GE’S breakup signals how far the conglomerate model has fallen
As Larry Culp revealed his plan to break General Electric Co. into three on Tuesday, he closed a defining chapter in U.S. corporate history, signalling how far from favour the conglomerate business model has fallen.
With Japan’s best-known industrial group Toshiba also considering splitting into three under pressure from activist investors and IBM getting out of its services business, all are following a path taken by the likes of United Technologies, Dowdupont, ABB and Siemens: distancing themselves further from the time four or five decades ago when conglomerates defined corporate best practice.
While one former executive talked of “the end of the GE we knew,” Culp, who has been chief executive since 2018, said the company had simply concluded that letting the health care, aviation and energy businesses fend for themselves with “greater focus, tailored capital allocation and strategic flexibility” was the best way to set them up for the next 100 years.
“I’m going to leave the look back, the retrospectives, to the academics and the historians, frankly. I’ve spent my entire career with these models and there are different answers for different businesses at different points of time,” Culp told the Financial Times.
But the symbolism was clear, said Sara Moeller, professor of finance at Pittsburgh University: “Basically, GE is telling us that smaller is better.”
The rise of private equity had made it harder for industrial companies to compete for the deals that conglomerates depended on, she added. Now they needed to “focus and stay within lane, while becoming more efficient.”
For years in the late 1990s and early 2000s, GE was the most valuable company in the U.S., with a market capitalization peaking at almost US$600 billion in 2000. Jack Welch, its chair and chief executive for 20 years until 2001, personified its reputation for being able to manage any business.
“There was almost an Elon Musk hype that drove the stock,” recalled Jeffrey Sonnenfeld, a professor at Yale School of Management.
Its share price history does not capture the extent of its cultural impact, however. Generations of Americans bought GE light bulbs and GE fridges, Ronald Reagan advertised its products before becoming president and Kurt Vonnegut was a GE publicist before he wrote Slaughterhouse-five.
But the breakup Culp unveiled, reversing decades of acquisitions, also had its roots in history. Described by Deane Dray of RBC Capital Markets as the longest anticipated breakup in the industrial sector, it is the latest and largest step in a painful process of cleaning up and simplifying GE that started after the financial crisis exposed a near-fatal flaw in its model.
Welch transformed GE Capital, a division originally focused on helping clients finance purchases of its aircraft engines and power turbines, into a financial services powerhouse involved in everything from subprime mortgages to insurance. He himself called it “the blob.”
The financial crisis of 2007-2009 exposed how much the group depended on GE Capital and how little investors understood about the risks lurking within it.
GE Capital had been “a cookie jar” into which executives could dip to smooth over uneven results from other operating businesses, Sonnenfeld said. “Many of them did not perform well but GE Capital provided protection.”
Questions about the quality of GE’S accounting also emerged after the crisis. It later agreed to pay US$50 million to settle civil accounting fraud charges brought by U.S. regulators.
“GE bent the accounting rules beyond the breaking point,” said Robert Khuzami, director of the U.S. Securities and Exchange Commission’s enforcement division, at the time.
In its 2009 settlement, GE did not admit or deny allegations that it had used improper accounting methods to flatter its results. It neither admitted nor denied separate SEC charges that it had misled investors, which it settled for US$200 million in December.
The process of trying to bring GE Capital’s risks under control began under Welch’s successor Jeff Immelt, who began a series of disposals including the Us$30-billion sale of a specialty finance portfolio to Wells Fargo in 2015. By then, he had also sold Nbcuniversal to Comcast; in 2016 he sold GE’S century-old appliances business too, to China’s Haier.
Immelt, who ran GE from just before the September 11 attacks of 2001 until 2017, sold most of GE Capital, but continued pursuing acquisitions. Fatefully, he bought Alstom’s power business in 2015 just as the market moved away from fossil fuels.
It has taken two more chief executives to fully reckon with GE’S past. Soon after Culp took over, he wrote down Alstom’s value by US$23 billion, but he was not Immelt’s chosen successor.
That was John Flannery, a company veteran who started with a plan to strip GE down to its electricity and aviation divisions. He lasted just over a year, before the plunging share price prompted the board to turn to Culp, the first outsider to run the business.
Explaining the significance of GE’S breakup on Tuesday, Culp did not focus on history but liabilities. He inherited US$140 billion of gross debt and will have cut that to under US$65 billion by the end of this year, with a focus on manufacturing efficiency, improving cash flow and selling more businesses, including aviation services and life sciences. Since he took the job, GE’S market capitalization has risen from US$98 billion to US$122 billion.
His plan will take until early 2024 to complete, after which he intends to remain with the aviation business, which will keep the GE name.
The three separate companies would shape the future of flight, advance precision health care and lead the energy transition, he said. But failing a remarkable revaluation, they will be dwarfed by today’s biggest innovators, such as Apple, Amazon and Tesla.
That has prompted speculation that one or more could be M&A targets. “The aviation business, in particular, could be better off in the hands of a buyout firm that can turn it around,” said a dealmaker close to GE.
GE’S split could also prompt other conglomerates such as 3M, Eaton and Emerson to simplify their portfolios, said Dray.
Frank Aquila, global head of M&A at law firm Sullivan & Cromwell, agreed. “GE has finally found the key to unlocking the remaining value for its shareholders,” he said. “Given the pressure from activist investors we are likely to see more spinoffs.”
As for Culp, a near-doubling of GE’S stock since the depths of the pandemic has already unlocked incentives that were worth US$129 million at Tuesday’s closing price. Culp lost an advisory shareholder vote on his pay in May but if GE’S share price rises 20 per cent from Tuesday night’s level and stays there for 30 consecutive days, he could receive US$233 million.
“Certainly investors have been skeptical of this award,” said Brian Johnson, executive director of ISS Corporate Solutions, a corporate governance data provider. “Nonetheless, the stock price has improved since the grant was made.”
Asked how the split reflected on his record, Culp did not talk about endings. “Hopefully,” he said, “I’m still in the early days of my time with GE.”