The deal to sell General Electric's (NYSE:GE) biopharma business to Danaher (NYSE:DHR) grabbed the headlines recently. Now that the dust has settled on the announcement, it's time to look in more detail at what's really changed.
For Danaher, it's a case of natural evolution. But for GE, it's evidence of a change of emphasis toward debt reduction by CEO Larry Culp.
Danaher buys growth
After the initial euphoria over the deal, GE's stock is now down -- but Danaher's stock has risen by a double-digit percentage. The deal is good news for Danaher, as it continues the company's strategy of refocusing on its growth areas, such as life sciences and diagnostics.
Danaher is already set to spin off its underperforming dental segment, and the purchase of GE's biopharma business is a natural progression of its strategic aims. Not only is it a good fit, but the fact that 75% of GE's biopharma sales come from consumables is also in line with Danaher's long-held goal of increasing recurring revenue.
In a nutshell, the deal adds growth. And it allows Danaher to apply its much-admired Danaher Business System (DBS) -- a set of core principles embodying lean manufacturing processes and continuous improvement -- to the new business in an effort to improve productivity.
What it means to General Electric
Of course, Larry Culp knows all about DBS, because he's the man responsible for implementing it at Danaher in the first place. In fact, Culp's highly successful tenure at Danaher, and his proven ability to extract every ounce of productivity from a business, are key reasons that many feel confident in his ability to turn GE around.
For General Electric, the deal should also be seen as a net positive, but understanding why might require some explanation.
The $21.4 billion deal includes $21 billion in cash and the assumption of some $400 million in pension liabilities. It's easy to conclude that this will go a long way toward reducing GE's industrial net debt of around $55 billion (GE Capital also has $66 billion in debt), but there's a snag. In fact, there's an $18 billion snag.
Ever since former CEO John Flannery announced the plan to separate GE Healthcare in June 2018, it's been understood that $18 billion worth of debt and pension obligations would be transferred along with GE Healthcare.
However, as already noted, the biopharma deal will only transfer $400 million in liabilities, and the previously planned Healthcare spinoff is reported to be under evaluation. In other words, GE won't be transferring the $18 billion in debt and pensions anytime soon.
Moreover, GE Healthcare will be left with 86% of its previous Healthcare revenue. And given that GE's life sciences segment grew 8% in its last quarter but the healthcare segment had organic growth of just 6%, it's fair to say that Healthcare's growth rate could slow.
All told, just because GE is selling BioPharma for $21.4 billion, it doesn't mean GE's debt problems are over, because the plan to transfer $18 billion in debt and pensions in a general healthcare spinoff is on hold for now. However, the deal is good news for other, more subtle reasons.
Check out the latest earnings call transcript for General Electric.
2 reasons the deal is good news for GE
First, selling the biopharma business separately has, arguably, resulted in a higher price for it than GE would have gotten by including it in a GE Healthcare spinoff. This is in line with the general trend of industrial conglomerates trying to release value by separating disparate businesses from each other.
Second, this is further evidence of Culp's decisiveness in dealing with debt problems. For example, in Flannery's original plan for Healthcare, 80% of the segment was going to be distributed to GE shareholders, with 20% being monetized by GE. Subsequently, Culp has modified the terms of the Westinghouse Air Brake Technologies deal so that GE keeps 24.9% of shares in the new Wabtec, compared to 9.9% under Flannery's plan. Culp also said he was willing to monetize up to 50% of the potential Healthcare spinoff, compared to Flannery's 20%.
The recent deal means GE shareholders now won't receive anything directly from the biopharma business. Instead, GE will "use the proceeds from the transaction to reduce leverage and strengthen its balance sheet," according to the press release. That should do a lot to appease debt holders and strengthen the company's creditworthiness.
The key conclusion for GE investors
The deal marks continued progress in Culp's plan to quash any lingering fears about GE's liquidity. That should be welcomed by investors: Flannery's plan to distribute the lion's share of GE Transportation and GE Healthcare directly to shareholders didn't do much for the share price, or for concerns about the company's debt.
That said, the bearish argument against GE has never been solely about its liquidity; it's also been a question of its run rate of earnings and free cash flow, given an ailing power segment and a troubled GE Capital. The key to the investment proposition at GE remains the shape of the potential earnings recovery at GE Power.
The market still awaits Culp's guidance on GE Power, and an indication of how long the turnaround will take, but the deal with Danaher will result in a cash infusion, which should at least buy GE more time to deal with issues at GE Power and Capital.