Downfall of GE Capital & Corporate Shrinking : Even the Best Fall Down Sometimes
Downfall of GE Capital : Established in 1892 and known to have been one of Thomas Edison’s legacies, and once one of the most prestigious and successful companies globally, General Electric’s (“GE’s”) downfall has been startling.
The question is, will it ever recover from the shell it is today from what once was the crème de la crème of Corporate America (if not the world)?
At its peak in 2000-2001, GE’s market value stood at a massive $600 billion, and the Dow Jones Industrial Average was at nearly 11,000.
Today, the Dow Jones has tripled to nearly 33,000; however, GE’s market value has plummeted nearly $550 billion to $53 billion. Adding insult to injury, GE found itself removed from the Dow Jones Industrial Average, where it was once the sole name to have endured for the benchmark’s first 100 years.
GE’s credit ratings have been slashed from what was once AAA in 2006 to BBB+ negative, just a couple notches above “junk bond” status. And now GE is no longer an industrial conglomerate and innovation hub but a struggling manufacturer of jet engines, wind turbines, and a residual healthcare business – as it continues to shrink in market value, product lines, and relevance to the markets, clients, and the public eye.
Significant blame for this is Jeff Immelt’s 16-year run as General Electric’s chief executive. More recently, others go further back to blame predecessor and legendary GE CEO Jack Welch. Named “Manager of the Century” by Fortune Magazine in 1999, we can now see that he wreaked havoc on the management model built by Alfred Sloan, CEO of GM.
Jack Welch’s style was summed up in his nickname of “Neutron Jack” – which was the elimination of people by dropping a “neutron bomb” while leaving structures intact. Inheriting one of the most successful companies, his ruthless management style (bottom 10% were let go annually), the loss of strategic focus, loss of research superiority, dodgy accounting practices, and the move into financial services ultimately led to GE’s downfall.
Jeff Immelt took over the reins on September 10, 2001, the day before 9/11, when airlines were hijacked and flown into the World Trade Center towers and the Pentagon. The tragedy’s net result was that many of GE’s core jet engine and aerospace business lines were decimated. An ominous start to what some say Jeff Immelt was dealt an impossible hand after CEO Jack Welch’s departure.
From a high of $58.13 on September 1, 2000, to a low of $9.54 of 2000-2010 on March 20, 2009, the stock moved sideways (mostly) between $20-30 per from 2001 to the financial crisis beginning in 2007, during Immelt’s 16+ year tenure and continued even lower after the financial crisis – now under $13 a share.
One can attribute a number of reasons for Immelt’s and, by extension, GE’s biggest downfalls:
(1) Immelt oversaw a company “too big to manage,” with a potpourri of unrelated businesses, including dog insurance.
(2) Despite the potpourri, GE wove a corporate fabric or culture of “hubris” with a long-held belief that “it can’t happen here, we’re GE.” This was perpetuated from the top-down and the bottom-up with its entry-level rotational and training program of nurturing Finance associates to become financial auditors groomed to become GE’s future business CEOs.
This rotational program created a pipeline of generational, lifetime employees believing that GE was “bullet-proof.” The net result was that despite all the changes external to GE since 9/11, GE had built a self-fulfilling insular wall that change – or “turning the aircraft carrier” was not necessary. GE was neither nimble nor agile against disruptive and more aggressive competitors. It also led to overpriced or misguided acquisitions like Alstom.
(3) Another primary reason for Immelt’s and GE’s downfall was GE Capital – essentially a giant unregulated financial institution. It was initially viewed as operating at a competitive advantage because it was not weighed down by costly Federal and state regulations and cheap commercial paper to fund its industrial businesses.
It became GE’s albatross because Immelt decided too late to sell off GE Capital’s massive, decentralized business lines. The financial crisis of 2007 – 2010 exposed GE’s dependence on GE Capital to issue low-cost commercial paper whose market dried up. The perception that GE was a global systemically important financial institution dragged its share price along with the significant banks even though GE sought to convince markets it was an industrial firm.
Compounding this further was that in 2013, GE Capital was officially designated a SIFI, which imposed even more substantial scrutiny from the Federal Reserve.
Long suspected as a “black box” GE Capital – and by extension, GE was compelled to open the door for the Fed as a primary regulator to turn over every financial and internal control rock, stone, and pebble of GE Capital’s and GE’s governance, risk and controls. Compounding this scrutiny was the inherent conflict of interest of GE’s entry-level auditor-to-business CEO rotation program, which challenged whether GE’s auditors were sufficiently independent to assess GE’s internal accounting controls.
This scrutiny led to a poor relationship with the Fed because GE could no longer operate with the perceived “black box” and was subject to the Fed’s and Securities and Exchange Commission’s (“SEC’s”) and shareholders’ scrutiny.
(4) Unlike traditional banks long audited by the Fed and other regulators, non-banks, including GE, were good at producing written policies, articulating ethics and compliance training but often did not execute robust monitoring and compliance testing programs to demonstrate and document employees were complying with relevant laws, regulations and GE policies and practice. The market’s view of the GE Capital albatross combined with Fed supervision’s significant cost ultimately led to the dismantling of GE Capital and, along with it, the beginning of the end of what was the great, General Electric.
(5) Immelt and perhaps Welch oversaw a decentralized conglomerate that was “too big to manage.” Each business line and division operated autonomously with decentralized budgets and duplicate, triplicate, and often even more repetitive infrastructures, in which “Neutron Jack,” as he was well known, ruthlessly created a “Game of Thrones” culture of competitive in-fighting within subdivisions with little or no accountability.
Without strong centralized governance and management oversight compounded by continuous investor pressure to improve its market value, it seemed inevitable that GE’s aircraft carrier would ultimately be grounded and not have the internal controls to accurately reflect its financial performance for some of its insurance and other divisions.
In 2017, Immelt was ousted and replaced briefly by insider John Flannery who lasted a year and was succeeded by outsider, H. Lawrence Culp Jr. in 2018. Almost immediately, the market reacted positively with Culp’s efforts to reduce debt and shed a significant number of businesses and subsidiaries no longer perceived to be core to the company – especially GE Capital.
With Immelt’s departure in 2017, there has been little sign of meaningful recovery, as reputational headline after headline continued, including the SEC’s investigation and GE’s ultimately acquiescing to pay $200 million with the SEC for misleading investors.
More specifically, their failure to disclose failures in its business lines of power and insurance.
GE misled investors by not explaining that significant profits stemmed from reductions in prior costs estimates and failing to say that increase in cash collections was at the expense of future cash and did not warn of the uncertainty from lower projected costs for long term portfolios in its insurance line. The firm was found to have violated the “anti-fraud, reporting, disclosure controls, and accounting controls provisions of the securities laws.”
The Latest – Downfall of GE Capital
As of Fall 2020, General Electric announced it was re-engineering its audit function so that: it no longer reports to the Chief Financial Officer nor rotates its auditors into the businesses, an inherent conflict of interest in the short- to medium-term if the auditors are intended to be hired by the business by taking a “light touch” approach to their audits.
Despite some incremental rise in share price, GE has continued to struggle due to the ongoing pandemic, especially its aviation unit. With travel being grounded for a good portion of 2020, the demand for new engines, parts, and planes was non-existent.
The most significant remaining piece of GE Capital is GECAS (GE Capital Aviation Services), which functions as a jet leasing company. With access to over 1,600 aircraft, it has cemented itself as one of the most prominent players in the realm.
Initially, Culp did not want to sell the divisions, but it is more appealing with the ongoing effects of the pandemic. Keeping with his mission “to even out cash flows and refocus on core areas, he has divested the biotech, lightbulb, and most of its oil operations. Two critical assets that exist are its ability to make healthcare machines and power-generating equipment.
As of March 12, 2021, GE announced an agreement to combine its GECAS with AerCap Holdings. In the words of Culp, “Today marks GE’s transformation to a more focused, simpler, and stronger industrial company. Coupled with our continuing efforts to strengthen GE’s performance, operations, and culture, this deal brings GE closer to our future—delivering value for the long term and leading the energy transition, precision health, and the future of flight.”
The deal proposed a 1-for-8 reverse stock split, a move typically for firms concerned that their stock price will drop below thresholds that may exclude mutual fund investors.
Another prospect is that the management sees a limited possibility for recovery financially. This deal increases debt leverage and is expected to downgrade to BBB from BBB+ (S&P), while Moody’s maintained Baa1.
Pending the closing of this deal, GE Capital would be folded into GE’s larger corporation and will not be separated on financial reports. This “simpler structure” aims to make the firm more “normal” in accounting, leverage in FCF,” to broaden investor base and narrow valuation discounts.
Indeed, if nothing else, it is a lesson in how even the mightiest companies can fall victim to poor management and corporate culture and the stock market’s unforgiving nature.
Written by Jack Argiro
Edited by Karina Thanawala, Alexander Fleiss, Calvin Ma, Abhinav Raghunathan
Downfall of GE Capital & Corporate Shrinking : Even the Best Fall Down Sometimes