Deep Dive on GE: Sum-of-the-Parts Valuation

As noted in a previous post, it is most appropriate to value GE as a single, stand-alone enterprise.  Several unifying investment themes support this view:

  1. Turbines:  GE is a world leader in turbine technology.  Its Power business is a global leader in natural gas-fired and steam turbines.  Aviation is a leader in jet fuel-fired turbines.  Over the years, advances in gas turbine manufacturing and technology from GE’s Global Research Center have supported and sustained the competitive advantages of both businesses.  In recent years, GE has also become a leader in the application of 3-D printing technology which has reduced the manufacturing cost and enhanced turbine performance.

  2. The Global Leader in Electricity.  Since its founding, GE has been the leading supplier of products and services to electric utilities.  Its reach extends globally to at least 90% of the world’s utilities.  GE is a leading producer of all types of electric power generators, including gas turbines, coal-fired boilers, nuclear reactors, hydro-electric generators and wind turbines.  It is also a world leader in electric grid systems.  Its strong market position and large customer base support the efforts of its Gas Power and Renewable Energy businesses.

  3. GE Global Research Center.  Over many years, through the application of technologies developed at the GE Global Research Center, GE has been able to innovate at scale (e.g. the H Class gas turbine), reduce product costs and reap additional value from its installed base (through upgrades and other services).  It is a leader in material science, combustion technology, compression technology, sensors, nanotechnology, and miniaturization, among others.  More recently, GE has used analytics to improve the productivity of machines in its installed base and inform its R&D efforts.  Its expertise has long been applied across all of GE’s businesses to initiate and support new product introductions.

  4. Digital Technology.  GE was an early proponent of the industrial internet and the internet of things.  Although it scaled up its digital organization quickly seeking competitive advantage, it was forced to scale back as GE has slimmed down its operations, especially in shared functions like corporate and research.  Today, the organization targets more immediate digital application opportunities: those that can deliver a quick ROI to GE and its customers.  Despite the retrenchment, Digital remains a leader in the space and should derive more benefits from the initiative over time, as GE and its customers discover better ways to apply and utilize digital technologies to industrial machinery and integrated systems.

  5. Management Excellence.  Although its star may seem to have been tarnished over the past few years, GE still embodies America’s managerial elite.

While these themes support the case for keeping GE’s Power, Renewable Energy and Aviation businesses together under a single corporate umbrella, Healthcare does not seem to be as obvious a fit.  It has a distinctly different customer base and utilizes a separate set of technologies.  Over the years, it has introduced the world to x-rays, computed tomography (CT) scanners and hand-held ultrasound scanners.  It remains a leader in the application of new technology to medical devices and equipment and more recently in the development of digital solutions for health care operators.  While different from the rest of GE, its unique product base supports and broadens the capabilities of the Global Research Center and GE Digital.

While GE is best viewed as a single business enterprise, a sum-of-the-parts valuation will inform the analysis of its share price.  My analysis of GE’s value as a single enterprise concluded that GE’s stock would be worth $11.16, if its valuation matched the average of S&P 500 Industrial constituents and $14.00, if its valuation also returned to the year-end 2019 level.  My sum-of-the-parts valuation suggests that GE’s stock is worth between $12.00 and $17.49, based mostly upon current and year-end 2019 peer group valuations.

Conglomerates have historically traded at a discount to the sum of the values of each of their businesses.  In my view, the higher sum-of-the-parts valuation supports the view that GE’s stock should be valued at a premium to its Industrial peer group average.

The table above values each of GE’s business segments based upon my projections for 2020 EBITDA for each of GE’s segments at a range of valuation multiples.  The valuation multiples mostly reflect the differences in valuations from the beginning of the year to today.  For the three segments whose estimated values are based on their EBITDA multiples, I have used comparable company, sector and market multiples obtained from the platform of S&P Global Market Intelligence (SPGMI) to inform and support my analysis.

The lower multiples that have accompanied the recent sharp drop in stock prices reflect concerns that forward earnings (and EBITDA) will have to be cut across most sectors.  My EBITDA projections, which are consistent with management latest 2020 earnings guidance, are unchanged.  Based upon recent events, GE’s 2020 second quarter earnings will probably fall short of estimates implied by guidance.  Given the uncertainty about the impact of COVID-19, GE may withdraw its full year guidance until there is more clarity in the outlook.  It might then choose perhaps to provide only one quarter’s forward guidance.

Power.  GE Power remains a turnaround in progress.  The recovery in its Gas Power division is well on its way, but improvement in its Power Portfolio division is still in its early stages.  Although segment EBITDA more than doubled in 2019, it has further recovery potential.

Power produced more than $5 billion of EBITDA annually from 2014 to 2016 when the market was absorbing more than 50GW of new gas-fired capacity annually.  Over the past couple of years, it has downsized its capacity in anticipation of a 30GW market.  Thus, its maximum potential EBITDA under favorable market conditions may be $2-$3 billion annually, as a guess.  Even so, because of its recovery potential, Power has greater earnings growth possibilities today from its current earnings base than many industrial businesses.

Power’s major competitors include Siemens and Hitachi, industrial conglomerates with broad business portfolios, making them unsuitable comps.  Broader market measures, like the S&P 500 and the S&P 500 Industrial sector are both currently valued at about 11.2 times forward EBITDA, according to SPGMI, down from an estimated 13.8 times at year-end 2019.

With the greater earnings rebound potential of Power, I use an EBITDA valuation range of 12-15 times which, based upon my 2020 projected EBITDA of $1.4 billion, produces a value estimate of between $16.7 billion and $20.9 billion.

Renewable Energy.  GE’s Renewable Energy segment posted negative EBITDA of $241 million in 2019 and I project that its EBITDA will improve only to breakeven in 2020.  Vestas (CPSE:VWS) is the global leader in wind turbines and related services, its only business, so it looks like a reasonable comp.  Analysts project that Vestas will grow its revenues and earnings per share by 16% in 2020.  Without the benefit of positive EBITDA, I believe that valuing Renewable Energy as a multiple of revenues is an acceptable alternative.  On its projected 2020 revenues, Vestas currently has total enterprise value-to-revenues multiple of 0.92 times.  Using a valuation range of 0.55-0.75 times and projected revenues of $16.8 billion for Renewable Energy, I estimate that its enterprise value is $9.2 billion on the low end and $12.6 billion on the high end.

Aviation.  Much of the decline in GE’s stock can be traced to concerns about GE Aviation, which provided 65% of GE Industrial’s pre-tax earnings in 2019.  If the steep drop in air travel extends beyond mid-summer, airlines will delay more deliveries of new aircraft, which would lead to further cuts in engine production.  With their planes flying less, they would also stretch out engine maintenance.

GE Aviation, through its CFM International joint venture, has already scaled back production of the Leap, due to the grounding of Boeing’s 737 Max.  Although it delivered 1,568 Leap engines in 2019, it has cut Leap production capacity to 1,400 engines from its original plan of 2,000.  The sharp COVID-related drop in air travel could cause production to fall further.

On April 2, GE furloughed half of its Aviation manufacturing staff for one-month, after previously announcing a 10% cut in the workforce.  CEO Larry Culp described this as a defense move that would allow the company to play offense later on.  Under the circumstances, Aviation will probably not be able to meet its earnings guidance for the 2020 second quarter and for the full year.  Still. if COVID-19 releases its grip within the next few months and air travel begins to recover, the financial markets will begin to look through this earnings shortfall.  As expectations of a return of economic activity to pre-COVID 19 levels set in, the outlook for GE Aviation should brighten.

There is upside to Aviation’s earnings in 2021, if Max sales push back to earlier targets.  A return to the originally planned 2,000 engine production capacity could bring in an additional $2.4 billion of revenues and perhaps $700 million or more in profit, according to my rough estimates.  In addition, Aviation is rolling out the GE9X engine in 2021 and it expects double-digit growth in its military engine business.

GE Aviation’s competitors include Pratt & Whitney, a subsidiary of Raytheon Technologies (NYSE:RTX) and Rolls Royce (LSE:RR), which is also diversified.  Rolls Royce is a tough comp because it posted 2019 EBITDA that was barely above breakeven, so its trailing valuation multiples is meaningless.  Its forward EBITDA multiple of only 3.8 times reflects uncertainty about its ability to achieve improved performance.

Safran LTD (ENXTPA:SAF), the French aerospace and defense company, is GE Aviation’s partner in the CFM International joint venture (which assembles the LEAP and CFM56 jet engines), making it an obvious choice for a comparable valuation, even though it operates in some different businesses.  Its stock has suffered a significant setback in 2020, falling 43% from the beginning of the year to March 31 and nearly 40% from its late January 2020 peak, an all-time high.  (The stock has also fallen nearly 23% since March 31.)

Since the beginning of the year, forward earnings estimates for Safran have declined 31.7% from $7.66 (€7.10) per share to $5.23 (€4.75), currently.  Undoubtedly, much of the decline is due to concerns about the impact of COVID-19 on the global aviation industry.

By my rough calculations, the forward EPS decline translates into a forward EBITDA decline of 23.5%. Combined with the drop in the share price, Safran’s estimated 2020 forward TEV/EBITDA multiple has fallen from 12.4 times at the beginning of 2020 and 13.5 times at the stock’s peak to 9.9 times at the end of March.

I also compare GE Aviation to several large, primarily U.S.-based aerospace and defense companies who are among the largest cap constituents in SPGMI’s global Aerospace and Defense industry group, including Lockheed Martin (NYSE:LMT), Boeing (BA), Northrop Grumman (NOC), Airbus (ENXTPA:AIR), L3Harris Technologies (LHX) and General Dynamics (GD).  Using SPGMI data and incorporating the performance of the Dow Jones U.S. Aerospace and Defense Index, I estimate that the group’s TEV/EBITDA multiple has dropped from 13.5 times at the beginning of the year and 14.7 at its late January peak to 11.4 times at March 31.  (Since then, it has fallen further to 10.9 times.)

Based upon these comparables, I value GE Aviation at 12.0 times projected 2020 EBITDA of $8.2 billion on the low end and 16 times EBITDA on the high end.  Those high and low multiples correspond roughly to the 2019 year-end and current multiples of its aerospace and defense peer group, taking into account GE Aviation’s uniquely strong market position.

Healthcare completed the sale of its BioPharma business to Danaher for $21.4 billion (and net proceeds of about $20 billion) on March 31.  I project that Healthcare will deliver 2020 EBITDA of $3.7 billion, down 18.9% from 2019.  The decline is due to the loss of an estimated $1.2 billion from the sale of BioPharma, offset partially by the 9% EBITDA growth in the base business.

For comparable valuations, I have looked briefly at fifteen Healthcare Equipment companies that are constituents in the S&P 500.  This group includes ABMD, ABT, BAX, BDX, BSX, DHR, EW, HOLX, IDXX, ISRG, MDT, RMD, SYK, TFX and ZBH.  As of April 3rd, the group had an average forward EBITDA multiple of 19.2 times, ranging from 10.4 and 13.1 times for Hologic (HOLX) and Medtronic (MDT) at the low end to 27.6 and 29.0 for IDEXX Laboratories (IDXX) and Intuitive Surgical (ISRG) at the high end.

For this group, there is a strong correlation of forward EBITDA and earnings multiples to revenue and earnings growth.  The high-end valuations are held by companies growing revenues and earnings in the double-digits; low end valuations go to low single-digit growers.  For the valuation of GE Healthcare, I am assuming forward EBITDA multiples ranging from 14 to 16, which is well below the mean, based upon its revenue and earnings growth rates that are on the low end of the group’s range.

Allocation of Corporate Costs.  Rather than allocate corporate costs to each segment, I capitalize them at the average valuation multiple for the segments and add the total to segment valuations.  In my analysis, the valuation multiple for corporate costs ranges from 13.3 times to 16.8 times.

Total valuation of GE Industrial Segments.  Adding together the segments plus corporate, the total valuation for GE Industrial’s segments ranges from $153.9 billion to $195.5 billion.  The low-end valuation is consistent with current market values for each segment, while the high-end valuation is more reflective of valuation multiples from the beginning of the year before the onset of COVID-19.

Baker Hughes.  GE has an investment in Baker Hughes that includes a $706 million promissory note receivable and 377.4 million common shares, equal to a 36.8% stake.  At the March 31, 2020 closing price of $10.50, the shares were worth $3.96 billion.  Together with the promissory note, GE’s investment is worth $4.67 billion, down from $10.38 billion at the start of the year, when Baker Hughes’s share price was $25.63.

Excess Cash.  At the end of 2019, GE had $13.2 billion of excess industrial cash on its balance sheet, defined as 75% of Industrial cash of $17.6 billion, according to the company.  To this $13.2 billion, I add the estimated remaining $2.3 billion of BioPharma sale proceeds, after paying down $13.2 billion of debt ($12.2 billion of intercompany debt owed to GE Capital and $1.0 billion of maturing debt at GE Industrial) and contributing $4.5 billion to GE pension plans.  I do not include as excess cash any of the $18.8 billion held by GE Capital.

Industrial Debt and Preferred Stock.  From the estimated total value of GE Industrial businesses, its investment in Baker Hughes and excess cash, I deduct $47.8 billion of Industrial debt and GE preferred stock outstanding.  A breakdown of this debt and preferred stock was given in a previous post

Total Value of GE Industrial.  Based upon my assumptions for each of the segments, I estimate that the equity value of GE Industrial is $126.2 billion to 167.9 billion.  As noted, the low end of the range is based upon current market values, the high end on values existing at the beginning of the year.

General Electric sum-of-the-parts valuation (Part 2) - GE Capital and total estimated per share value.  Lark Research estimates.

GE Capital.  My analysis, detailed in a separate post, indicates a negative value of between $15 billion and $21.3 billion for GE Capital.  My comp for GE Capital Aviation Services (GECAS) is AerCap Holdings, N.V. (NYSE:AER) and my comp for Energy Financial Services (EFS), Industrial Finance (IF) and Working Capital Solutions (WCS) is CIT Group (NYSE:CIT). Segment earnings, as defined by GE Capital, are equivalent to net income (i.e. after interest and taxes).  Projected segment earnings for GE Capital are consistent with management’s 2020 guidance of a $300 million to $500 million loss.

My analysis assumes that the value of GE Capital’s legacy insurance operations is negative $6 billion, which is equal to the present value of its remaining $7.1 billion in regulatory capital contributions spread out over the next four years and discounted at a 10% rate.

I estimate that the value of the Other Continuing Operations segment is negative $19.1 billion.  This equals the remaining $31.4 billion of GE Capital debt assumed by GE, partially offset by the $12.2 billion intercompany loan to GE from GE Capital.

Importantly, my valuation for GE Capital does not consider the $18.8 billion of cash on GE’s balance sheet.  Capital is holding this cash to cover its liquidity needs and other cash requirements.  If GE Capital returns to the debt markets in 2021 as planned, it could free up some of this cash to pay down debt.

My valuation for GE Capital also does not consider the potential cash that could be raised from $2.3 billion of assets held-for-sale, $0.2 billion of businesses held-for-sale and $3.8 billion of net assets from discontinued operations at 31-Dec-19.

Despite the negative valuation, GE Capital is on a path to profitability that could bring its valuation to breakeven or better over the next couple of years.  With the mandatory conversion of its Series D Preferred Shares into equity, Capital will save $460 million of annual dividend payments in 2021, bringing it close to breakeven profitability.

GE’s Equity Value.  Combining my valuation estimates for GE Industrial and GE Capital, GE’s sum-of-the-parts equity market capitalization ranges from $104.9 billion to $152.8 billion. On a per share basis, that equates to $12.00 to $17.50.  The range mostly reflects the wide swing in stock prices this year.

As a stand-alone enterprise, I valued GE shares at $11.16 to $14.00.  The higher sum-of-the-parts valuation supports my view that GE’s stock should trade eventually at a premium to its peer group.

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

April 5, 2020

Stephen P. Percoco
Lark Research
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