I was asked today what I thought about Berkshire Hathaway’s bail-out of GE – did it make me less of a GE fan?
No. Firstly, Warren Buffet’s $3B investment in GE is not a bail-out (read about the deal here). The U.S. bail-out package is for purchasing distressed assets that have questionable value. That is not what Berkshire Hathaway did. Mr. Buffet created one of those private equity deals you and I could only dream of getting. For his investment he gets preferred shares, which have a 10% coupon yield — that’s about 5x what you or I can get on a savings account now – and places his dividend right up there at the top of the payments G.E. will make. If GE would like to repay the money Mr. Buffet is investing they can do so in 3 years – as long as the company pays an additional 10% premium over the dividend. Thirdly, Mr. Buffet receives warrants to purchase $3B of GE stock at $22.50 a share – about half what the stock was worth a year ago, equal to its recent lows, and a price not seen by GE shareholders since the market crash of 2001 (see GE chart here). So Mr. Buffet has what would be called a real sweetheart deal. A big dividend, a buyout premium, and options to make billions if GE survives and remains a long term winner. Mr. Buffet did not simply buy GE common stock, the option available to us mere investing mortals, so we have to look at GE differently than Mr. Buffet did.
GE is the only company that has been on the Dow Jones Industrial Average since its inception. The only one. More than 100 years. But this does not mean it will remain on the DJIA. History is not a good reason to be optimistic about GE – and Mr. Buffet’s likelihood of pocketing a few billion more dollars for the Gates charity. You should be optimistic about GE because in the middle of this rather dramatic market disruption, GE is fast taking action to become a more competitive company. Not just shore up its old business, like most of the banks are doing, but rather repositioning its portfolio to be more successful in the post-crisis market.
We have already heard that the crisis is causing, and will for a goodly while cause, debt to be more expensive. And harder to come by. Long before debt becomes a problem, and long before anyone questions GE’s credit worthiness, GE is already taking action to increase its cash hoard and preserve it’s AAA debt rating. While others are contemplating what to do, GE is raising money from its businesses, Mr. Buffet, from its planned sale of another $12billion in stock. Given the currently low stock price, many CEOs would say "I won’t sell more equity until the markets recover and the value goes back up. I want to avoid earnigs dilution." But GE’s Chairman is acting now to prepare the company for competition in the post-crisis market.
Instead of worrying about dilution, Chairman Immelt admits he is raising cash because "it gives us the opportunity to play offense in this market should conditions allow." Get that – rather than being on his heals and reacting defensively, GE’s leadership is getting its act together to take advantage of low asset values during and after this crisis. It is making sure the company has the resources to continue investing in White Space – to continue being a Disruptive market player in markets that others are just now trying to figure out. GE is revamping its portfolio to be a market leader in 2012, 2015 and 2020.
GE is reporting a bad quarter – and none too good year. But the leadership has recognized the risk of falling into a growth stall. Rather than trying to wait and see what happens, and drift off into the Flats and the Swamp, leadership is taking fast action to throw GE right back into the Rapids. GE is revamping its financial services business to adjust to the market shift. And it is selling many of its long-held U.S. businesses that are facing far slower growth – like the iconic appliance and light bulb businesses. Imagine that, selling the business most closely identified with founder Thomas Edison – the light bulb. In this "nothing is sacred" attack on the existing business portfolio the company is moving rapidly into infrastructure projects like water production in developing markets China and India.
Short term GE’s equity value is subject to the whims of traders and the overall market direction. But looking long-term, it’s hard not to be optimistic about a company that’s doing such a good job of using scenarios to do its planning, keeping track of competitors, taking action leveraging market disruptions and keeping White Space alive and vibrant for future growth.