By: Scott Davis
GE has had a rough summer. Starting with a rather mediocre earnings report in late July, and now getting hit hard with the publication of a short report out today. We aren’t going to address all the issues here, but just try to add some context.
First and foremost, the fact that we are writing this note just shows how bad things have gotten for GE. Two new CEO’s in the last couple of years, same with CFO’s, IR teams, etc. GE has been a hot mess. And the heat won’t end any time soon. It will really take another year or so to dial in GE’s liabilities with precision.
The basic issue for shareholders, however, is what is or isn’t discounted in the stock. Since earnings and cash flow are non-existent at GE right now, and the company is in full “turnaround” mode, it’s pretty tough to find a valuation to hang on to. But in simple terms, our average company trades at 2.6x revenues on 2019 numbers. If GE was “normal”, with its 2019E revenue base of $106B (net of the 1/2 BHGE it doesn’t own) its market cap would be about $276B versus the current cap of $74B, implying about $202B of liabilities above and beyond the 2x norm. Note that GE’s leverage ratio is pretty dynamic right now. With $20B coming in the door at year end with the Danaher deal, leverage in theory isn’t any more than our average company. Depending on insurance. The short report out today cites $38B of “accounting fraud”. In theory, if GE “only” has $38B of additional liabilities, the stock would be quite a bargain. Obviously, these are big headline numbers, enough to elicit panic selling today.
Point being: the market is already discounting some sort of adverse result from GE’s long-term care insurance business and a hefty discount for accounting irregularities.
The short report accurately depicts a GE culture that historically hid losses and deceived investors. We lived it. This part is real. And GE has no credibility at all in responding to the report today as inaccurate. The truth is that GE is using a set of assumptions, the short report uses another. We don’t know where the truth lies. In the game of insurance, future liabilities are a big unknown, and interest rate assumptions make it no easier. But we would argue that the short report likely has some real truth to it. GE has not been conservative enough, we would guess. That would fit its historical pattern.
The short report, however, misses the reality that Larry Culp is now CEO and his reputation as an honest leader has been earned over many years. We remind investors that Danaher was accused of accounting fraud by forensic folks by about 15 years ago.