When a company's management is asked what investors might not understand about their business or earnings prospects, it's usually time to listen. Based on his comments at the Barclays Industrial Select Conference, General Electric Company's (NYSE:GE) CFO Jeff Bornstein thinks the market is underestimating the potential of Predix, GE's cloud-based platform-as-a-service (PaaS) solution that runs applications helping users capture and analyze industrial data. Does this mean the company has a hidden value about to be released in future years?
Bornstein's view that people following General Electric might not "intuitively understand" the opportunity from Predix highlights that management sees upside potential in its investments in the industrial Internet. Why might investors be missing it? Three reasons:
- It's hard for industrial investors (largely analyzing hardware) to think of General Electric as a digital company.
- There are few visible, tangible benefits so far from the industrial Internet.
- It requires conceptual understanding.
If these three things are true, and Bornstein is right, then there is upside opportunity if General Electric can release value from Predix in the way management feels it can.
Benefits of Predix
The next step is to look at the five benefits Predix can bring to General Electric:
- Cost savings through utilization on its own production activity, such as learning how to cut unit production costs when ramping up production of new high-ticket items such as the H-turbine, LEAP engine, or Tier 4 locomotive.
- Data capture and analytics is a value add that can be sold into the company's installed base, or with new solutions.
- Predix not only will help customers run assets better -- whether with General Electric hardware or not -- but it should lead to increased services revenue for the company, as analytics will advise companies when to service equipment.
- Bornstein argued that the analytics capability could lead to changes to products based on the data feedback -- better product outcomes mean the company's hardware is more attractive to buyers.
- Predix could become the standard operating platform of the industrial Internet.
What it all means
Starting with cost savings, it's a good idea to look at some tangible examples. The three General Electric product examples outlined above relate to new high-ticket items on which the company is ramping up production. It may seem a relatively unimportant part of operations, and cost-cutting is rarely seen as sexy by investors, but it directly impacts the bottom line.
Consider the difficulties that The Boeing Company (NYSE:BA) is having with ballooning deferred production costs on the 787, or even how United Technologies' (NYSE:UTX) Pratt & Whitney segment is hoping to reduce unit production costs as it starts to produce its geared turbofan engine -- which is, incidentally, the key competition to the LEAP engine.
The benefits of cutting costs on these programs are tangible: In fact, it is arguably the single most important challenge/opportunity ahead for Boeing and United Technologies this year. In this way, industrial companies really can use the industrial Internet to cut design or production costs. Indeed, General Electric CEO Jeff Immelt claimed the company had already generated $400 million of internal productivity by using its analytics capability.
Value add and increased services revenue
If customers are better optimizing their assets by using Predix analytics, then there's a clear value add that General Electric can sell to them. Things like increasing fuel efficiency on an aircraft engine or an industrial gas turbine by a small amount may appear mundane, but it leads to significant cost savings to a company.
Similarly, if customers are running their assets better using Predix, they are likely to have a stronger relationship with General Electric, which could lead to increased, and more consistent, service revenue -- something to consider as the company starts working on the installed base it acquired with the purchase of Alstom's energy assets.
In addition, General Electric could end up servicing other hardware manufacturers' products. For the record, services contribute the majority of the company's industrial profits.
Product changes and platform
The ability to make hardware changes in reaction to analytics data from usage is clearly a major plus for customers and General Electric alike, and it helps differentiate the company from its competition.
Moreover, whether the Predix platform becomes the industry-standard operating platform of the industrial Internet or not, General Electric's hardware and services would become more attractive to customers because they (hardware and services) are integrated with the platform.
The bottom line
Putting all of this together, it's clear that Predix does have tangible benefits, but they are not easily seen right now, or even quantified yet. However, things like reducing design and production costs, optimizing asset performance, strengthening service ties, and producing tailored products are key considerations for the kind of high-cost/long-cycle products that the industrial giant sells.
If the market really is missing the opportunity from Predix, then the case to buy the stock is a good one, because the industrial Internet is real, and it's already happening, with General Electric at the forefront.
Lee Samaha 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.