On Friday (10/6), after the market close, General Electric (GE) announced that three of its senior executives, all Vice Chairs – John Rice, CEO of GE’s Global Growth Operations, Beth Comstock, CEO of GE’s Business Innovations and Jeff Bornstein, CFO – will retire from the company on December 31, 2017. Jamie Miller, currently the CEO of GE’s Transportation business was named CFO effective November 1, 2017.
These management changes follow a series of moves that indicate that GE, under new Chairman and CEO John Flannery, is in the process of making a big push to cut costs and boost profitability. Taken together, these moves suggest that GE might cut announce planned restructuring charges that would significantly lower its 2017 GAAP earnings. Like many analysts, I now expect that the 2018 EPS target of $2.00 will be revised downward.
The early moves by Mr. Flannery, since being named CEO in June, have set the tone for the change in expectations. Earlier this summer, the company said that it would scale back the size (and thus the cost) of its new headquarters in Boston. It has also announced that it would be selling its fleet of corporate aircraft; even though some question whether GE will save money doing so. More recently, GE has said that it will no longer provide company cars for its senior managers. Thus, visible symbols of what some might view as corporate extravagance are being eliminated.
There have been press reports that GE’s digital initiative – the most visible aspect of its corporate strategy over the past few years – will be scaled back. GE had scaled up its digital capabilities quite rapidly in a short period of time, essentially giving the business a blank check to get big fast. It is not so surprising, therefore, that the initiative would eventually face a period of consolidation; but the timing of the cutbacks comes sooner than I had expected.
The business media has also reported that GE is now looking to scale back GE Capital even more. GE Capital’s asset sale program was previously thought to be in its final stages. However, at June 30, GE Capital still had assets of $160 billion, equal to about 45% of total assets for the consolidated company, and a total investment (equity plus receivables) of nearly $70 billion. About $70 billion of the $160 billion in assets is cash and investments, some of which supports $27 billion of legacy insurance liabilities. In my mind, it is still too early to say that GE’s transition to a digital industrial company is complete. It would not be surprising to see Mr. Flannery move to sell the remaining non-core assets of GE Capital, even if it requires booking losses to do so.
Press reports accompanying the management transition announcements noted that the company has committed, with prodding from activist investor Trian Partners, to reduce its annual operating expenses by $2 billion by the end of 2018. GE has been restructuring its operations for several years now; but it has so far been able to offset its annual restructuring costs with gains from asset sales. Given that most of the sales of GE Capital assets and certain industrial businesses are now mostly complete, the company may face higher uncovered restructuring costs in the remainder of this year and in 2018 to reach that aggressive cost cutting target.
More importantly, a further reduction of $2 billion in annual operating costs will likely bite deeply into GE’s operations. Friday’s announced retirements of John Rice and Beth Comstock provide a hint at what is to come.
The decision to scale back the digital effort (while remaining committed to it) suggests a mindset of focusing only on those initiatives that are likely to produce immediate results. I have also heard rumors that GE is planning significant cuts in its Global Research organization, perhaps even to reduce its major research centers (located in Niskayuna, NY (near Schenectady), Bangalore, India; Munich, Germany; Shanghai, China and Rio de Janeiro, Brazil) from five to as few as two. If so, this would represent more than just a refocusing to boost near-term profits; it would also represent a fundamental shift in GE’s global business strategy.
GE’s current global go-to-market strategy was highlighted by Mr. Immelt in his most recent letter to shareholders (in GE’s 2016 annual report). There, he noted that GE has long sought to win new business by being both “global and local.” Having research centers in key strategic locations around the world allows GE to develop products tailored to local needs. Sometimes, those same products have global market potential. GE’s portable ultrasound machine is an example of a product developed for a local market that subsequently became a big seller worldwide.
GE’s global research capabilities are undoubtedly costly. Without the proper focus, such expenses can be non-productive. Yet, GE has long emphasized initiatives to bring products out of the labs to market as quickly as possible.
A strong local research presence also helps GE to operate as a local company, which facilitates sales across all product lines. In his 2017 Letter to Shareholders, Mr. Immelt expressed his belief in GE’s global capabilities emphatically: “You can only solve local problems where you have local capability. I would confidently state that GE has the finest local footprint of any company in the world.”
Although we do not know for sure what Mr. Flannery plans to do. The retirement of John Rice, who headed GE’s Global Growth Organization, fits with the notion that GE is scaling back global research expenditures and growth initiatives. The retirement of Ms. Comstock, who headed GE’s Business Innovations unit, would be consistent with this conclusion, as well. Such a change in strategy could in some ways make the transition from Immelt to Flannery seem as stark as Obama to Trump.
On the other hand, the retirement of CFO Jeff Bornstein is a head scratcher. According to press reports, Mr. Bornstein was one of four candidates considered as possible successors to Mr. Immelt. Concurrent with the announcement of Mr. Flannery’s appointment as CEO in June, Mr. Bornstein was elevated to the position of Vice Chairman and reportedly given an expanded compensation package. Press reports indicated that Mr. Flannery and Mr. Bornstein were friends who worked together at GE Capital earlier in their careers. Mr. Bornstein’s decision to retire less than four months after being named Vice Chairman clearly seems sudden, but any explanation for the move is just speculation. Perhaps Mr. Flannery’s cost cutting plan is more far-reaching than Mr. Bornstein envisioned, so that the magnitude of the restructuring costs, anticipated losses on asset sales and/or cuts in earnings guidance might raise questions about actions that were or should have been taken under Mr. Bornstein’s tenure. Of course, there are other possible explanations.
According to press reports, GE’s moves since naming Mr. Flannery as CEO reflect pressure from Trian Partners. Yet, in its 2015 white paper, Trian praised Mr. Immelt for the many steps that GE had taken at the time to reshape its strategic direction, narrow GE Capital’s mandate, refocus on the industrial businesses and restructure its operations. While Trian has not, to my knowledge, made any public statements about recent developments at GE, if the recent press reports are true, it suggests that Trian has become impatient with GE’s inability to meet its financial targets (even though much of the shortfall is attributable to challenging industry conditions in oil & gas, transportation and power). If so, it seems that Amazon is the only U.S. public company that can stick with its long-term strategy through all phases of the business cycle without having to meet profit targets.
If the conclusions that I have drawn from recent events at GE are correct, they paint a picture of sweeping change that could mark a major shift in the company’s long-term strategy. If Mr. Flannery announces steep restructuring costs with a cut in 2018 guidance, but an expected sharp rebound in 2019, investors may bid up the shares. Yet, some investors may still have concerns about the long-term impact of the strategy shift. While Mr. Flannery’s initiative is likely to emphasize short-term gains, such a shift in strategy may turn out to be appropriate, if indeed the world becomes more insular.
GE reports third quarter earnings on October 20. Mr. Flannery will deliver an update to investors on November 13.
October 8, 2017
Stephen P. Percoco
Lark Research, Inc.
839 Dewitt Street
Linden, New Jersey 07036
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