The GE Deal: Smoke and Mirrors
Mark Twain famously said that there are lies, damn lies, and statistics. In the world of finance where numbers drive decisions every second of every day, it can be difficult to know when a particular statistic represents good news. Just like advanced statistics in baseball can offer both clarity and confusion at the same time, so too can an array of market data increase and decrease comprehension. Not all financial statistics need be as complicated as linear regression: some can be quite straight-forward. General Electric's announcement of a one-billion-dollar deal with the Kingdom of Saudi Arabia, for instance, doesn't require a Ph.D in economics to understand. While it's not a damn lie -- GE will certainly receive a paycheck that has a lot of digits printed on it -- it's not the windfall that the company has spun it as to investors.
For over 100 years, the business model of General Electric (GE on the NYSE, trading for $29.05 a share) hasn't changed particularly much: start with patents, buy up exciting new technologies like radio and television, and leverage a ton of divestments in order to ensure that each of their 15 department segments make money. GE's biggest change in a century wasn't a result of two world wars or two dozen recessions but the development of the GE store, a business move meant to break down the barriers of their operations (while, incidentally, moving the company headquarters to Boston) for the purpose of developing horizontal capabilities. In a nutshell, GE wants all their divisions to compete for the same business goals using the same metrics and delivering the same results. That kind of corporate strategy could give any accounting or legal firm a collective ulcer, but it's a smart move. The huge number of corporate mergers in just the past year, amounting to nearly five trillion dollars (that's trillion, with a T), indicates that GE can no longer parcel their operations. Instead, they want to compete with rival Fortune 500 companies using simplified strategy as the opposition grows fatter and fatter. The linchpin of their fantastic transformation comes down to a fundamental shift away from finance and towards infrastructure.
To say that a company has started to shift away from finance doesn't quite hit home when you consider that a 25% stake in finance (GE's targeted line, down from their current ratio of 35%) still accounts for $30 billion of their $120 billion in revenue. Yet, with Morgan Stanley anticipating that global infrastructure spending will hit five trillion dollars per year by 2020, one cannot help to think that GE is moving in the right direction. GE's industrial division earns a 14% return on capital, a figure that's quite good by any account -- better than the overwhelming majority of hedge funds, for instance -- but the finance division has been in the red for so long that the company announced they would sell off about thirty billion in commercial loans and leases to Wells Fargo. Going back to the industrial drawing board echoes the company's roots, selling refrigerators and light bulbs back when they were radically new technology, while providing the company with far more innovation potential. There's only so many ways, after all, that you can engineer a loan agreement.
With the radical corporate shift in place, both philosophically and physically, GE announced on the last day of 2015 trading that they had closed a one-billion-dollar deal with Saudi Arabia in order to build gas turbine systems for Saudi power plants throughout the country. It seemed the perfect cherry on top, representing their newfound commitment to building instead of lending. Even the most cynical of investors know that a contract for a billion dollars represents a fantastic coup for any business, whether the business trades on the NASDAQ or operates out of a garage. Nor should the reaction be overlooked: on a day when the Dow dropped a full percentage point, GE's stock rose by a little less than five percent. Investors shouldn't think that this is some kind of windfall, however. Nor should they fall victim to GE's PR department, who would have you believe that this deal represents a major triumph for a new ideology. In reality, it's more like business as usual -- or maybe even a slight disappointment.
To start with, this isn't the first deal GE has closed with Saudi Arabia to construct power turbines. In fact, the company operates a manufacturing facility in Saudi Arabia, where 30% of all jobs are filled by non-Saudis. German archrival Seimens, not to be outdone, built their own manufacturing center in Saudi Arabia after they netted a $250 million contract to provide energy transmission fixtures. Half of all the power plans in the kingdom of Saud rely on GE parts, and it's not even clear that GE is winning the market war in the Middle East. Seimens earned a bid to build electricity substations in Egypt only a week before GE closed their vaunted billion-dollar deal; Honeywell won a contract with the United Arab Emirates to supply aviation parts and services. While it's not lipstick on a pig, the GE-Saudi deal appears to be more like an over-puffed piece on a slow news day than a ground-breaking business deal.
- The Takeaway: buying and selling on one particular business deal rarely pays dividends. GE represents a stable growth mechanism even though the newfound approach towards industrials comes with more risk than if the company continued the status quo of finance. Investors shouldn't consider the Saudi deal to be a trigger unless they're eager for a change in their own holdings. GE's performance generally matches that of the economy writ large, meaning it's in the midst of a growth cycle. It takes a lot to rock their boat, both up and down. The Saudi deal is a blip on the radar that won't be remembered in even a few weeks' time.