The Year In Review: GE’s Power and Aviation Businesses Offset The Decline From Oil & Gas
The year 2016 was an eventful year for the heavy equipment manufacturer General Electric (NYSE: GE). GE’s overall industrial segments grew on the back of GE Power, GE Aviation and GE Renewable Energy, partially offset by a decline in the Oil & Gas and Transportation segments. GE shifted its gears towards digital business and launched its Predix platform this year. Thus, management stated to its investors that GE’s future lies in its digital business as much as it lies in its industrial segments. Among many acquisitions initiated this year, the biggest was the transaction with Baker Hughes (NYSE: BHI), which was announced in November 2016 in order to expand into new markets where the competition is less to survive the slumping oil industry. This deal is estimated to generate overall synergies of about $1.6 billion by 2020, due to the complementary nature of GE’s oil & gas and Baker Hughes businesses. This estimation is based on the assumption that oil prices will reach $60 per barrel by 2020. However, we believe that with OPEC deal to cap their oil production finalized in 2016, GE is likely to be the likely long-term winner from this deal.
Overall Business Grew On the Back of Power and Renewable Energy
GE’s industrial revenues grew nearly 6% in the first 9 months of 2016 compared to less than 0.5% growth observed last year. It was a significant improvement and was driven by strong performance of power and renewable energy segments. However, considering that the renewable energy constitutes just 3% of GE’s industrial profits, it becomes imperative to focus on GE power. GE power and GE renewable energy revenues saw about 27% and 51% growth respectively in the first nine months of 2016 primarily due to GE digital and Alstom-GE joint venture growth this year. However, this was partially offset by the decline of nearly 20% in both oil and gas and transportation segment due to the downturn in the oil industry. Due to this, GE’s investors remained skeptical on GE and its stock price fluctuated in 2016.
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So, what changed this year? First, Alstom-GE joint venture, which started its operations last year, started to pay off this year resulting in momentous revenue growth for GE power and renewable energy segment. Second, GE aviation also grew in 2016 due to newly acquired businesses and strong growth in both domestic and international air traffic. Third, GE’s Oil & Gas and Transportation segments saw a steep decline in revenues this year compared to last year due to the continued downturn in oil, gas and mining sectors. Fourth, GE announced the deal to form the joint venture with Baker Hughes company later in 2016 aimed at reducing costs and gaining market share. Fourth, GE launched its Predix platform earlier in 2016, in order to bolster its position in the fast-growing industrial IoT market.
Oil & Gas Decline Resulted in Joint Venture with Baker Hughes
The continued downturn in the oil industry forced all the major oil companies including Schlumberger (NYSE: SLB) to look for partnerships and acquisitions in order to reduce costs and gain market share. GE plucked this opportunity to boost the fortunes of its sinking oil and gas segment business in the current downturn. This joint venture with Baker Hughes will be the second largest oilfield services company globally with estimated annual revenues of $32 billion.
The ‘new’ Baker Hughes will include GE’s oil & gas segment and the old Baker Hughes company. GE will own 62.5% of the new firm and contribute $7.4 billion to fund a special dividend of $17.50 a share to Baker Hughes stockholders. It may seem at the first glance that GE is paying too much for the deal but there is more to it than meets the eye. If GE would have bought Baker Hughes, it would have represented a $24 billion cost. The company avoided that by forming a joint venture. Additionally, GE secured the funding of $7.4 billion in form of zero interest rate debt from GE Capital, which it spun off recently.
Silver Linings: GE Digital Beat our Expectations
GE estimates the industrial internet to be a $225 billion market by 2020. GE is on an acquisition spree and recently has acquired several smaller firms in the field of artificial intelligence and industrial internet of things. GE acquired two Artificial Intelligence companies, wise.io and Bit Stew Systems Inc., both of which enable the ingestion of masses of data for industrial applications. GE also bought Service-Max for $915 million in November 2016. This company is a cloud-based provider of software used in inventory and workforce management. These deals are likely to consolidate GE’s industrial internet vision in the coming years.
Currently, GE’s digital revenues are primarily contributed by its power and healthcare segments and is expected to reach $7 billion by the end of 2016. We believe that GE will be able to gain a first-mover advantage over its peers as it is investing enormously in its Predix platform and applying the solutions on its industrial segments on a pilot basis. More than 19,000 developers are building on Predix and more than 270 companies have joined the GE Digital Alliance, including Cisco, AT&T, and Verizon. We estimate that GE’s software business has a lot of upside potential and may reach $15 billion by 2020.
We will follow up this analysis with the expectations for 2017, and how our valuation fits in that. Meanwhile, please let us know your views by commenting in the box below.
Notes:
1) The purpose of these analyses is to help readers focus on a few important things. We hope such lean communication sparks thinking, and encourages readers to comment and ask questions on the comment section, or email content@trefis.com
2) Figures mentioned are approximate values to help our readers remember the key concepts more intuitively. For precise figures, please refer to our complete analysis of General Electric
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