General Electric (NYSE:GE) could not have timed its buying French conglomerate Alstom's (NASDAQOTH:AOMFF) energy assets any better. Oil and gas is GE's fastest-growing segment and a major component of the company's ambition of generating 75% of earnings from its industrial business by 2016. But the crude oil free fall, from more than $100 per barrel in June 2014 to less than $50 in 2015, will slow the segment's growth momentum, in GE's own words. The company is expecting the oil and gas segment's top and bottom lines to be flat to down 5% in 2015 as oil companies into shale fracking are curbing capital expenditure, and are unlikely to order GE's equipment at last year's levels.
Alstom's assets could now become the deciding factor in GE's attempts at increasing dependence on the industrial business and decreasing reliance on GE Capital.
"The Future of Power Generation"
GE did its homework before targeting Alstom's energy business. The American conglomerate lists some compelling statistics for "the future of power generation" on its website, detailing the enormous prospects of the global power-generation market:
- Global power-generation capacity could increase by 3,400 GW during the next 10 years.
- Electricity generation across the planet is forecast to increase by 54% by 2030.
- Over the next decade, 60% of electricity generation is estimated to be sourced from gas and fossil fuels.
- About 70% of gas turbine orders are projected to be for a combined-cycle plant that could increase annual combined-cycle plant orders by 1.3 times to 68 GW in the next decade. (A combined-cycle power plant combines gas and steam turbines to generate 50% more electricity from the same resources than a conventional simple-cycle plant does.)
The bullish industry trends are also backed up by a 2014 report published by consulting firm Frost & Sullivan. The report predicts the size of the global gas and steam turbine markets could rise from $32.51 billion in 2013 to $43.49 billion in 2020.
"GE plus Alstom, there's $60 billion in growth markets"
That's what GE CEO Jeff Immelt said at the company's investor meeting in December. Since GE announced the Alstom deal last year, Immelt has stressed that the integration could have a $60 billion exposure to fast-growing emerging markets. While Immelt did not break out the specific regions or the industries, according to the Economist, GE has been investing in clean coal and wind power in developing nations such as India and China. High environmental pollution levels, especially in Asian countries, are encouraging people to convert to clean power -- which is expected to be the next big thing for turbine makers like GE and Alstom.
After GE integrates Alstom's assets, it could have 30 factories in China, which, according to the Frost & Sullivan report, could emerge as the largest gas turbine market by the end of the decade. China is on a mission to reduce its dependence on coal plants, and is aggressively investing in gas turbines. Other growth markets include the Middle East, North Africa, Turkey, and India.
The Alstom deal, which is expected to conclude by the middle of this year, will pump up GE's power operations and expand turbine capacity. It will give GE access to Alstom's offshore wind turbines and complementary steam and gas turbine products. The American conglomerate is a leading global player in the gas turbine business, but lacks presence in steam turbines. With Alstom's expertise in steam turbines, GE will become competitive in building combined-cycle plants.
"An acquisition that's very consistent with our execution skills"
GE estimates that by 2020, synergies from integrating Alstom's energy assets will produce $1.2 billion in annual cost savings. According to the company, margin in Alstom's service business is 10 percentage points lower than in GE's service business. Immelt, who made the above statement on CNBC, hopes this differential can be tapped to boost profits.
Also, there's supply chain efficiency: Between GE and the businesses that it bought from Alstom, there are goods worth more than $1 billion that one of them buys and the other sells every year. After integrating Alstom's assets, if GE does not use a third-party supplier for these purchases, it could generate $200 million in annual savings, assuming a 20% margin.
GE estimates the Alstom deal will be accretive to earnings by $0.01 per share in 2015 and roughly $0.06 to $0.09 per share in 2016, then grow from there to yield high-teen returns.
At a time when GE's oil and gas business has come under pressure, Alstom's energy assets can help GE reach its goal of generating 75% of its earnings from core industrial operations. Immelt has talked so much about this goal that it has become crucial that the company doesn't falter in attaining it. Investors should keep an eye on how the integration progresses, as it's likely to be one of GE's most critical growth drivers.
ICRA Online and Eshna Basu have 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.