In 2019 Baker Hughes (NYSE:BKR) made an important, if largely symbolic, change: It dropped the tag line "a GE Company" from the end of its name. Nevertheless, here's why Baker Hughes and General Electric (NYSE:GE) are still tied together at the hip, why they both want this situation to end -- and why a change could unlock value for each company.
A complicated history
In late 2017 General Electric merged its energy industry operations with those of Baker Hughes. At the time, the suggestion was that this pair-up would create an industry giant with a combination of scale and diversification that would set it apart from its peers. GE ended up with a roughly 62% ownership stake in the entity, which was called "Baker Hughes, a GE Company."
The combination didn't work out quite as planned. Yes, Baker Hughes was able to provide services in the upstream, midstream, and downstream segments, giving it an incredibly broad portfolio. But the energy sector was in a downturn, so demand was weak, and integration efforts added to early red ink. That combination left investors less than enthusiastic, and Baker Hughes' shares started falling. At this point they have lost roughly two-thirds of their value over the last three years.
One of the big problems is that GE remains a giant shareholder. This industrial giant is dealing with major financial headwinds as it continues to try and revitalize its business following the deep 2007-to-2009 recession. There have been three CEOs, multiple dividend cuts, an SEC investigation, lots of write offs, and some big asset sales since the so-called "Great Recession" as GE looks to right the ship. The company's Baker Hughes stake is, in the end, going to be an important source of cash to help with that effort. In fact, General Electric has already reduced its stake from roughly 62% to a touch under 37%.
Why GE's looking for change
The benefit GE would secure by selling its Baker Hughes stake is pretty simple: money. Specifically, money it needs to help reduce its leverage and fund investment in its remaining businesses. The problem is that GE's still-weak financial position has left many fearing that it is working from a position of weakness, which was particularly true of its early Baker Hughes stock sales.
Even though GE's ownership is now below 50%, the overhang on Baker Hughes doesn't go away. Although GE's financial situation appears to be improving, it continues to have a number of issues to deal with (such as the poor performance of two of its four divisions, a still-heavy debt load, and lingering problems within its troubled financial division). Moreover, it has a stated its intention of jettisoning the roughly 37% of Baker Hughes that it still owns. Selling more of Baker Hughes will provide more cash, which is good for GE. But without a clear timeline for that sale (the two companies are "working collaboratively" on the sales effort), investors will remain hesitant to jump into Baker Hughes.
That logic here is simple: If GE needs to sell a massive ownership stake, then any uptick in Baker Hughes stock could be accompanied by a flood of GE-owned shares into the market. That would sate any demand there was for Baker Hughes from other investors, and squash what might otherwise turn into a stock rally. Until GE is out of the picture at Baker Hughes, the oil services giant's stock has a big headwind to deal with.
What's it mean for shareholders?
The irony in all of this is that Baker Hughes' recent results appear to show that it has turned the corner for the better. Yes, the energy sector it serves is still struggling, but it has positioned itself well to deal with that adversity. The big risk is that the stock could be stuck in neutral until GE is out of the picture.
GE, meanwhile, has bought itself some valuable financial breathing room with its decision to sell a big piece of its medical business. That's good news for GE, because it can now afford to take its time selling its remaining Baker Hughes stake. But in the end that's a bad outcome for Baker Hughes, because it means the GE overhang will continue for an unknown period of time.
Although GE is likely to sell its stake sooner rather than later, most investors should stay on the sidelines until GE's ownership in Baker Hughes is much lower than it is today. Which is unfortunate, since Baker Hughes's business seems to be on the mend.