How the Alstom Acquisition can Boost General Electric Company’s Earnings

In its efforts to expand the industrial business, GE is in an acquisition mode. Alstom looks tailor-made.

May 5, 2014 at 10:54AM

Acquisitions have been a way of life for General Electric (NYSE:GE), taking over 200 companies in the past decade alone. Through these new additions, GE has been trying to expand its core industrial segment and reduce dependence on the finance business. The latest on its radar is France's Alstom (NASDAQOTH:AOMFF), GE's closest competitor to date in the power generation sector. GE has made a $17 billion bid and Alstom's committee will review the offer by June 2.

Let's find out why GE is keen on this acquisition and how it can benefit.

Re-alignment of business lines
GE has taken brisk measures to cut its finance arm GE Capital down to size after the financial crisis of 2008-2009. This segment once constituted more than half of the company's earnings, but now GE wants to reduce it to less than 30% .

The U.S. major aims to increase its industrial segment's share to 70% by 2015, up from 55%  at present. Then again, under the industrial umbrella, GE is focusing on the power, aviation, and the oil and gas sectors. Acquiring Alstom's power generation business would bring GE closer to its goal.

While the industrial segment registered a good 12% profit growth in the first quarter ended March, the financial business posted a decline in revenue. The key top line drivers in the industrial segment were the power, oil and gas, and aviation sectors, which offset the weakness witnessed in the energy, health care, transportation, and appliances sectors. Notably, these industrial operating activities contributed almost 70% to total cash generation.

Source: Company presentation, chart prepared by author.

The Alstom allure
A Bloomberg report says that the deal might be the best one during GE chief executive officer Jeffrey Immelt's tenure. The U.S. giant is trying to reposition in the European and emerging markets where its power generation sector has not yet caught pace. Alstom fits the bill as it has a strong hold in the European market. Not only that, but it is also the right candidate for GE to save on taxes under U.S. rules. One effective way of reducing its huge $57-billion overseas cash pile sans tax liabilities is to acquire a foreign business.

GE is fighting tooth and nail to get its hands on the European industrial giant, even with a skeptical French government not too keen on letting a U.S. company take over. The deal has taken a political color as both a government-owned utility and the national railways are big clients of Alstom.

Boost to industrial business
The Alstom acquisition will add to GE's growth drivers as it specializes in making equipment for power plants, smart grids, renewable energy, and trains. Its iconic high-speed TGV trains will help boost sales of GE's lagging transportation segment in the European market.

Alstom pioneers in power plant generation, being a leading provider of gas, hydro, and wind turbines in Europe. Though GE remains a dominant player in gas turbines, it has fallen behind in coal-fueled turbines. Alstom stands second only to the German bigwig Siemens in manufacturing these coal-fueled turbines. The takeover will add to GE's product portfolio in emerging markets where cheaper coal-fueled steam turbines are preferred.

A quick look at Alstom's segment sale breakdown for fiscals 2013 and 2014 shows its perfect alignment with those of GE's.

Source: Alstom investor presentation, chart prepared by author.

According to a Wall Street Journal report, the combined energy assets of these two companies would create a dominant player in the European power-generation industry. Since 71% of Alstom's revenue in 2013 was driven by its energy business and it was the third biggest player in the power-transmission gear market, GE's buyout of the former's power generation and transmission grid assets could substantially add to the American behemoth's earnings.

Last words
GE is putting its money where its mouth is and looks poised to gain from the union. The move will help the company derive its target earnings from the industrial operations by 2015. It would give GE a definitive position in the European market and expand its presence in the emerging markets. Overall, the synergies from this association cannot be undermined and GE could benefit from all perspectives.

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ICRA Online has no position in any stocks mentioned. The Motley Fool owns shares of General Electric Company. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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