The Case for a General Electric Breakup Under New CEO Larry Culp

Jon C. Ogg

While firing an underperforming chief executive officer can help a company, sometimes the bad news is that more bad news is coming. This week’s firing of John Flannery as CEO of General Electric Co. (NYSE: GE) should put investors on alert that a breakup of GE is now more likely than it was even back when Flannery was conducting his own review of the company.

This potential breakup became more likely after the news broke that GE was booted out of the Dow Jones industrial average. But a new CEO only will create more of a belief that a breakup of GE is more likely. And when investors consider who is taking over at GE, they probably will consider the breakup case even further.

While there is a case that GE is better off as a whole entity and that separating GE’s various debt instruments from unit to unit would be difficult, there is the very serious notion that nothing else may work. What if Wall Street continues to treat the combined General Electric as a company named General Eclectic?

Flannery bombed in convincing Wall Street that his strategy was going to turn GE around. Its new CEO is Larry Culp, who is only 55 years old. Culp previously served as chief executive officer and president of Danaher from 2000 to 2014, leading a transformation from an industrial manufacturer into a leading science and technology company. What does this tell you about GE as being an industrial manufacturing outfit?

If you look beyond the quotes in GE’s press release, the company noted that Culp effectively executed a disciplined capital allocation approach, and that he helped with a series of strategic acquisitions and dispositions and targeted investing in high-impact organic growth and margin expansion.

The GE announcement also noted that, under Culp, Danaher delivered strong free cash flow to drive long-term shareholder value and that Danaher’s market capitalization and revenues grew fivefold under his 14-year tenure.

Now break out the actual quote from Culp on assuming the CEO role:

GE remains a fundamentally strong company with great businesses and tremendous talent. It is a privilege to be asked to lead this iconic company. We will be working very hard in the coming weeks to drive superior execution, and we will move with urgency. We remain committed to strengthening the balance sheet including deleveraging. Tom and I will work with our board colleagues on opportunities for continued board renewal. We have a lot of work ahead of us to unlock the value of GE.

Also noted in last week’s news break was the turbines from the power business. GE said on Monday that it will take a noncash goodwill impairment charge related to the GE Power business and that the charge is likely to constitute substantially all the $23 billion or so tied to the unit. Also worth noting was the statement that the impairment charge is not yet finalized and remains subject to review, which means more charges may be possible (and less for that matter). Still, GE cited weaker performance in the GE Power business as the main reason for lowering its previously indicated guidance for free cash flow and in earnings per share for 2018.

Now consider how CEO Culp has an incentive to boost GE’s share price. He will receive payouts if GE’s stock rises at least 50% and can stay there for 30 consecutive trading days. The news of his hire took it up about 10% alone.

Several analysts have issued views in the wake of GE’s big CEO change.

RBC Capital Markets raised its rating to Outperform from Sector Perform and raised its price target to $15 from $13 after the CEO change.

Moody’s said that it was reviewing GE Credit for a possible downgrade, and that downgrade was more than one notch. Standard & Poor’s downgraded GE, and it is now only three notches above “junk bond” status. These both addressed weakness in power, but also both include at least inklings about GE’s future structure changing as the company tries to deleverage its balance sheet.

Merrill Lynch has only a Neutral rating but also has a $14 price objective. The firm is projecting a significant dividend cut as one of the first orders of business as the company has to shore up its balance sheet before lots of debt comes due in 2019. The Merrill Lynch report said:

We expect additional management and operational changes within GE’s segments, particularly Power… Accelerating portfolio moves announced in July could be another avenue to shore up the balance sheet, such as accelerating monetization of 62.5% BHGE ownership.

Morningstar has a $16.10 fair value estimate on GE, but it thinks that the Culp strategy may be quite similar to Flannery’s strategy. That report said:

We think Culp is the right person for CEO and should help GE realize the value of its assets. Given an outsider’s operating pedigree, we expect differences in execution under Culp, even as we suspect he’ll largely stick with GE’s current roadmap–focusing on Aviation, Power, and Renewable Energy — as laid out by Flannery and approved by the current board.

It’s hard to imagine that the future GE will look nothing like the GE that prior generations knew. That said, the world keeps on turning — and GE hasn’t been keeping up with it.

GE shares closed up 4.2% at $13.18 on Friday. That’s up nearly 17% from the $11.29 the prior Friday, before Flannery was fired and Culp was named CEO. Its 52-week trading range is now $11.21 to $24.54.