General Electric (NYSE:GE) recently filed documents with the SEC relating to the impending IPO of its North America consumer credit card segment, which is part of GE Capital.
The new business, which is up for IPO, will be named Synchrony Financial and will trade under the ticker symbol SYF. According to the SEC filing, 20% of Synchrony will be put up for sale to the public (IPO). The remaining 80% of Synchrony will be held by GE to be spun off later in 2015, potentially through some sort of share swap deal.
Commentators are reading too much into mind-numbingly routine details of the impending spin-off -- figures, dates, projections -- and overlooking the true purpose of the move.
Redefinition of revenue streams
In 2013, GE Capital accounted for 40% of GE's overall earnings. However by 2015, GE CEO Jeffrey Immelt says that GE Capital should account for 30% of GE's overall earnings. Why the deliberate move to redefine the revenue streams and reduce exposure in the financial segment?
The financial segment -- GE Capital -- requires a significant amount of leverage to achieve the same return on equity when stacked against the industrial sector. So, reduced exposure to the financial segment allows GE to reduce the amount of debt it takes and in effect improve its return on equity, allowing it to compete more effectively for investors relative to its industrial peers. Furthermore, overall interest rates are facing significant upward pressure amid the Fed's taper. As such, borrowing at such a time could be expensive for GE. It is therefore wise to reduce exposure in business segments such as GE Capital that stir the need for heavy borrowing relative to its alternative industrial segment.
The impending Synchrony Financial IPO and consequent full spin-off of the segment thereby serves to increase GE's return on equity and overall attractiveness to investors. In addition, it has its own unique set of benefits that if critically analyzed, are telling of the wider strategy at play.
First, let's look at the structure of the spin-off. GE will initially issue an IPO for 20% of Synchrony. Then in 2015, it will spin off the remaining 80% stake that it holds, effectively relinquishing its entire position in the operation.
Here is the catch: The Synchrony Financial IPO will be priced in such a way that there is some substantial upside to the stock post-IPO. As such, GE's 80% stake in the business will be deemed more attractive after the IPO. Ideally, GE should be able to spin off the 80% stake in 2015 at a good premium compared to the IPO price, giving it sufficient capital to push forward with its ambitious buyback program. In a recent letter to shareholders, GE asserted that it expects to return $90 billion to shareholders by 2016. The company returned $18 billion in 2013.
GE is focusing on creating shareholder value to drive up demand for its shares and allow it to more easily raise capital through the equity market, which is safer and allows for flexibility when compared with the debt market. Unlike the case with capital sourced from debt instruments, a company doesn't necessarily have to pay back equity, and even when it does share its profit to shareholders or the providers of equity, the rate at which it pays out dividends is entirely at its discretion -- though there is often a distinction between this ideal and the actual reality; does the term activist investing or the name Carl Icahn ring a bell?
Why does GE have an insatiable need for capital, particularly 'safer' capital from equity markets?
All roads lead to oil and gas production infrastructure
By reducing overall downside risks, GE will be able to attract investors in the equity market, giving it 'safer' capital needed to throw its full weight behind the industrial segment, particularly oil and gas infrastructure.
As my colleague Isaac Pino argued in a previous article, GE is putting a lot of emphasis on innovation and efficiency, including pushing forward with efforts to reduce its new product introduction cycle by 30% over the next few years in order to present first-to-market solutions to its customers.
This renewed interest in innovation is slowly pushing GE into the epicenter of America's shale boom narrative. GE has identified a huge problem with fracking -- the technology behind America's oil production resurgence.
Shale output declines faster than output from unconventional plays. One estimate from the International Energy Agency says that it will take up to 2,500 new wells a year to sustain output of 1 million barrels per day in North Dakota's Bakken shale. In stark contrast, Iraq could comfortably do the same with 60 wells.
This means that for the U.S. to increase its output at a faster pace, it will need to engage in more drilling and production when compared with other countries that pursue conventional plays. But there is a downside. Fracking is not only cripplingly expensive relative to conventional methods reduced production in the overall upstream industry is indicative -- but it also uses unsustainable volumes of water.
General Electric is advancing a capture-use-recapture system that uses CO2 instead of water for fracking. The CO2 is recycled. This reduces overall costs and limits carbon emissions. In addition, the CO2 reduces the need for water, conserving current supplies.
Overall, GE's capture-use-recapture CO2 system should be a game changer in the oil and gas production sector as producers are looking for cheaper and greener ways to produce oil and remain competitive. This new fracking solution, if properly explored, will allow GE to widen its revenue streams from the industrial sector. However, the implementation and marketing will require heavy capital spending.
This explains the reduced exposure in risky highly leveraged segments such as GE Capital as well as the deliberate attempt to make GE's shares more attractive in order to rope in more investors in the equity markets.
Lennox Yieke has no position in any stocks mentioned. The Motley Fool owns shares of General Electric Company. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.