Shares of General Electric (GE +0.30%) have sunk more than 7% in the week after the company released third-quarter earnings. The market has overreacted to poor wind sales and a smaller GE Capital unit, but another big trend was largely overlooked. General Electric's Oil & Gas unit put in a tremendous quarter, with revenue up 4% and profit up 18%, and management guided for double-digit growth in the business for this year and next. This performance is good validation for General Electric, which has invested more than $11 billion in oil and gas since 2007, largely through acquisitions. If this strategy is working, could GE have the same treatment in mind for the mining equipment industry? And if so, who might be next?
Gas giant
As General Electric has pivoted away from the financial business and toward industrial equipment and infrastructure after the Great Recession, its Oil & Gas unit has been quite a sleeper success. Orders have grown from only $4 billion in 2004 to $16 billion in 2011, largely on the back of successfully integrated acquisitions like VetcoGray in 2007, Hydril Pressure Control in 2008 and Dresser and Wellstream in 2011.
Technological synergies with other General Electric business units allow GE Oil & Gas to punch above its weight. For example, GE Oil & Gas has a huge market opportunity in natural gas turbines as cheap natural gas displaces other energy sources for power generation. GE's turbomachinery is the best in the industry, as Oil & Gas has been able to leverage aeroderivative technologies developed by GE Aviation for jet engines as well as power-generation technology developed by GE Energy for windmills and other turbines. These sorts of technological spillovers make GE Oil & Gas a far more formidable competitor to incumbent power generation equipment suppliers like Emerson Electric (EMR +0.76%) than the unit's size would suggest.
With around $15 billion in revenue, General Electric's Oil & Gas unit is now the fourth largest oilfield services and equipment provider by sales. It still has a long way to go to catch market leader Schlumberger (SLB +0.30%), with annual revenue approaching $45 billion, but GE's extensive geographic diversity makes it look a bit more like Schlumberger than closer competitor Halliburton (HAL +1.38%), which derives more than half of its $28 billion in revenue from North America.
Contending with low natural gas prices hurting new demand for oil- and gas-field services, these big incumbents have been underperforming recently, with Schlumberger losing 30% of its value and Halliburton declining 20% over the past five years. Valuations have been depressed industrywide, which gave General Electric some great buying opportunities. Since cleaning house after the recession, General Electric has shored up its balance sheet and stabilized revenue, allowing the company to not only pay a 3.2% dividend, but also to issue cheap debt in order to capitalize on good deals in the oil & gas sector.
Jumping for Joy?
Now, similar headwinds seem to be facing the mining industry, with valuations dropping accordingly. Miners have been pulling back their capital expenditures, with global mining giant BHP Billiton (BHP +2.52%) alone postponing nearly $70 billion in project work in August after a sharp drop in profits. Caterpillar (CAT +1.54%), as the world's largest manufacturer of heavy equipment for mining and construction, is a particularly notable bellwether. When Caterpillar dropped its guidance out to 2015 on predictions of slower global economic growth, mining equipment suppliers worldwide experienced a broad decline in prices. If General Electric seeks to pursue the same strategy for its mining equipment as it did in Oil & Gas, these low prices might just signal another acquisitions spree.
Last spring, GE CEO Jeff Immelt indicated that 2012 wouldn't see any big deals, targeting $1 billion to $3 billion as a good range for new acquisitions. So far, that's been the case, but with the end of the year in sight, I'm wondering whether General Electric might be tempted to make a big deal for the $6.7 billion mining equipment manufacturer Joy Global (JOY +0.00%). With sales of over $4.4 billion in 2011, acquiring Joy would allow General Electric to meet its goal of doubling mining revenue to $5 billion at a stroke.
General Electric would also be acquiring something of an industry leader. While small, Joy has an extensive aftermarket servicing business that allowed it to boast an impressive operating margin of 21% in 2011, nearly double the 12% achieved by industry leader Caterpillar. Even better, Joy is selling for only around eight times forward earnings, close to a five year low. GE could offer a significant premium and still get a good deal.
For its part, Joy might appreciate the scale and technological spillovers that becoming a part of General Electric offers, as the company attempts to compete with Caterpillar, a company over ten times its size. In October, Joy Global CEO Michael Sutherlin indicated he was open to a potential sale if the price was right, saying "if somebody, GE or somebody else, wanted to come and make an offer that was very attractive for our shareholders, we'd do the right thing for our shareholders."
