General Electric: $25 Billion Debt Reduction Has Little Substance

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General Electric (GE) unveiled new initiatives to “create value” last month. Transportation is already out through a combination with Wabtec (WAB), now Healthcare and Baker Hughes (BGHE) will follow. The management touted the planned $25 billion debt reduction by 2020 for GE Industrial; and as debt goes down, you would think that equity value increases.

Unfortunately for bulls, I do not believe that the current plan will create much value for shareholders. The reason is that a significant part of the planned debt reduction isn’t the result of internal cash flow generation; at the end of the day, the management is just shifting liabilities around, all of which are the responsibility of current shareholders.

Short-term Plan

In the short-term, the management plans to reach the $25 billion on target by transferring $18 billion of debt to the planned Healthcare spin-off, with the remainder coming from free cash flow or asset sales.

While technically GE Industrial’s debt will be reduced by $25 billion by the end of the restructuring initiative, we can’t just pretend that those $25 billion magically disappeared. By transferring debt to Healthcare, the overall equity value of the eventual Healthcare spinoff decreases. The transfer of debt effectively increases the value of GE Industrial and at the expense of the Healthcare spinoff.

Considering that “core” GE is Industrial, one could say that the management is righting the ship by shedding non-core assets. However, from a valuation perspective, a shareholder today already owns core and non-core assets, hence any transfer of value between them prior to the spinoff makes no difference today.

The remainder of the debt reduction doesn’t look particularly difficult to me considering that the management had guided for $6-7 billion of free cash flow in 2018. But then again, considering their track record of poor execution, perhaps that isn’t guaranteed as well.

Long-term Plan

Beyond the Healthcare spinoff, which is expected to occur in 12-18 months, GE has a lot of potential cash locked up in various assets for sale, the biggest of which is its Baker Hughes stake.

GE’s 62.5% stake in Baker Hughes is currently worth around $22.5 billion, so if the company successfully divests the stake at current prices, it is definitely a decent chunk of change. However, does this disposition create any incremental value for shareholders? That answer is a big no.

GE’s stake in Baker Hughes has always been the easiest piece to analyze and understand since there is a public market value, this means that any incremental value above what has already been priced in today would have to come from Baker Hughes’ future appreciation.

Even though the management stated that they want an “orderly separation” of the Baker Hughes stake after the July 2019 lock-up period expiration, it is clear that GE will be a price-insensitive seller. If I were a Baker Hughes shareholder bull, I certainly wouldn’t be in a hurry to buy today.

Could Baker Hughes’ stock appreciate in the future? Certainly, but the incremental value created by the decision to sell the stake is far from a sure thing as it is at the whim of market conditions.

Conclusion

I applaud the management’s desire to enact change. The various asset divestitures and spinoffs will make the remain-co more transparent and easier to understand; however, I simply don’t see the upside. Based on management’s assumptions, only $7 billion of value will be created over the next two years, assuming that the majority of the debt pay down will come from free cash flows. Relative to GE’s $121 billion market cap, I don’t see any reason to be excited.

Like what I said about the Wabtec deal, one way to create value from asset sales is to sell things for more than they are worth; shifting liabilities before spinning off a segment that the current shareholders already own or selling an easily valued stake of a public company certainly doesn’t fit the bill.

I believe that bullish investors are still jumping the gun here if they believe that the new restructuring initiatives will be fruitful. Opportunity, if any, will likely present itself after the spinoffs and asset sales are completed. Perhaps remain-co will trade at a significant discount as investors shift their dollars to the Healthcare spinoff; but such an opportunity cannot exist at present, as such I remain bearish on General Electric.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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