable Industrial Company By Selling Most GE Capital Assets, April 10th, 2015, General Electric))

On the flip side, there are also certain disadvantages that will accompany the exit of GE Capital. The biggest one will be the shrinking of earnings that will occur with the sale of GE Capital’s assets. For example, the real-estate business under GE Capital alone bought in $1 billion in earnings in 2014. Even though GE Capital lowered the overall return on equity at GE, it contributed to 42% of GE’s earnings in the same year. GE is striving to reduce this dependence to 25% by 2016. [3] GE will also lose an important tax shelter that it enjoys due to GE Capital’s investments internationally. While last year GE’s overall tax rate came to about 10%, it is expected to be in the mid to high 20’s moving forward with the sale of majority of GE Capital’s assets, making its tax rate more comparable to its industrial peers. [6]

Progress on the Exit Plan So Far

GE is moving fast on its decision to exit out of its financial services business. GE has already reached an agreement to sell bulk of Capital’s real-estate assets to funds managed by Blackstone. At closing, Wells Fargo will be acquiring a portion of the performing loans. This entire arrangement is valued at approximately $26.5 billion. ((GE To Create Simpler, More Valuable Industrial Company By Selling Most GE Capital Assets, April 10th, 2015, General Electric)) GE is also reportedly in talks with Element Financial for the sale of its fleet assets, which is expectedly to close by the end of the quarter. Element and GE have worked together in the past when the former bought the latter’s Canadian fleet assets in 2013 for 570 million Canadian dollars. [7] And with the new month, GE has launched a bidding process for much of what remains.  Though GE initially indicated that it anticipates to close the majority of its financial assets sale by 2017, the market for purchase of their assets is looking good and they now expect to complete majority of this process in 2016. [8]

View Interactive Institutional Research (Powered by Trefis):

 

Relevant Articles
  1. What’s Next For General Electric Stock After 70% Gains In A Year?
  2. Down 20% This Year Is RTX Stock A Better Pick Than General Electric?
  3. Should You Pick General Electric Stock At $110 After A Solid Q3?
  4. After An 18% Top-Line Growth In Q2 Will General Electric Stock Deliver Another Strong Quarter?
  5. Is General Electric Stock A Better Pick Over Its Sector Peer?
  6. Will General Electric Stock Rise Post Q4?

Global Large CapU.S. Mid & Small CapEuropean Large & Mid Cap

 

More Trefis Research

Notes:
  1. GE To Create Simpler, More Valuable Industrial Company By Selling Most GE Capital Assets, April 10th, 2015, General Electric []
  2. GE Capital Company Overview, GE Capital []
  3. GE Seeks Exit from Banking Business, April 10th, 2015, Wall Street Journal [] []
  4. GE cuts dividend for first time since 1938, February 27th, 2009, Financial Times []
  5. GE: The Industrial Logic of Exiting Finance, April 10th, 2015, Wall Street Journal []
  6. Price of Selling GE Capital? Tax Breaks, April 13th, 2015, Wall Street Journal []
  7. GE in talks with Element Financial on fleet assets sale: Bloomberg, May 27th, 2015, Reuters []
  8. GE speeds up target for GE Capital finance asset sales, May 20th, 2015, Business Insider []