Deep Dive on GE: Consolidated Enterprise Valuation

In my view, the most appropriate way to look at GE’s stock valuation is to consider the company as a single enterprise.  In this analysis, I compare its current valuation to peers.  My calculations for GE’S enterprise value-to-EBITDA multiple at 31-Dec-19 and 30-Mar-20 are given in the table below:   

Valuation of General Electric, excluding GE Capital at 31-Dec-10 and Pro forma 30-Mar-20.  Projections by Lark Research.

Here, I value GE Industrial as a proxy for the entire company.  My analysis assumes that GE Capital has no impact on the valuation, neither adding to or detracting from GE’s value.  I cover GE Capital in greater detail in a separate post.

The table above assesses GE Industrial’s valuation at two separate times:  The left-hand column shows its valuation at the end of 2019.  The right-hand column at March 30, 2020.  The 2019 valuation includes actual results.  The 2020 valuation uses my projections for GE Industrial’s 2020 EBITDA and also adjusts debt for the application of the anticipated proceeds from the sale of BioPharma.

The components of GE’s debt in the table above are, with one exception, those provided by management in its calculation of the Industrial leverage net debt-to-EBITDA ratio, as given in the appendix to the 2020 Outlook slide presentation.  “Industrial leverage” is an unusual term.  According to GE’s definition, it includes the estimated present value of GE’s pension deficit.  It also includes GE’s operating lease liabilities and 50% of the liquidation value of its preferred stock. (In the table above, I use the full liquidation value of the preferred.) GE’s total debt is then partially offset by excess cash, defined as 75% of GE Industrial’s cash and cash equivalents.

The inclusion of the present value of the pension deficit is required because GE excludes from its calculation of EBITDA non-operating benefit costs (which primarily represent the interest cost and amortization of the net actuarial loss of the pension plans, partially offset by the expected return on plan assets).  By using Industrial leverage net debt, GE is providing a more comprehensive look at its fixed obligations that presumably addresses the concerns expressed by some investors that its large pension deficit represents debt.

Another important choice that GE made in its net debt calculation was the exclusion of assumed debt from GE Capital.  Besides its external debt, which totaled $20.7 billion at the end of 2019, GE Industrial has $31.4 billion of debt on its balance sheet that it has assumed from GE Capital.  Partially offsetting this assumed debt is $12.2 billion that it borrowed intercompany from GE Capital.

In its financial statements, GE states clearly that the assumed debt should be considered an obligation of GE Capital and that the intercompany debt is an obligation of GE.  Consequently, the total $32.9 billion of debt outstanding at December 31, 2019, as shown in the table above, equals the $20.7 billion of external debt plus the $12.2 billion of intercompany loans).

Many investors would disagree with this exclusion and rightly so.  (I discuss this issue in greater detail in the post on GE Capital.)  However, the $31.4 billion of assumed debt will probably be reduced by $12.2 billion or more with the proceeds from the sale of BioPharma, after GE repays its intercompany loans from GE Capital.  That would leave $19.2 billion or less of assumed GE Capital debt outstanding.

Over time, GE has reduced this assumed debt from $87.7 billion in 2015 to $46.7 billion in 2017 to $31.4 billion in 2019. It will probably pay it off completely within the next few years.  Nevertheless, in the above analysis, if you include the additional $19.2 billion of assumed GE Capital debt, net of the $12.2 billion repayment, GE’s TEV/EBITDA ratios would rise to 15.0 (from 13.3) at 31-Dec-19 and to 10.4 (from 8.5) at 30-Mar-20.)

My pro forma debt figures at March 30, 2020 reflect the application of the estimated $20 billion of proceeds from the sale of BioPharma to reduce to zero the $12.2 billion of intercompany debt, reduce GE Industrial’s external debt by $1 billion, reduce the present value of the pension deficit by $4.5 billion ( the midpoint of the $4-$5 billion range given in management’s guidance) and increase excess cash by the remaining $2.3 billion.

This stand-alone valuation shows that GE was valued at 13.3 times EBITDA at the end of 2019.  By comparison, S&P Global Market Intelligence (SPGMI) calculates that the S&P 500 Industrial sector (SPI) was valued at 13.7 times EBITDA at year-end 2019.  Taken at face value, the market was valuing GE at a level pretty close to its peer group, even though GE remains a turnaround in progress (which should give it greater upside earnings potential that the average company in the S&P 500 Industrial sector over the next few years).  This valuation may reflect investors taking a “show me” posture in their assessment of GE’s value.

There are differences between my calculations of GE’s EBITDA and its trailing 12-month net enterprise value-to-EBITDA ratio (TEV/EBITDA) and SPGMI’s.  These differences also apply to SPGMI’s calculations for the S&P 500 Industrial sector.  For example, SPGMI bases its calculations on GE’s consolidated figures, whereas I focus here on GE Industrial.  Also, SPGMI’s TEV/EBITDA calculation for 2019 uses third quarter debt levels and trailing 12-month EBITDA and the 31-Dec-19 stock price.  (This presents a problem for comparing my 31-Dec-19 TEV/EBITDA calculation with SPGMI’s, but not for the 30-Mar-20 TEV/EBITDA calculation, because both are based upon GE’s 2019 full year financial statements.) 

Given those differences (and others), SPGMI says that GE’s TEV/EBITDA ratio at December 31, 2019 was 12.07, compared with my estimate of 13.3.  By shifting the basis of comparison to be consistent with mine (i.e. using full year 2019 financial figures and GE’s 2019 year-end stock price), I calculate GE’s TEV/EBITDA ratio at 13.4 using SPGMI’s methodology, which is surprisingly close to my estimate of 13.3. 

As of the close of trading on March 30, GE’s stock has fallen 29.3% year-to-date, a steeper drop than the S&P 500 Industrial sectors 26.5% decline.  With the drop in the stock, I calculate that its TEV/EBITDA ratio, excluding the pro forma adjustments, has fallen to 10.7 times.  SPGMI calculates that the S&P 500 Industrial sector’s EV/EBITDA ratio has fallen to 11.2 times.  (The basis of the calculation using the March 30 multiple for SPI is the same: both ratios use 2019 full year figures.)  The discount between GE and its peer group appears to have widened slightly.

The comparison does not consider the impact of the sale of BioPharma on GE’s financial position.  On March 19, GE and Danaher reported that the sale of BioPharma had received all regulatory clearances and is expected to close today, March 31.

On a pro forma basis, incorporating the anticipated debt reduction of $13.2 billion (including the $12.2 billion of intercompany debt and roughly $1.0 billion of GE Industrial debt scheduled to mature), reducing the present value of GE’s pension deficit by $4.5 billion and adding the remaining $2.3 billion of proceeds to excess cash, GE’s enterprise value was $101.3 billion at 30-Mar-19.  Against my 2020 projected EBITDA of $11.6 billion, its TEV/EBITDA ratio is 8.7, which is an even wider discount from the S&P 500 Industrial sector’s 11.2 TEV/EBITDA multiple.

The wide valuation gap suggests that the market is not considering the positive impact of the application of the BioPharma sale proceeds to reduce GE’s debt.  I believe that the discount represents a significant opportunity, but it may also reflect other concerns, including the risk that GE’s 2020 EBITDA will be lower than indicated in management’s guidance due to the impact of COVID-19 and perhaps the risk that GE Capital might be am ongoing drag on GE’s earnings.

As noted above, the consensus view anticipates that COVID-19 will have a significant negative impact on the global economy in the second and third quarters, but assuming that the virus is contained, the economy should begin to rebound sometime in the third quarter and its recovery should gather momentum from the fourth quarter and into 2021.  If this happens, the financial markets should begin to look past the negative two-quarter impact of the virus before the economic recovery takes hold.  Given the passage of the $2.2 trillion stimulus package, which includes support for both the airline industry and Boeing should they need it, I believe that the economic effects of COVID-19 should be contained.

From a valuation perspective, if investors regain confidence in GE’s turnaround, the current valuation gap between its stock and its peer group should narrow.  In the above analysis, if GE’s pro forma 2020 TEV/EBITDA ratio rises from 8.7 to the peer group average of 11.1, its stock price would increase to about $11.16 from its March 30 price of $7.89.  If the market recovers and GE’s valuation returns to its year-end 2019 level (i.e. a TEV/EBITDA ratio of 13.3), its stock price would rise further to about $14.00.  Presumably, if the company continues to demonstrate progress in its turnaround in 2021 and beyond, its stock will have additional upside.

Other Posts in this “Deep Dive on GE” series:
The 2020 Outlook for Its Businesses (March 31, 2020)
Projected 2020 Consolidated Results (March 31, 2020)
GE Capital (April 3, 2020)
Sum-of-the-Parts Valuation (April 5, 2020)

March 31, 2020, revised April 6, 2020 to correct an error in the estimate of the recovery potential in GE’s stock, pro forma for the net debt reduction from the sale of BioPharma, as a result of closing its peer group valuation gap and returning to pre-COVID-19 levels. The original post had a valuation estimate of $12.19 per share. The corrected value is about $14.00. The difference reflects the omission of $15.5 million of excess cash from the valuation calculation, which is equivalent to $1.77 per share.

Stephen P. Percoco
Lark Research
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