- General Electric is on acquisition spree with a focus on industrial business.
- Focus on industrial business make business-sense considering their competitive strength in the field.
- The market remains concerned over the end result of the ongoing Group restructuring.
General Electric's (NYSE:GE) history can be traced back to when Thomas Edison consolidated his businesses to form Edison General Electric Co. in 1889 and subsequently incorporated it as General Electric Co. 3 years later. Over time, it has become a conglomerate giant with exposure in various industries spanning from aviation, chemical, food & beverage, healthcare, industrials, and even finance.
It’s definitely back to basics for GE. The latest acquisition has confirmed this theory. During the previous month, it launched a bid to purchase metal-based 3D printers, Arcam and SLM Solutions for $1.4 billion, which will boost the company’s position in the high potential 3D printing industry.
As disclosed, additive manufacturing is an important aspect of GE’s transformation into a digital industrial company over time. While the acquisition is not revenue accretive, it seems like a cost saving play for them, considering that their aviation segment has been mostly using 3D printing and other segments such as Power, Oil & Gas and healthcare units are also utilizing 3D printing technology. In the previous year, it had continued the acquisition spree in the industrial space including the acquisition of Alstom’s conglomerate power and grid business. It is likely that the company will continue acquisition of complementary industrial businesses with an investment budget of $3 billion to $5 billion a year.
Conversely, it has been disposing of some of its financial services businesses where the largest exit was from the lending business of GE Capital. This actually is a bold move from the current management, considering that this segment contributes a third of their earnings. The plan could be to gradually exit from the segment, but at the same time continue buying back its own shares so that the impact on earnings per share is muted.
The decision to focus on industrial segments is laudable, as the company has substantial operating scale and competitors will not be able to match even with continuous investments. For instance, GE has a solid market share in some of its largest industrial business and carries sizable intangibles of around $7 billion in the form of patents, technology and software.
Source: GE Management Analysis & Discussion, Annual Report 2015
Looking at the above figures, it seems that industrial segment generated solid profits of around $18 billion in 2015 and segmental profit margins of around 16.5%. This is definitely higher than the net profit margins of the entire company of only 9% in 2015.
Hence, the focus on industrial segment would enhance the overall net profitability and operating margins. Consequently, this would also translate to higher cash return to shareholders through dividends (i.e., average growth of 15% over the 5-year period) and share repurchases.
“Short Term Pain, Long Term Gain”
Despite these restructuring efforts, the market seems unimpressed with the overall strategic plan of the company. In fact, year-to-date returns have been negative 5%. The increase in the exposure to industrial business has exposed the company to the cyclical nature of the end markets of the industrial business.
During the last 5 years, revenues have also declined from $147 billion in 2011 to $117 billion in 2015 as the company disposed of some significant assets. Overall, the market is also concerned about how the company will be able to manage the newly acquired businesses and how they can integrate into the GE model. While these concerns are valid, the company’s solid experience in the industrial space dating back to the old times would mitigate this risk. Additionally, they also have sizable backlogs, which means strong revenue visibility for the company in a long term.
On a longer term, the new GE will have lighter assets and management would definitely focus on its core competencies. It also helps to know that management has provided an emphasis on improving its overall return on equity; something that investors would be happy to know.