GE's Restructuring Pleases Investors And Avoids Other Risks

April 21, 2015

On April 10, General Electric, which for 123 years has been one of America's best known and most highly respected companies, announced a radical return to its basic industrial roots. After years of disappointing share performance, and a campaign of criticism by frustrated investors, Chief Executive Jeff Immelt decided to spin off most of its $500 billion GE Capital arm which, if taken as a stand-alone company, would have been the seventh largest bank in the U.S.

Despite the fact that the unit had contributed some 42 percent to GE's group profits in 2014, the financial unit had nevertheless become a perceived albatross around the neck of the industrial conglomerate. The move greatly pleased investors, who rewarded the stock with one of its best days in years. The question we should be asking ourselves is why is it so undesirable to be a bank in the United States? What does that say about the underlying strength of the economy?

In the financial crisis of 2008/09, GE Capital, like all the other major financial firms, had to be rescued from insolvency by the government's TARP or Troubled Asset Relief Program. In the aftermath, GE was branded, as was other large non-banks like AIG, MetLife and Prudential Financial, as a SIFI, or Systematically Important Financial Institution, and thereby 'too big to fail'. 

This categorization exposed GE to a whole new wave of supervision by the Federal Reserve Board and a host of new regulations under the new Dodd-Frank law. This put the firm at a competitive disadvantage against the U.S. markets in general, and other industrial firms in particular. In fact, from its pre-recession highs in May of 2008, GE was off about 20% in the more than six years leading up to this month's announcement. Over the same time frame, the Dow Jones Industrial Index (of which GE is a part) was up about 36%, with shares of such rivals as United Technologies up much more. This substantial gap caused considerable frustration among GE management and shareholders. GE had performed more like a financial firm (the S&P 500 Financial Sector lost about 12% over that time frame).

Shrewd investors have long believed that 'core competence' is key to success. GE's core competence was as an industrial company building advanced aircraft engines in direct competition with Rolls Royce, power turbines and a whole raft of electrical products including advanced medical devices. Some investors saw GE's foray into finance, mortgage lending, and credit cards as a dangerous departure. In addition, investors have long seen financial earnings inherently as considerably more risky than industrial earnings. As a result, investors assigned a lower value, or price earnings ratio, to financial companies' earnings. On the face of it, these factors gave GE good reason to divest its Capital division.

But while those questions are still theoretical, GE shareholders are looking at some tangible benefits. The company has authorized that over the next four years it expects that more than $90 billion that is realized from its asset divestitures will be directed expressly towards shareholders. Some $35 billion in the form of increased dividends, while $50 billion in the form of share buy backs.


John Browne is a Senior Economic Consultant to Euro Pacific Capital. Opinions expressed are those of the writer, and may or may not reflect those held by Euro Pacific Capital, or its CEO, Peter Schiff.

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