Rob Cox: Immelt pins GE colors to Alstom’s mast

By Rob Cox
September 10, 2015

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

It has taken 14 years, but Jeff Immelt has finally been emancipated – by the French. The General Electric chairman and chief executive has spent the bulk of his tenure since taking charge the day before the Sept. 11 attacks on the World Trade Center defending, bailing out and now jettisoning his predecessor’s experiment in finance. The takeover of Parisian rival Alstom’s energy infrastructure business offers an exit opportunity from that long shareholder nightmare.

If the revised arithmetic on the Alstom deal, which European regulators approved this week, is to be believed, GE will be getting the company for a song. Though relatively small in the context of a global conglomerate with $125 billion in sales, the transaction will help determine Immelt’s legacy and position his replacement for success in ways that Jack Welch failed to do for him.

The investing masses haven’t been kind to Immelt. When he took over on this day in 2001, GE shares traded at just over $39 apiece, giving the company a market capitalization of about $390 billion. They now fetch less than $25, valuing GE at $250 billion. To fully understand the $140 billion lost under Immelt’s watch requires the same kind of dissection the boss is currently performing on the company.

In the year before he officially occupied Welch’s office at the company’s Connecticut headquarters, GE earned about $13 billion, which fund managers valued at a multiple of about 30 times. At today’s prices, it’s more like 17 times the modestly higher $15 billion in net income.

There’s good reason for this less sanguine perspective. The 2008 crisis exposed flaws in the financial edifice that Jack built. In hindsight, of course, it’s easy to say that Immelt should have separated GE Capital from its industrial businesses before the collapse of Lehman Brothers. But investors, who were dancing to the same tune as Citigroup chief Chuck Prince, would have vilified him at the time.

For the past six years, Immelt has had to fight to keep the company from being pulled down the drain by GE Capital, contend with the consequences of depending on government assistance in those efforts, nurse it back to health and now auction off its parts to the highest bidders. The results of that process will be another important facet of how Immelt’s tenure will be remembered.

What it ultimately means, however, is that Immelt has been a seller of assets more than an acquirer. In addition to the mega-auction of GE Capital, he unloaded NBC Universal, plastics and – trustbusters permitting – GE’s appliances business. Alstom, by contrast, stands as the shining example of GE’s shrewd move to refocus on industry over finance and a major test of the company’s acumen as a buyer. On paper and for now at least, it stacks up flatteringly for Immelt.

When GE launched the offer in April 2014, it proposed paying $13.5 billion for Alstom’s power and grid businesses. At the time, GE projected these assets would generate earnings before income and tax of about $1.3 billion. In addition, the company said it would be able to slash costs by $1.2 billion within five years. On that basis, the deal looked capable of generating a return on capital of nearly 14 percent, nicely above GE’s 9 percent cost of capital.

Since then, the deal has been significantly altered in ways that should lift GE’s potential returns. First, the purchase price has come down to about $9.4 billion. This largely reflects investments of around $2.8 billion that Alstom made in three joint ventures, which it will retain. Alstom can, however, put these back to GE. Any promised synergies are not, however, dependent on that happening.

Most importantly, Immelt raised his cost savings target by a whopping $1.8 billion to a total of $3 billion within five years. The net present value of these – assuming a GE tax rate of 25 percent after divesting most of its financial arm and a 5 percent discount rate over five years – would be some $17 billion. That would leave almost enough left over to buy another Alstom. Even if GE has to repurchase the joint ventures, and assume the French company’s pension liabilities, the return on capital adds up to a remarkably robust 20 percent.

It almost sounds too good to be true. Joe Ritchie, who covers GE for Goldman Sachs, questioned the optimism in a recent report. “Even allowing for greater product overlap/margin improvement,” he wrote, “the synergy targets could prove aggressive given they represent more than [twice] those realized in recent industrial deals.”

Alstom’s energy business reported sales for the year ended in March of about $15 billion. Even though the savings will accrue by uniting with GE’s own related activities, to hack out a $3 billion slug of costs will require uncharacteristic ruthlessness for Immelt. With his long professional record practically on the line with the Alstom deal, though, he has more than enough incentive to get it done.

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