General Electric shock and after
19 Apr 2008
It is not everyday that a company sheds nearly $45 billion in market capitalisation. There are not many companies with that kind of market value anyway for that matter. This jaw- dropping crash befell the General Electric stock last week, when the company's quarterly profits fell short of analyst expectations and the profit forecast for the current year was cut. The stock fell 12.8 per cent that day, its worst single day decline since Black Monday, 1987.
GE's results triggered yet another wave of panic in the financial markets as analysts became more convinced that credit market troubles are deeper than expected. More are now willing to buy the argument that credit troubles have started affecting areas of the economy which were earlier considered insulated and it will be a while before the global economy shakes off the after-effects of the ongoing crisis. (See: GE downed by credit woes in Q1 2008; reports first decline in profits since 2003)
Why the surprise hurt so much
On the face of it, it is surprising that the weak numbers from General Electric surprised so many. After all, GE derives more than half of its profits from financial services and this is not exactly a period of soaring profits for financial services firms. The company's financing arm, GE Capital Services, is just another giant financial services firm with businesses ranging from commercial finance to credit cards. GE Capital escaped heavy bruising until now as it did not have much exposure to mortgage-backed securities like the big banks and securities firms.
But, GE Capital couldn't fully escape the ravages of the liquidity squeeze. The division couldn't complete some real estate and other transaction during the last weeks of March, presumably because lack of liquidity deterred potential buyers. GE also wrote down its investment portfolio, including securitised assets, by $270 million for the quarter. That seems peanuts when compared to the billions of dollars written off by big banks. But, GE was not expected to have a rough day at all.
In the words of Jeffery Immelt, GE CEO, ''the last two weeks in March were a different world in financial services''. Yet, much of the disappointment was Immelt's own making. Until mid-March, the CEO of the world's premier industrial conglomerate was very confident that his company would meet its profit targets.
He presented a 10-per cent profit growth forecast for 2008 as a fait accompli, by claiming early this year that it is 'in the bag'. That forecast has now been cut in half. The results and the revised forecast showed that even Immelt was clueless about his company's performance, barely two weeks before the close of the quarter.
Immelt has a 'credibility problem', according to his mentor, predecessor and GE's high-profile former CEO Jack Welch. ''Here's the screw-up: You made a promise that you'd deliver this, and you missed three weeks later'', Welch said. GE CEO's are supposed to do better than that. ''I'd get out a gun and shoot him if he doesn't make what he promised now'', Welch promised.
''We let people down. That's not what we want people to expect of GE. We hate disappointing investors. It's not part of the company. It's not part of the culture. We take accountability for that'', Immelt owned up.
It ain't no ordinary company
Now, GE is not any other company to dismiss an unexpected downward shift in its business fortunes as inconsequential. It is the most diversified multinational, with a finger or toe on everything from aircraft engines to small-ticket consumer loans and television broadcasting. GE is the closest corporate proxy to the global economy one can get – if the global economy is doing well, GE will do well and vice versa. Just as Citibank's troubles heralded the deep crisis that has engulfed banks and financial services companies, many now fear that GE's difficulty in meeting its numbers will be repeated across other similar businesses.
Most investors had looked at GE as a safe hedge against the slowing US economy. The company's expanding reliance on overseas businesses was expected to shield its performance. Overseas revenues of GE exceeded US revenues for the first time recently, helped by strong global demand for capital equipment and infrastructure assets. These positive factors helped the stock outperform the broad market, until the big fall last week.
The real worry signs
It is not the unexpected weakness in GE Capital Services that is troubling analysts and observers, but the rather muted performance at the company's industrial divisions. Healthcare and industrial businesses reported a decline in profits while the media and entertainment division NBC Universal reported a marginal growth in its bottom line.
GE's infrastructure business was the lone bright spot with a 17 per cent profit growth, helped by strong global demand for industrial equipment. Even here, order book growth has moderated and margins have come down – indicative of the company's difficulty in passing on higher input costs to customers.
Is the slowdown in GE's infrastructure business indicative of a wider decline in global economic growth? So far, the revised global growth projections have accounted for only a modest decline – mostly because of the decline in consumer demand in developed economies. The collateral damage to fast growing economies like China and India were thought to be modest. Infrastructure investments in these countries were expected to expand at a rapid pace. If other global capital equipment suppliers also report a decline in order book growth, these assumptions will have to be revised.
In India, we have already seen a decline in capital goods output growth in recent months. Unless the recovery in February industrial growth extends to subsequent months, it may mean that the growth slowdown may be deeper than current forecasts. More significantly, any sustained decline in capital investment growth would mean that the global downturn may last much longer than most now expect.