When Jeff Immelt took the reins of General Electric from the legendary CEO, Jack Welch, the company seemed invincible:
- GE had steadily delivered 12% year-to-year growth rate for last decade despite the economics ups and downs.
- The industrial conglomerate wooed the Wall Street with ~20 P/E ratio, 600B market cap, and sterling AAA ratings for its commercial papers.
Moreover, GE’s monogamy logo, aka meatball internally, had been deeply integrated into American’s lives. It is no better word to summarize the breadth and depth of GE’s outreach than Immelt’s own word about the 911 attack:
My second day as chairman, a plane I lease, flying with engines I built, crashed into a building that I insure, and it was covered with a network I own.
Albeit the castle was built upon a shaky foundation with cracks.
Grow at any cost
As GE’s new CEO, Immelt is on the hot seat to propel the growth for the industrial conglomerate:
The GE appliances faced cut-throat competitions from Chinese manufacturers, which was sold to Haier on 2016 for $5.6B.
The GE Power clung to the gas turbine, while the world slowly pivoted to the renewable energy.
Earlier in the Jack Welch’s tenure, the GE leadership had recognized the importance of GE Capital. Thanks to its sterling AAA rating, GE Capital can tap the commercial paper markets for cheap capitals. Then they could merge or acquire a company with relative-low P/E ratio to boost their revenues, and stock price. The logic worked as:
- GE acquired company with $2B revenue with $10B price tag, thus the P/E ratio is 5.
- The annual revenue will bump from $30B to $32B, this would beat the Wall Street’s earning estimation based on the P/E ratio as 20.
This trick works on the condition that GE can maintain its sterling AAA rating to access cheap capitals, and also the Wall Street had faith on its long-term growth.
De-facto Finance Institution
The GE Capital went even further under Immelt’s leadership. There was no easier way to make money than lending especially when the commercial papers could provide infinite capital. At the peak, GE Capital contributed more than 40% profits to the conglomerate.
Though there was a catch: the finance institution generally has low P/E ratio due to the risk. If GE is a de-facto finance institution, then the its stock price should be halved to reflect the reality.
GE Capital’s reckless operation dragged the company with huge exposure to the financial risks during the 2008 meltdown. It barely survived the bankrupcy thanks to the bailout. On 2015, Immelt announced that GE would sell most of GE Capital over the next two years.
Too big to understand
The philosophy of the industrial conglomerate is to diversify the products and services offerings to hedge the risk of economics down turns, which is a common practice adopted by portfolio managers. However, these entangled internal accountings obscure the corporation’s financial health.
GE also took some debatable accounting manuvors if not fraudulent. For example, GE Power sold the turbines at loss, then extracted revenues from the long-lasting service contracts. GE would adjust the cost of parts to recoganize revenue in paper, aka without any positive cash flow, to smooth the revenue growth. In Dec 9, 2020, GE agreed to pay $200 million penalty for disclosure violation for settlement with SEC.
The stock price was then considered the sole metrics while other signals were lost in the noices. Immelt spent more than $108B on stock buyback after 2004. At the end of 2018, GE’s entire market value was $67 billion.
I think GE’s problem was rooted from the relaxing accounting practice. Without discinpline, the senior leadership was incentived to inflat the short-term revenue at the cost of future growth.
Another contributing factor is the malfunction of the board. Both Welch and Immelt managed to cultivate boards in their favors. We have seen the disasterous outcome of neglect boards in other companies, such as WeWork.
It is unfair to cast all blames to Immelt though he was ultimately accountable for GE’s fallacy. I would read Hot Seat to see from his perspective.