General Electric (GE 3.94%) has always been a tough pick for the average investor, thanks to its extremely diverse businesses. But the highly anticipated spinoff of GE's $53 billion Consumer Finance arm, which will see bank earnings trimmed down to less than 30% of overall profits, will finally make the company one of the higher-quality and cleaner ways to play the broad industrial infrastructure cycle.
GE's finance arm currently accounts for a higher percentage of the firm's revenues than its core energy infrastructure segment, as shown below:
Source: PR Newswire, figures in billions of U.S. dollars.
Too big to grow?
General Electric's unwieldy size and sheer complexity, coupled with its seeming lack of initiative, have usually led investors to shun the industrial conglomerate in favor of its more nimble rivals such as Honeywell (HON +0.54%), United Technologies (UTX +0.77%), 3M, and Illinois Tool Works.
Although GE remains the Industrials Select SPDR ETF's largest holding, the stock has generally lagged its industrial peers for the last decade or so. GE shares have gained 26.08% year to date, marginally outperforming the S&P 500, which has risen 25.79%, but lagging behind peers Honeywell, United Technologies, 3M and Illinois Tool Works.
The lengthy underperformance can be pinned on GE's Consumer Finance arm, and the devastating effects of the global economic recession. GE's Consumer Finance segment provides store credit cards for 55 million Americans, and retailers such as Wal-Mart and Gap.
GE has no doubt been relying too heavily on its Consumer Finance arm, which accounted for close to half of the company's overall profits over the last decade or so.
The extraordinary disruption of the capital markets in 2008 badly impinged on GE's ability to complete asset sales resulting in significantly higher mark-to-market impairment losses.
Although the Consumer Finance segment was critical in fueling growth of GE's profits for many years, that changed with the recession. In the aftermath of the recession, credit use hit a wall, and investors became wary of paying too much for stocks that rely heavily on the banking sector.
Suddenly, GE's cash cow turned into one of its biggest curses. Even though the segment has rebounded -- it posted $2.2 billion profits in 2012, accounting for a third of GE's 2012 profits -- the risk of a repeat of this scenario has been depressing GE's share price. The spinoff of the retail finance division will minimize this risk, and help investors once again view the company as a pure-play industrial stock.
Cash from sale to finance other operations
GE plans to sell 20% of its Consumer Finance arm in the first-quarter of 2014 through an IPO, and use the proceeds of that sale to finance its other stand-alone operations. Bernstein Research estimates that GE's Consumer Finance division is worth $18 billion-$20 billion, so the planned sale should therefore fetch the company $3.6 billion- $4 billion.
The remaining 80% stake will be offered to GE shareholders in a highly unusual split-off plan planned for 2015. Shareholders willing to buy shares of the retailing finance arm will have to do so using their existing GE stock. This way, the company will reduce its outstanding shares from the current 10 billion-plus to around 9 billion.
GE will be looking to further strengthen its industrial segment, that deals with the manufacture of aircraft engines, gas turbines, locomotives, CT scanners, and gas drilling equipment. In the last quarter, GE's industrial segment recorded a healthy 11% growth in profits to $3.97 billion. The double-digit growth helped the company beat consensus analysts' estimates of $0.35 earnings per share by posting an EPS of $0.40.
Although the company is yet to offer the full details of the specific operations it will be revamping using the retailing finance cash, one big suspect is its aircraft engine manufacturing segment. United Technology has overtaken GE in this important segment after its bought Goodrich in 2011 in a huge $16.5 billion deal.
The Goodrich acquisition has now helped United Technology to acquire top-dog status in the aerospace industry, with estimates that the company can now comfortably supply 65%-70% of the parts used in the manufacture of an aircraft. That's a lot more than the 40% GE can manage, or the 35% that Honeywell, another key competitor, can supply.
United Technologies is already enjoying the benefits of its new status as a major supplier of big aircraft parts, and recorded a huge 65% jump in aircraft parts orders in the second-quarter. GE has never been known to be slouch when facing such competition, and will most likely move to bolster its aircraft parts manufacturing division.
Farewell to finance
One of the biggest potential benefits of the GE's Consumer Finance spinoff is that the conglomerate will cut off its credit risk, and avert a repeat of what happened in 2008-2009. The reduced risk could help make the stock more attractive in the eyes of investors, enable GE to compete better with its industrial rivals, and hopefully buoy the share price.
