How the GE Breakup Will Give Shareholders a Chance to Make Up

In this segment from MarketFoolery, host Chris Hill and Motley Fool Pro's Jeff Fischer weigh in on the perhaps long-overdue news that General Electric (GE 8.28%) is about to undergo a major split, and additional serious asset divestitures are on the horizon.

The spinoff of the healthcare unit is the biggest headline-grabber, and its plans to move further away from the oil and gas sector by selling its stake in Baker Hughes, a GE Company (BKR 1.66%) are significant as well. But what should be even more interesting to investors is the internal changes CEO John Flannery plans for the leaner company he's creating.

A full transcript follows the video.

This video was recorded on June 26, 2018.

Chris Hill: Let's move on to General Electric. Some good news for General Electric and its shareholders. GE's stock having its best day in three years. Up on, actually, a lot of news, but I guess first and foremost, General Electric is spinning off its Healthcare unit. The company also said it plans to, eventually, over the next couple of years, divest its stake in Baker Hughes, which is the oil services company. What did you think of this move, when you saw it this morning?

Jeff Fischer: The portfolio is changing, as GE's CEO put it. I think that's a good way to look at it. They have a portfolio companies --

Hill: [laughs] That's also, in some ways, a huge understatement. I mean, yes, it's changing today. Just, in the brief tenure of John Flannery, that's a massive understatement.

Fischer: A sprawling portfolio. They're going to focus -- and it's going to take time -- around its Power and Aviation and Renewable Energy business. Chris, as you said, they're going to slowly move away from oil and gas and focus more on power turbines; aviation, which is one division that's doing well; and renewable energy, where they think there's a lot more growth ahead.

I think it's going to be a long road to get there. They still have their struggling finance division, which they didn't talk about today that I saw. They have a net $100 billion in debt. S&P is warning that their debt could be downgraded. These moves will cut revenue by less than half. They're looking to focus on business units that now account for a bit more than half of revenue and a bigger portion of net income and profits, which is smart.

But the bigger change that I like is that the plan is going to move from being very centrally managed to a much more Buffett style. Each division gets to manage itself. For decades, they've been managed from the top, even though they're a sprawling conglomeration, spread all around the world. I think if anything points to how poorly that can work compared to how well diversified management works, it would be, compare GE's return over the past ten, 20 years to Buffett's return. As we all know, Buffett is very decentralized. He lets each business run itself. GE is moving in that direction. The head office, which is getting much smaller, is going to think more strategically in capital allocation, and not so day-to-day, hands-on. That should be taken care of at the direct company level.

Hill: I think it's a great move. Presumably, beyond the fact that you're going to have this decentralized decision-making at General Electric, you're also presumably going to get greater transparency into how those --

Fischer: That would be good.

Hill: -- units are doing on the private side. And, as you said, you look at their Aviation division, that's one of, if not the best-performing division at GE. The Power business has really struggled. I would expect that, over the next couple of years, what we'll see is, potentially, some changes there, whether it's further divesting from that unit or potentially taking some of the cash that they have and looking to acquire other divisions.

We were talking this morning -- and I've said this on the podcast for months now -- I think General Electric, as a company to watch, is the most interesting it's been in 25 years, easily. And I think that's because of John Flannery and the fact that he went in there as CEO and basically said, "There are no sacred cows here. I'm going to look at everything. Everything is on the table, in terms of whether or not we're going to increase investment or just cut it all together."

Fischer: And it's because, Chris, you have a dark side that likes to see things be dismantled, dismembered. [laughs]

Hill: [laughs] It's not so much that! I mean, I have a dark side, but it has little to do with corporate structure. But, I'm always interested to see with these larger conglomerates -- and we've seen it for years play out with Procter & Gamble -- is, what's working? Procter & Gamble at one point had over 100 separate brands that they were managing. They're not all performing at the same level, so how did they decide what to cut and what to double down on? That sort of thing. I think in the case of GE, I don't expect Flannery, over the next three years, to methodically make this a smaller and smaller company, as some people have theorized. I think at some point, with this greater transparency, he's going to look at these divisions and say, "This is where we need to be making further investments."

Fischer: I agree, Chris. That's very interesting to me, and probably to most of us listening, because we're portfolio managers ourselves. That's really what he's doing. But, the company will end up being much smaller for quite a while, maybe roughly half its size. When they spin off the health business, it's very likely they'll need to lower the dividend again because their income just won't support the current dividend. Investors should be aware that the dividend, which is around 3.6%, I believe, is likely going lower.

You still have surprising losses in the long-term insurance business that pop up here and again. That business is not well-run, in my opinion. GE Capital lending is still kind of a black box. There's a lot that still needs to come to light. It's going to get messy, it's going to get much smaller. You can't count on the dividend staying where it is. And, again, there's that $100 billion in net debt. That does limit how much more they can acquire and how aggressive they can be in trying to go after market share and be innovative, etc.

They almost have to focus on the few things that are going well for them. Aviation is one of them. Imagine if they started to lose their edge in that business. They're doing everything to avoid losing that edge. They need to focus on their strengths and go from there.

Would I own the stock? I don't, I don't plan to. I think it's a really interesting case study, though. It entered the Dow in 1907, and now, as of today, it left. This is a bit of history here, Chris.

Hill: Right! And, again, to go back to the people who make the decision -- I don't know who these people are, but the people who decided, "GE has to go, and Walgreens is the one we want." Today is Walgreens' first day in the Dow, it's GE's first day out of the Dow. Last time I looked, Walgreens was in the red and GE was up 7%, it was having its best day in three years. Well-timed, everybody at the Dow committee! Well done!

Fischer: I think GE had to have timed this announcement last night, too. Like, "We'll show the Dow!" And to take the pressure off.

Hill: Yes. Good for them! I like, by the way, how you referred to the fact that we are all portfolio managers. I think that's one of those things that, the average listener doesn't necessarily think as himself or herself as a portfolio manager, but if you're investing in stocks, or you have your 401(k) plan, yeah, you actually are.

Fischer: Yeah. Once you own three, four, five, six stocks or a 401(k) plan with however many holdings, you're managing that portfolio. In Motley Fool Pro, which I manage, we have 25 long investments, and we're struggling with a couple of them almost always. You're always thinking, "What do we do with that one, or that one?" That's GE in a nutshell, just slightly larger.

Hill: [laughs] Just slightly.

Fischer: With a lot of jobs at stake.