Slowdown arrives at precisely the worst time for GE

General Electric's turnaround plan already faces enormous obstacles: tons of debt. A weak power division. Sh...

Posted: Jan 8, 2019 8:17 PM
Updated: Jan 8, 2019 8:17 PM

General Electric's turnaround plan already faces enormous obstacles: tons of debt. A weak power division. Shrinking cash flows.

Now GE has to grapple with two other big challenges. There's mounting evidence that the US and global economies are slowing, perhaps significantly. And convulsions in financial markets could make fixing GE and its debt-riddled balance sheet even trickier to manage.

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"It's coming at the worst possible time," said Deane Dray, an RBC analyst who covers GE.

GE (GE) was in trouble even when the economy and market were booming. Its stock price crashed by 64% between the end of 2016 and the start of the fourth quarter. The long-treasured dividend was slashed to a penny. Century-old businesses were put up for sale. And the company turned to its first-ever outsider CEO.

But the mood in financial markets has darkened considerably since new boss Larry Culp took the helm on October 1. Last month was the stock market's worst December since the Great Depression.

Although US stocks — including GE — have rebounded nicely since Christmas Eve, economic red flags keep popping up.

China's manufacturing sector is in contraction. US factory activity slowed at the fastest pace in a decade. And Apple (AAPL) blamed a sales warning on trouble in China and rising trade tensions.

"GE is not the kind of name to own going into an economic slowing," said John Inch, a GE analyst at Gordon Haskett. "Its balance sheet is horrendous. It only stands to reason that as economic conditions slow, possibly tip, towards recession, that the company will not fare well."

The idea of a recession seemed far-fetched last summer when the stock market was surging. But it's now a contingency that CEOs need to plan for in the not-too-distant future. Nearly half of US CFOs polled by Duke University fear a 2019 recession.

"The GE turnaround is going to take time. And if the market and economic cycles turn against them, it's going to make everything harder to do," said Dray.

GE did not respond to a request for comment for this story.

'The buyers will pull back'

At a minimum, an economic slowdown and turbulence in financial markets will prolong GE's recovery plan. That's because the effort hinges in part on paying down a mountain of debt by selling off various businesses. GE wants to sell its stake in Baker Hughes (BHGE), as well as spin off the healthcare division and shrink its financial services business even further.

But recession fears will make it difficult for GE to get a fair price for those businesses, which potentially limits the amount of cash it can raise. GE already has a long history of buying assets at high prices and later selling them for way less. GE wrote down the value of its power division by $22 billion last year.

"If they're selling businesses and we're approaching a recession, the buyers will pull back," Dray said.

A central part of GE's turnaround is its plan to spin off GE Healthcare, the profitable division that makes MRI machines and other equipment. Health care is considered a defensive business because people need to go to the hospital and doctor's office no matter the economic conditions.

GE filed confidential paperwork for an IPO of the health care division, aiming for an offering in mid-2019, CNBC reported in December. GE declined to comment to CNN Business about the IPO report.

But it's unclear if the financial markets will cooperate, especially when mega IPOs from huge private companies like Uber, Lyft and Airbnb loom over the year.

"This IPO of healthcare is do or die to GE," said Inch.

Recession would clip aviation, power

The epicenter of GE's cash crisis is the company's power division, which makes turbines used by coal and natural gas power plants. An economic slowdown could add to severe pricing pressure at GE Power caused by the shift to renewables.

The bright spot at GE is its aviation business, which will remain a central part of the future company. But some analysts fear the aging aviation boom could come to a screeching halt if the economy shows cracks.

"Investors assume aviation will go up straight up in perpetuity," said Inch. "That's dangerous thinking. It's how bubbles and crashes form."

Airline stocks plummeted last week after Delta Air Lines (DAL) warned of sales and fare weakness at the end of 2018.

GE races to raise billions

Culp seems to realize that GE has little room for error right now.

He moved aggressively late last year to find ways to raise cash. GE said it will raise $4 billion by speeding up its divorce plan with Baker Hughes. And GE plans to raise another $1.5 billion by selling a GE Capital portfolio of healthcare equipment leases and loans.

Some on Wall Street are betting the worst may be over for GE. After nosediving to an eight-year low of $6.71 on December 12, GE has spiked about 23%.

The stock got another boost after Bloomberg News reported late Friday that Apollo Global Management is working to line up financing to buy GE's jet-leasing business. Sources told Bloomberg News that the business, viewed as the crown jewel of GE Capital, could fetch as much as $40 billion.

GE declined to comment on the report. Executives previously indicated that a sale of the leasing business was possible, though not necessarily the primary plan.

Selling the leasing business "should help reduce the existential question marks facing the company," Barclays analyst Julian Mitchell wrote to clients on Sunday.

Now would be a good time to resolve those questions. The economic clock is ticking.

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