GE’s Comeuppance—Poster Boy For Financial Engineering Run Amok

By David Stockman

GE is taking a pounding this morning for cutting its dividend by 50%, and we’d say it’s about time for both.

That is, its unaffordable and unsustainable disgorgement of cash into the stock market should have been drastically curtailed long ago. Likewise, even a quasi-honest stock market would have severely punished the gong show of dumbkopf M&A, financial engineering and crony capitalist sleaze that occurred under former CEO Jeff Immelt’s 17 year reign.

So consider GE yet another poster boy for the Fed’s destruction of honest price discovery on Wall Street, and its conversion into a gambling casino that rewards blatant value destruction in the C-suites. The GE saga, in fact, exemplifies the reason that growth, good jobs and rising incomes are dying in Flyover America.

Thus, on the eve of the financial crisis in December 2007, GE’s LTM net income posted at $22.1 billion. During the decade since then it has been all downhill—-with the September 2017 LTM figure coming in at just $7.5 billion.

In that regard, the Wall Street stock peddlers love growth rates, so here’s one for the record books: GE’s 10-year net income CAGR is negative 10.2%!

Moreover, it should have never gotten close to that because on the free market Immelt would have been unceremoniously dumped by the company’s shareholders and board in September 2008. That’s when the company’s infamous commercial paper funding crisis occurred, and Immelt saved his own hide by arranging for a $30 billion Washington bailout through Treasury Secretary Paulson and Bernanke.

Needless to say, that act of crony capitalist largesse stunk to high heaven. That’s because GE had a $830 billion balance sheet and more than enough assets to fund itself through a fire sale if necessary, but via an highly dilutive issuance of equity or long-term debt if all else failed.

But Immelt was having none of honest self-help because he had substantially goosed GE’s net income through the age old game of investing long and illiquid for higher yields and returns—especially through GE Capital’s then $600 billion balance sheet of equipment and building leases, commercial loans, junk debt and private equity—while funding short, hot and cheap.

Overall, the company’s short term debt totaled $205 billion on the eve of the Wall Street meltdown, and upwards of $90 billion of that was accounted for by commercial paper.

The latter allegedly couldn’t be rolled over when the Lehman bankruptcy roiled the $3 trillion money market fund sector, but that’s one of the great risible myths of the financial crisis. Immelt just didn’t want to pay-up for funding to replace about $30 billion of commercial paper that was coming due during the next several months.

That is to say, Immelt ixnayed selling liquid assets at a deep discount, or borrowing short-term at perhaps double digit rates temporarily or raising the aforementioned dilutive equity or debt capital.  That is, the very thing that free enterprise companies are supposed to do when the get themselves into funding trouble.

Instead, Immelt was all over Washington prevaricating about “market failure” and the need for extraordinary state intervention. But the very idea that the mighty GE could not have raised capital equivalent to less than 4% of its balance sheet at any price is flat-out ludicrous.

The truth of the matter, however, is GE’s prior year earnings had been $2.17 per share, and Immelt desperately wanted a 2008 bonus that required beating that benchmark. By contrast, funding the commercial paper hole at going market rates during the crisis—-and yes high rates are how markets clear when they become overly speculative and imbalanced— might have reduced GEs earnings below $1 per share, and KO’d management bonuses for a year or so.

So the CEO of America’s only remaining AAA industrial company balance sheet at the time cried wolf in manner that was truly reprehensible. Yet in accommodating this blatant act of racketeering, the Fed also set up the casino for the horrid mis-pricing of the GE stock which occurred thereafter.

Notwithstanding the endless shrinkage of its net income during the following years, in fact, GE was being valued at 32X its net income of $8.8 billion as recently as the end of 2016.

That’s right. Double digit earnings decline for a decade—-including another 15% by the September 2017 LTM—-and the company gets valued by the Wall Street punters as a high tech growth stock!

GE Net Income (TTM) Chart

The reason isn’t hard to identify, of course. Immelt and the GE board embarked upon a stupendous spree of balance sheet and cash flow strip-mining in order to pump a tidal wave of cash into the Wall Street casino. To wit, during the period since the Fed/Washington bailout in Q4 of 2008, GE has injected $112 billion into Wall Street in the form of dividends and stock buybacks.

To be clear, as avid free marketers we are all for investors getting a big share of company profits and thereby reaping a fair return on their capital. But here’s the thing: During that same period GE posted only $84 billion of net income, meaning that it was “over-sharing”. Big time.

There is simply no rule of sound or sustainable finance that says a giant conglomerate with drastically shrinking earnings can disgorge 133% of its earnings to Wall Street, and live to tell about it.

Moreover, that’s not the half of it. On top of these huge distributions, GE also undertook massive M&A deals which aggregated to a gross total of $575 billion during the course of Immelt’s tenure.

That’s right. The man presided over a half-trillion dollar asset shuffling and churning operation during a nearly two decade tenure that would never have happened on an honest free market. As Forbes cogently described the company’s financial engineering madness:

How much? By the company’s own calculations, during Immelt’s tenure, GE made 380 acquisitions that came at a cost of over $175 billion. It further sold off 370 assets worth a total of $400 billion. Thus, GE struck an average of 46 acquisitions and divestitures annually during Immelt’s tenure at a value of $35 billion, churning roughly 9% of its total current enterprise value every year.

Mega deals included the acquisition of Alstom ’s power business and the assembly of an oil and gas equipment operation that now will merge with drill-bit inventor Baker Hughes. Exists ranged from GE’s sprawling and capital consumer financial services operations, banks across Europe, a US financial arm called Synchrony Financial, mortgage insurer Genworth, tens of billions in portfolios of loans and real estate — to operating businesses such as NBCUniversal, GE Plastics, GE Water, GE Appliances. Immelt even is getting rid of GE’s light bulb business, which holds a lineage that traces to the days of Thomas Edison.

Despite all of the wheeling and dealing, which made Immelt an investment banker’s dream, GE’s stock is poised to end lower than when he assumed the reins in September 2001.

In fact, a lot lower after this morning’s stock market revolt. When Immelt took the helm back in early 2001, GE’s stock was $45 per share compared to $19 and sinking at the moment.
GE Chart

To be sure, these endless rounds of M&A deals were welcome on Wall Street as measured by the $1.7 billion of M&A fees GE generated over the period. Likewise, the fast money boys were duly appreciative of the endless waves of cash pumped back into the casino by GE’s massive stock buybacks and unearned dividends.

But it was all one great con job. Since the time that Immelt blackmailed Washington in September 2008 with the phony threat the GE was ready to up puke all over the Ameircan econ0my, about all it has to show for this egregious spree of financial engineering is a 15% shrinkage of its share count (from 10.2 billion to 8.7 billion shares) compared to the 66% drop in its net income, as shown in the chart above.

Oh, and there’s the fact that after all that accomplishment, Immelt was pleased to head Barrack Obama’s task force on how to stimulate economic growth and jobs!

Indeed, that Immelt could have ever been considered a business statesman tells you exactly the kind of fantasyland that prevails on both ends of the Acela Corridor.

And GE is not a one-off aberration. As we will discuss further tomorrow, the GE financial engineering madness that finally proved too much for even the casino punters this morning is simply an illustrative case of the US economy writ large.

During the 2007-2016 period, the main street economy was assaulted by nearly $11 trillion of M&A deals and more than $5 trillion of stock buybacks. Virtually none of that massive financial engineering added to the efficiency, productivity or growth capacity of the US economy; it simply flowed into the Wall Street casino where it bid up a shrinking portfolio of companies and outstanding shares.

And then Washington wonders why growth, jobs and worker incomes have faltered. Even then, the GOP blames the IRS when the true culprit is domiciled at the nearby Eccles Building; and as for the Dems, they apparently blame the Kremlin.

In any event, neither party is even remotely in the right zip code, meaning that this present elephantine bubble while inflate until it reaches its own unsustainable apogee–like in 2000 and 2008. Then it will self-correct—swiftly, violently and all too soon.