General Electric (NYSE:GE) stock is evolving.
Once a titan of the financial services industry, GE has spent the last few years reinventing itself, and returning to its industrial roots -- with a particular focus on the energy industry. That evolution moved one step farther along last week, when GE announced that it is buying the Heat Recovery Steam Generator (HRSG) business away from Korean giant Doosan Engineering & Construction (DEC) for $250 million.
As we've noted in recent writings, GE has enjoyed some measure of success from its recent energy investments. As fellow Fool Justin Loiseau pointed out last month, GE's renewable energy business "enjoyed the most organic order growth of any unit" in the company last quarter. It only makes sense, therefore, that the company would double down on that success with an investment in heat recovery, which by its very nature is a business focused on energy efficiency.
What heat recovery steam is
Within a combined-cycle power plant, heat recovery steam technology allows a power generator to capture the exhaust heat (i.e. "waste heat") produced by a gas turbine, and use it to heat water and drive a steam turbine to produce additional power output -- from the same fuel input. So what HRSG's equipment does, in essence, is produce free power, and GE says this tech "can help generate up to 33 percent of the power output of the plant."
That sounds like a good thing. But what about the price that GE is paying to acquire HRSG?
Stealing the crown jewels
Valued at $239 million today, DEC shares have fallen 26% since it was learned last week that General Electric is acquiring HRSG. But why was that? After all, the $250 million that GE is paying for HRSG was worth nearly 80% of DEC's whole market cap when the deal was announced. Shouldn't that cash infusion have made DEC shares go up and not down?
Well, according to data from S&P Global Market Intelligence, DEC is itself only a small company, and not a very successful one. Although it does $1.5 billion in annual sales, those sales resulted in a $443 million loss for the company last year. So right off the bat, you can guess that DEC was not well positioned to strike a hard bargain with GE.
And here's the key point: Full-year financials on DEC are not yet available, but according to what S&P Global does know about the company, DEC's HRSG unit did $132 million in revenue through the first nine months of 2015. That made it DEC's smallest major operating unit but, at an operating profit margin of 8.4%, DEC's most profitable business.
What it means to investors
Bluntly stated, what GE has done here is that it negotiated to buy away one of DEC's few profit-making businesses, and leave behind most of DEC's money-losing ventures. In exchange, General Electric will pay about 1.4 times sales for HRSG (GE's own price-to-sales ratio is 2.3), and acquire a business with an 8.4% operating profit margin, more profitable than its own 7.5% operating margin.
Translation: General Electric just bought DEC's crown jewels, and paid a costume-jewelry price for 'em. While small, this is a very good deal for General Electric stockowners, indeed.
Fool contributor Rich Smith does not own shares of, nor is he short, any company named above. You can find him on Motley Fool CAPS, publicly pontificating under the handle TMFDitty, where he's currently ranked No. 299 out of more than 75,000 rated members.
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