Is GE Paying Too Much for Growth?
by Tony D'Altorio, Investment U Research
Wednesday, April 6, 2011
Few companies can claim the same industrial pedigree as General Electric (NYSE: GE). With an ancestry that goes back to Thomas Edison, it's the longest-standing member of the Dow Jones Industrial Index.
Spread across 100 countries, GE represents quality American engineering in everything from light bulbs to jet engines. And it's been making acquisitions left and right in the energy sector as of late.
This week, it agreed to buy 90% of privately held Converteam for $3.2 billion.
Converteam, formerly Alstom Power Generation, manufactures equipment that converts renewable power into "grid-quality" electricity. A leader in the $30 billion market for power control systems, its sales rose 36% last year to $1.5 billion, according to GE.
Buying it out takes GE's energy acquisition spending in the oil and power sectors to over $11 billion since October. It also purchased Dresser, Wellstream, Lineage Power and the oil well support unit of John Wood Group.
It's all part of CEO Jeff Immelt's push to return the company to its industrial roots. And it makes sense, considering GE's past overdependence on financial services, which all but crippled the company during the global financial crisis.
Immelt to Shareholders... GE's Best Days Are Still Ahead
General Electric is a huge company with revenues of $150 billion last year. But that impressive size makes it difficult to grow... especially after a near-death experience.
Right now, the company is in recovery mode. Invigorated by the global economic upturn, its earnings should rise by 16% this year.
And Immelt assured shareholders in his latest annual report that GE's best days are still ahead. In essence, he is staking his reputation on his new vision for the company.
Immelt wants GE to depend far less on easy money from financial services. Instead, it needs to succeed through traditional innovation and manufacturing quality.
Certainly, it does have an impressive industrial product range in aircraft engines, power generation, medical equipment and more. But that doesn't automatically translate into strong earnings growth.
Jeff Immelt's Poor Acquisition Track Record
Part of Immelt's vision includes spending money, hence the $11 billion acquisition spree. But critics wonder whether that's really a good idea.
He has a notoriously poor acquisition track record over the past 10 years.
GE has spent heavily on the healthcare sector, water treatment sector and security businesses. And all of that has been disappointing.
As for his latest buys, people don't like their high price tags. Stephen Tusa at JPMorgan recently wrote that Immelt's deals look "like a 'growth grab,' in which valuation is not the primary factor."
He then threw Immelt's own words from 2009 back in his face, saying, "I really think if you go beyond 10 times EBITDA, it is hard to make it pay."
Other than Dresser, all of GE's recent deals have breached that limit.
GE's Future As a Growth Stock
To be fair, Immelt really has no other choice. He has to acquire fast-growing companies and hope they continue growing.
GE still depends too much on its finance arm, which Immelt is trying to limit to only 40% of operating earnings. And the company is also underexposed in emerging markets, which produce only a quarter of its revenues.
Then there's the fact that a number of competitors are arising from emerging nations. Analysts at Credit Suisse estimate that Chinese companies will pose GE a "medium to high threat" in half of its 18 main product areas.
All of that will most likely lead to poor, long-term stock performance. Sadly, that's on top of a decade of disappointing results.
On both a 10-year or five-year view, GE's stock has underperformed both the S&P 500 index and its closest international rival, Siemens.
Honeywell, which GE tried to buy in 2000-01, has seen its shares rise by more than 50% since then. Meanwhile, GE's shares have fallen by about the same.
In other words, there is still a lot of work to be done if GE's ever going to be a growth company again.