The GE Business You've Never Heard Of: And Why It Really Matters

The head of General Electric's (GE -2.11%) digital business, Patrick Byrne, recently gave a fascinating presentation at the Credit Suisse Global Industrials Conference. The presentation put some flesh on the bones of the investment case for GE stock. Specifically, it helped explain how the company will improve cash flow and profitability at its two turnaround businesses, power and renewable energy.

In order to avoid confusion, it's a good idea to follow Byrne's lead and talk about GE's digital business in terms of the solutions offered to its customers and then how GE is using digital technology to improve its own operations. Both are highly significant to the company.

General Electric's digital offerings for customers

First, a little history. GE's digital capability was highly promoted by former CEO Jeff Immelt. In fact, it was a large part of why he made an ill-fated spending spree in the power and oil and gas industries. The idea was that GE would build scale and then apply its digital and internet of things (IoT) capability to the assets it acquired in order to extract more value from them.

General Electric's digital solutions will help the energy grid function better. Image source: Getty Images.

It was a plausible idea. The problem was that GE's acquisition spree coincided with downturns in key end markets. For example, GE bought Alstom's power assets in 2015. Unfortunately for GE, the heavy-duty gas turbine market (the centerpiece of its power segment) has halved in the last five years. Similarly, GE made a slew of acquisitions in oil and gas, culminating in the combination of its oil and gas business with Baker Hughes in 2017. Alas, the price of oil has gone from around $100 a barrel in 2014 to around $45 today.  

Ultimately, GE was left holding assets that served shrinking end markets. As such, it became harder and harder to justify GE Digital's losses and cash burn. However, that was then and this is now. In fact, Byrne outlined that GE Digital is likely to break even on a profit and cash flow basis in 2021.

For reference, GE Digital's figures are included in GE Corporate. As such, reducing its losses is part of GE's plans to cut adjusted corporate operating costs to around $1 billion from $1.7 billion in 2019. That will help the company improve profitability and cash flow. 

Source: General Electric presentation at the Credit Suisse Global Industrials Conference.

Meanwhile, many of the arguments previously trumpeted for GE Digital are coming to fruition. Byrne highlighted how its IoT capability would improve asset utilization in electricity transmission and distribution: a key issue as the shift toward renewable energy takes place. GE Digital expects to unlock similar benefits in the power and oil and gas industries.

The use of web-enabled devices allows users to collate massive amounts of data, which they can then use to analyze, monitor, and manage how an asset is run or a grid is operated. In doing so, GE's customers can better manage their assets, predict failures, and reduce downtime. 

How GE's digital business will improve internal performance

Turning to the effect of GE's digital business on its own operations, there's cause for optimism. The investment case for GE stock rests on the idea that GE Aviation will make a comeback from the pandemic and the healthcare segment will continue to churn out free cash flow. Finally, and key to this article, the case for GE stock relies on the power and renewable energy segments improving earnings and cash flow, ultimately matching their peers.

Image source: Getty Images.

One way GE can achieve this is by using digital technologies to improve its services offerings in power and renewable energy. GE's services revenue tends to be a higher-margin activity than its equipment sales. For example, GE could potentially improve its margins by using data analysis to reduce wind and gas turbine failures -- issues that negatively affected GE in recent history. Early detection of failures will reduce warranty and service costs for GE.

What GE Digital means to investors

The transition to breakeven and then profitability at GE Digital will improve earnings and cash flow for GE on the whole. At the same time, the use of digital technology in GE's own operations is going to help improve margins at the key segments that management is turning around: power and renewable energy.

All told, GE Digital is finally on the cusp of making a contribution to GE's profitability. That should give investors confidence in GE's turnaround story.