General Electric Co. shouldn’t be so quick to rule out tapping the stock market to raise cash.
The embattled industrial conglomerate took a good first step toward bolstering its ailing balance sheet on Tuesday when it announced plans to slash its quarterly dividend to a penny per share. But new CEO Larry Culp rebuffed the idea of an equity raise. He gave little explanation for why he felt confident that such a step wouldn’t be necessary and declined to elaborate when pressed by an analyst on a conference call to discuss GE’s third-quarter earnings, which were also released on Tuesday.
Culp’s dismissal of the idea seems misguided, given the plethora of capital needs looming at the company. GE CFO Jamie Miller said Tuesday that the Securities and Exchange Commission had expanded its review of the company’s accounting to include a $22 billion goodwill impairment charge it’s booking in its power division. It’s not terribly surprising that SEC would be interested in this. Already the regulator was looking into the company’s surprise disclosure in January of a $15 billion reserve shortfall at a legacy insurance unit. The power write-down raises many of the same questions about the integrity of its internal controls.
More troubling is GE’s disclosure that the Department of Justice is now joining the SEC’s investigation, which suggests criminal charges are possible and raises the stakes for any possible penalty. On top of that, there’s the possibility that the industrial parent company could have to sink more funds into GE Capital. It has already committed to a $3 billion contribution in 2019, but CFO Miller says that’s now an “at least” figure.
The insurance-reserve shortfall could deepen under new accounting guidelines issued in August that mandate the adoption of a standardized discount rate, Gordon Haskett analyst John Inch noted last week. Miller said GE is reviewing the standard, which will “materially affect our financial statements when it takes effect in 2021.” GE has previously alluded to trying to somehow unload the insurance business, but it would likely need to pay someone to take it off the company’s hands. GE also continues to monitor the DOJ investigation into its WMC subprime mortgage business. It has already set aside $1.5 billion for that liability.Meanwhile, investor fraud lawsuits related to the insurance-reserve shortfall could expose GE to a more than $100 billion liability, although a settlement is likely to be closer to the range of $2.5 billion to $5 billion, according to Bloomberg Intelligence analyst Holly Froum. Investors are narrowly favored in the lawsuit because the magnitude of the charges may be enough to show recklessness and the goodwill charge may bolster their claims, Froum notes.
When you add it all up, that’s a lot of potential bills at a time when there’s not nearly enough cash coming in the door. The issues in the troubled power division “will persist longer and with deeper impact” than initially expected, causing GE to fall significantly short of its target for $6 billion in industrial free cash flow. Going into the earnings, analysts had expected GE to lower its full-year cash-flow target to about $4.15 billion. While third-quarter cash flow of $1.1 billion was better than anticipated, management’s commentary that the power unit is falling short of the targeted pace of operating improvement and facing execution issues and deal-closure delays suggest those expectations may need to be further reined in.
Let’s also not forget that this year’s cash flow still includes contributions from GE’s health-care business, which it plans to divest under a breakup outlined by former CEO John Flannery in June. Culp on Tuesday backed that strategy, although he said the timing of a split may change from the 12-month-to-18-month target laid out in June. While the divestiture will allow GE to offload some debt and raise cash via the sale of a partial stake in the business, Miller on Tuesday seemed to back away from a 2020 timeline for reducing GE’s net debt to less than 2.5 times its Ebitda, saying it would aim to reach that level over time with “substantial progress” through 2020.
A sale of aircraft lessor GECAS is on the table, which analysts estimate could yield about $10 billion. GE also could speed up the divestiture of its stake in the Baker Hughes energy business. Either would give GE more breathing room to resuscitate its power unit and rebuild its balance sheet. But an equity raise would allow Culp to take his time with these portfolio decisions and potentially get the GE Capital bogeyman off the company’s back once and for all. At this point, he can’t afford to rule anything out.