Podcast: General Electric Shows Signs of Life
New CEO Larry Culp is making progress at General Electric. Here’s what he’s likely to focus on next.
How the iconic American manufacturer lost its way—and how it can make its way back. Al Root is this week’s guest on Barron’s podcast The Readback.
General Electric was worth almost $600 billion in 2000. Today, it is just over a $100 billion. It is a staggering fall from grace that will be studied in business schools for years to come. So what went wrong? And can it be fixed?
Barron’s Alex Eule and Al Root addressed those questions and more in a recent episode of The Readback. Here’s a transcript of the podcast.
Alex Eule: Hey, Al.
Al Root: Hi, Alex.
Eule: You spend a ton of your time writing about GE (ticker: GE), and those stories end up being some of the most read stories on our website. And I’ve got to say, that always surprises me, I mean, GE is barely a shadow of itself anymore. Why do people still want to read about this company? Why do people still care so much about GE?
Root: Well, first of all, I take umbrage to the idea that one of my beloved industrials wouldn’t rate on the level of Apple (APPL) or Amazon (AMZN). But I think GE resonates for a few reasons. Not the least of which is there are hundreds of thousands of retirees that are impacted by decisions that the company makes about its pension and health care benefits.
Eule: And reading your stories on Barrons.com.
Root: Definitely. And, I mean, I believe the company turns 128 this year so it has been around for a long time. It is the iconic American manufacturer, and it is still one of the largest industrial companies in the world.
GE still makes the largest jet engine in the world now powering Boeing’s new triple 7x. It is called the GE9X engine. It is like 11 or 12 feet wide, has carbon fiber composite blade. So there is still a lot going on.
Eule: I want to talk about what kind of company GE is and what it could still become. But before we can do that we really need to go way back and explain how GE came to be. So take us back to 1892, Al.
Root: It started with the great American inventor of the lightbulb and the phonograph. This is Thomas Edison’s company, and so General Electric was about electricity. This was about delivering electricity into people’s homes for the first time.
Eule: So, it is no stretch to say this is a company that powered America?
Root: Right, so it is growing as the country is electrifying. And then it starts to power locomotives. It starts to power planes. It powers the turbines that generate electricity. It makes the appliances that run off electricity. It is all about electricity.
Root: And then they had to finance business, right? They would finance the jet engines and these huge capital purchases. Then, there is always the art and science of balancing between making good deals, bad deals, good decisions and bad decisions. And GE made the decision to get into banking. They started selling life insurance. They started doing credit cards.
Eule: And from there it got even a little bit weirder?
Root: Yeah, in 1986 they bought NBC. Now, they were a media company. So they have this credit card business. They have an equipment finance business. They have all of these industrial businesses. And they are bringing you the local and the national news.
Eule: Almost to cement General Electric’s role in culture, in 2006, NBC, still owned by General Electric, created a prime time sitcom about an industrial conglomerate owning a media company.
Archival Recording from 30 Rock: “I’m Jack Donaghy, new VP of development for NBC-GE-Universal-Kmart.”
Root: I like the narrative like this: So, in the 1980s and 1990s, we had Jack Welch. He was the iconic American CEO. The business guru, Jim Collins, wrote a book Good to Great about how amazing GE’s management culture was.
But, somewhere along the line, they lost their way. And then you get the NBC acquisition in 1986, and NBC’s 30 Rock comes out in 2006. And this whole GE management culture gets satirized with this business executive played by Alec Baldwin, trying to manage all these creative personalities at a media company.
Archival Recording from 30 Rock: “It is a great office. But sometimes you have to change things that are perfectly good just to make them your own.”
Root: It was an incredible moment of foreshadowing when the artists said to themselves like, this feels very weird being commanded by a suit from General Electric. And if you sold the stock when 30 Rock premiered in 2006, you would have saved yourself an incredible amount of pain.
Eule: I mean, the timing is fascinating, because in 2008 we had the financial crisis. At that point, GE had become a huge bank, and the financial crisis really hurt banks. So, this was really in some ways, the beginning of the end for GE.
Root: Right, so the stock very roughly gets cut in half through the credit crisis. The bank has to shrink materially and so it goes from being a $50 to $60 stock to a $20 to $30 stock. And so for the next 10 years it is growing off that base.
Then, in 2015, the company makes a really large bet on coal fired power generation.
Eule: Just as everybody else is starting to come back from the financial crisis.
Root: Right, they make the strategic decision to do a multibillion deal with a French company buying turbines that turn coal-generated steam into electricity.
Root: Right when the world is moving away from coal. Now, they knew that. What they thought was OK, we’ll be a larger power organization. We can cut costs. wW’ll have a more diverse portfolio. And maybe the critical error wasn’t understanding how fast coal-fired power generation was going to fallout of favor.
Eule: So, now we get to 2018. Coal isn’t doing well, they were wrong with that deal—and the stock basically bottoms were?
Root: So they take a $20 billion write-off in the steam power unit in 2018 They basically write off the entire value of the deal that they completed just like three years earlier.
The stock got as low as $6. So, it was sub $10 at the end of 2018, as people just piled into sell orders and got out of the stock as rapidly as they could.
Eule: Al, we’re about the same age out. I’m going make a bet and guess that your kitchen and your light fixtures were filled with GE products growing up. Today GE doesn’t even make those products anymore, do they?
Root: No, they have been selling assets for a long period.
Eule: So refrigerators, lightbulbs, we still can buy them, they are still branded as GE, but they are not made by GE.
Root: Yes, GE Appliances got sold to a Chinese company a few years back called Haier. So you can still go and buy a GE fridge—it’s just not manufactured by GE. Same thing with the lightbulbs. They used to make locomotives. They sold that business.
So what they’re left with is a power division that still makes turbines that generate electricity. They have renewable power too. They have the windmills—those giant onshore windmills that you see driving down the highway.
But GE is still a dominant producer of jet engines and their aerospace and defense business is very profitable and well run. And they still have GE Capital which finances aircrafts, along with all of these other products that they continue to make. They also still have the health-care division which makes things like pet scanners, MRI, and CT machines.
Eule: Al, GE is going to be studied in business school books for many years to come—it probably already is, actually—but I’m interested in your ideas here. What are the lessons that we have learned and are going to continue to learn from General Electric?
Root: It is a good question. I think sometimes we spend so much time talking about what the stock is going to do over the next 12 months that we don’t realize there is a lot to learn to make us better investors by going back a little bit.
And in the case of GE, one lesson is that I don’t like large transformational acquisitions. I don’t like huge deals sometimes done with debt that become a huge portion of the strategy or overall business. I think that there is both academic literature and tons of anecdotal evidence, saying it is better to do smaller acquisitions, those we call bolt-on acquisitions, than large transformational deals.
Another lesson is that a company’s cash flow is sacrosanct. You can’t spend earnings, you can only spend cash, and GE spent billions of dollars over many years buying back stocks. I bet they look back at recent history and think, man, we really could have used that money.
People say, well, you know, nobody knows the company better than the manager. So, stock buybacks are a positive signal for value investors—and that is true. But there should be a strong focus on cash flow.
And the third lesson is—and maybe I’m biased by my engineering background—but industrial companies should make industrial things. I mean, it was a media company. It was a banking enterprise. And if you look ahead I think what GE will be known for isn’t so much the managerial excellence of the 1980s and 1990s. Going forward they will be known as a premier engineering firm with engineering excellence at the core of what they do. They make the biggest, coolest, most complex machines in the world. And I’m happier that this is what GE will be in the future.
Eule: Al, you got the chance to actually interview GE’s new CEO Larry Culp last week, right?
Eule: How did that conversation go? What is he talking about these days?
Root: I would characterize him as, oh goodness, he’ll probably hate this, but he’s central casting. He’s a little taller than I am. He’s a handsome and optimistic guy.
Eule: [Laughs] That’s a tough bar to meet, Al.
Root: Well, I didn’t say he’s more handsome than I am. I just said he’s taller.
Eule: Good point.
Root: The thing that has impressed me about Larry, to this point, is the speed with which he took action. Over the last 12 or 14 months, GE sold upward of $30 billion in assets. They have done 12 deals, they have sort of attacked the balance sheet, getting debt down.
Culp has used the words “dismantling” Power headquarters. GE has completely redone the management structure in the power division, and Culp is targeting billions of dollars in cost reduction. So he sort of came in and took a look and said: This requires some radical steps.
Eule: You asked Larry Culp to grade himself, and he gave himself an incomplete grade from what I recall from your story. But investors are certainly very happy at least in the past year, right?
Root: Right. So, it is all a question of timing to a certain extent. The stock was up right around 50% in 2019, better than the market. It was its first big, positive return in three years. And GE stock was back on the radar as something that was actually worth owning for large institutional or even retail shareholders.
Root: But it is an incredibly controversial stock. Price targets on Wall Street range from $5 to $18 a share, and that $13 spread is more than a hundred percent of the current stock price.
Eule: So, basically we have a very big spread here of opinion from Wall Street as to how GE is going do in the coming year.
Root: Right, and to tie it all back to Mr. Culp, the bulls tend to say look, Larry has taken a dramatic action: He has a great record at his former company Danaher (DHR). We believe Larry can drive change and cut costs and get these businesses onto sort of a sustainable path.
Eule: And so, GE isn’t making lightbulbs or refrigerators anymore. We talked about some of the things they are making. If the company can succeed in this renaissance, what do you think GE becomes known for in three to five years from now?
Root: So looking ahead, this is still a turnaround company. So it will be a smaller, more focused organization. In three to five years , its dominant franchise will still be commercial aerospace.
GE will remain one of the dominant producers globally of jet engines for aerospace and defense applications. And they will be servicing those engines. The great thing about aerospace is the original equipment makers get to service all this stuff. And GE has about 65,000 engines out there.
It will still do power, mainly gas fired power, because turbines will still use gas and natural gas to generate electricity around the world for years. They’ll also do renewable power. Power will be smaller, aerospace will be bigger, and they will continue to have some health care business, but even that could be spun off maybe at some point in the future.
And then, after the turnaround is complete, maybe in a year or two, when people say OK, the balance sheet is in line and we’re happy with the size of GE Capital, that is when Larry Culp can look out in the future and say, you know what, we need to make this small acquisition or that small acquisition. And it can be sort of a whole new chapter for General Electric.
Eule: Wow, so the conglomerate could grow again. Are we talking about a $500 billion stock at some point again in GE’s future?
Root: Well, that is a great question. Remember when the Dow Jones Industrial Average was at 10,000 and somebody wrote the book Dow 40,000?
Eule: Uh-huh [laughs].
Root: [laughs] Just by virtue of compounding...
Eule: You heard it here first...
Root: It will probably be a $500 billion stock at some point out in the next 100 years.
Root: But I do think that the outlook is far better than it was. I don’t think even the bears would disagree that Culp and the new management philosophy and the new management team have restored stability. Now we’re arguing about what it;’s worth, how much will they be making out into the future. So there is a level of optimism there.
Root: The market is, of course, forward looking, and I think people should focus on what next year looks like. The outlook for commercial aerospace is very good. The power outlook still continues to be challenged. The problem with power is that the world is moving away from fossil fuel-based power generation. So, that problem is going to be with the company for a long time. They are going to be managing a declining business.
Eule: And maybe that’s an area for acquisitions going forward?
Root: Well, we’ve been talking about history lessons. A good lesson from history in a declining business is to combine and then continue to cut costs. I think at this point, just because of GE’s history, they would much rather sell assets than buy assets. So, I think power will continue to get smaller and they’ll try to focus on these end markets that are still growing.
Eule: Right. All right, we’re going to keep watching, and we will have you back on to talk about GE in the future. Thanks so much, Al.
Root: Thanks Alex.
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The Readback is a business and finance podcast published every Wednesday. We’d love to know what you think of the show, so please take a moment to rate and review us in iTunes—or write to Alex Eule at firstname.lastname@example.org and producer Mette Lützhøft at email@example.com.
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