When it comes to refrigerators, General Electric (NYSE:GE) is a household name. When it comes to banking, however, the industrial giant's not so interested in the everyday consumer.
To that end, the company filed paperwork with the SEC on Thursday to conduct an IPO for the North American retail finance unit, which makes up a portion of GE Capital's consumer business. On a day-to-day basis, the retail finance unit handles credit card financing for stores like Amazon.com and American Eagle. This credit card unit, which will be called Synchrony Financial after the spin-off, also happens to be the largest U.S. issuer of credit cards for retailers and related industries.
Let's look at how the upcoming spin-off could unlock value for GE investors along the way.
A view from 20,000 feet
To understand exactly what GE is parting ways with, here is a brief overview of how the businesses stack up at the conglomerate:
1. First, keep in mind that GE's banking division, GE Capital, generated $44 billion in revenue and $8.3 billion in profits in 2013. Of the whole GE pie, that made up 30% of revenue and 34% of segment profits for the latest fiscal year. That's a rather large slice, and one that GE intends to narrow to 30% of profits by 2015. The spin-off of the consumer business is a step in that direction.
2. Within GE Capital, the North American retail finance unit contributed $2 billion in profits during 2013, or roughly 29% of post-tax earnings. As you can see, this consumer business is no small potato either, so GE has decided to cut ties in a two-step process. Step one is the 2014 IPO.
3. This IPO, which could take place in the next couple of months, will consist of roughly 20% of the equity of GE's North American retail finance business. Step two will distribute the remaining 80% of the equity to GE shareholders next year. All told, the resulting company, Synchrony Financial, could fetch a value of up to $20 billion according to multiple estimates.
When it's all said and done, GE aims to separate itself from a non-core business that served as a distraction in recent years. Despite the hefty $1.98 billion in profits provided by North American retail finance in 2013, GE said this business is a "step removed from GE Capital's strength of lending to industrial middle-market companies."
For shareholders, there are several reasons to be optimistic about what this move brings to the table.
What the spin-off means for investors
The spin-off, first and foremost, signals a continuation of GE's plans to "right-size" GE Capital and reposition itself as an infrastructure leader. In that regard, GE considers the IPO and subsequent tax-free distribution to shareholders as the "last major action" to get to the right balance between industrial and banking businesses. That's good news for shareholders because it frees up management to focus on lending geared toward the mid-market customers, which is GE Capital's bread-and-butter business.
Secondly, GE's spin-off arrives at an attractive time for both the business and the market environment. As the Wall Street Journal reported, the underlying operations at soon-to-be Synchrony are quite strong. Profits, for example, have surged from $400 million to $2 billion in only four years. GE's waited wisely to conduct a spin-off at an opportune moment.
On top of that, the market for consumer lending is rebounding quite nicely. As a case in point, Santander Consumer, a similar lending business which makes car loans to subprime borrowers, recently raised $1.8 billion in an IPO that was enlarged due to heightened interest. Meanwhile, shares in credit card competitors like Discover Financial Services are up more than 80% in the past two years.
In other words, the timing couldn't be better. While GE's been making strides in other areas of the business, many analysts still believe the GE Capital overhang has been weighing down the stock. It's one of the key reasons GE's shares trade at a P/E multiple that's 17% lower than the industry average according to Morningstar.
Finally, the second half of the upcoming transaction will effectively result in a diminished share count as stockholders are able to swap their ownership in GE for shares in the consumer finance business in 2015. This will effectively serve as a beneficial buyback so long as the contracting outstanding shares are greater than the earnings diverted through the spin-off.
While GE's still in the early stages of the consumer finance spin-off, the payoff at the end of the road looks attractive both qualitatively and quantitatively. When it's all said and done, GE will be free to focus on growing financial earnings commensurate with the industrial side of the business, and shareholders will have the opportunity to invest in Synchrony – should they choose – or reap the benefits of the stock-for-stock swap through an increased claim to the parent company's earnings. The stand-alone unit might face some challenges on its own, but right now this is looking like a win-win for GE shareholders.