April 17, 2008
G.E.’s Shortfall Calls Credibility Into Question
By NELSON D. SCHWARTZ and CLAUDIA H. DEUTSCH
For seven lean years, Wall Street has given General Electric and its chief executive, Jeffrey R. Immelt, the benefit of the doubt.
Even as shares of this quintessential blue chip languished, analysts and investors acknowledged the challenge of running a company that sells everything from jet engines to Hollywood blockbusters to light bulbs and patiently waited for Mr. Immelt’s restructuring efforts to pay off.
Now, in the wake of a surprise earnings shortfall last week, Wall Street’s patience has run out as the stock has plunged to its lowest level in four years. While Mr. Immelt’s job seems secure for now, stock analysts who have long supported both him and the company’s sprawling structure now say a rethinking is in order.
“There is no doubt that this is a historic event,” said Steve Tusa, an analyst with JPMorgan Chase. “The company has to convince investors that something is going to change.”
Once-isolated calls for at least a partial breakup of the conglomerate have become a chorus, with NBC Universal, appliances and GE Money, the consumer finance unit, emerging as prime candidates for a sale or spinoff. Unloading these divisions would return billions to shareholders, advocates say, while allowing G.E. to focus on its booming infrastructure business, which sells big-iron items like locomotives, jet engines and power turbines.
“There’s a point in time when you say this is a big old monster, and parts could be better off on their own,” said Scott Lawson, a portfolio manager at Westwood Capital Management, which owns G.E. shares. “A breakup is looking more viable.”
Shares of G.E. closed at $32.23 on Wednesday, down from about $37 a week ago, and off sharply from where they were before Mr. Immelt took over on Sept. 7, 2001.
For Mr. Immelt, the problem now is not just the earnings disappointment — the consensus estimate for the first quarter was 51 cents and G.E. reported 44 cents — but a looming credibility gap. On March 13, he assured investors the company was on track to meet its profit targets. And in December, he told analysts that G.E.’s goal of earnings growth of at least 10 percent in 2008 was “in the bag.”
To make matters worse, under Mr. Immelt and his predecessor, John F. Welch Jr., G.E. was the kind of business that did not surprise investors and delivered what it had promised, no matter how severe the economic headwinds.
“I’ve been covering the company since 1996, and I’ve never seen a miss this big,” said Nicole Parent of Credit Suisse, who had rated G.E. as her top pick but downgraded it to neutral after the earnings report. “You have to ask what is the driving force behind the miss? Is the company too big to manage?”
When the news broke shortly after 6 a.m. last Friday, Mr. Tusa said: “I was on the train, and I almost fell out of my seat. It was a shock — people thought it was a misprint.”
The company blamed much of the shortfall on the widespread credit crisis, especially the rapid deterioration in conditions over the last two weeks of the quarter after Bear Stearns’s near-collapse in mid-March. Though G.E.’s huge finance business was its weakest performer, other segments like appliances and health care also fell short of expectations.
Until nearly the last minute, G.E. thought it could pull the quarter out. It knew health care was lagging behind, GE Money was suffering, sales of appliances were weak, and advertising on local NBC stations had slipped. But G.E. managers were confident that real estate sales and other financial transactions would make up for unexpected shortfalls elsewhere.
Then came the Bear Stearns implosion, and credit markets, already tight, locked up. “We had risks, but we had opportunities and plans that we thought would have enabled us to meet our guidance,” said Keith S. Sherin, G.E.’s chief financial officer. “The risks came to be realized, but the opportunities didn’t materialize.”
Even defenders of Mr. Immelt admit that the juxtaposition of the rosy predictions and the ensuing shortfall have shaken the reputation of G.E., which is the sixth-largest American company by revenue as well as a barometer of the broader economy.
“What happened is he got caught and created a credibility issue,” said Mr. Welch, who ran the company for 20 years before handing the reins over to Mr. Immelt in 2001. “He had all kinds of credibility a week ago, and he will get it back by delivering, but it will take some time.”
The clock is ticking, though. “He can’t have any more surprises if he wants to get his credibility back,” said Noel M. Tichy, a professor at the University of Michigan Business School who once ran G.E.’s management school at Crotonville, N.Y. “This is Strike 1. If there’s a Strike 3, it could take him out.”
Until recently, Mr. Immelt had largely drawn accolades from Wall Street, both for his easygoing style and his effort to burnish G.E.’s image with investments in environmentally friendly technology like wind energy. Mr. Welch, on the other hand, was something of a lightning rod, earning the nickname Neutron Jack when he cut thousands of jobs in the 1980s, as well as the fear of any lieutenant who let him down.
This is Mr. Immelt’s first major brush with investor anger, and indeed, in an interview, he said he understood Wall Street’s ire and that he needs to restore credibility. “I’m not making excuses for the quarter,” he said. “It wasn’t what we expect from ourselves or what people expect from us. And we will see what we can do better on forecasting and communicating. But you don’t rebuild credibility by talking about it. The execution of the balance of 2008 will be strong.”
Mr. Immelt remains adamant that it would be foolish to break up G.E.
“I’m not going to panic over one bad quarter and do something that is not in the strategic best interest of the company,” he said. “If I didn’t think that a big portfolio move was right before the first quarter, I don’t think it is now.”
Analysts have talked for years about spinning off divisions like NBC Universal, questioning the entertainment giant’s synergies with G.E.’s more traditional industrial and financial businesses. But institutional investors are now joining in the call for big structural changes.
Robert Spremulli, an analyst at TIAA-CREF, which owns G.E. shares, praised Mr. Immelt’s move into green businesses, but he wants G.E. to be “more aggressive about getting rid of appliances and lighting, and getting out of GE Money.” Big retailers like Wal-Mart have driven prices down so low that the margins on consumer goods are no longer attractive, he said.
Mr. Spremulli thinks G.E. should still have branded appliances in the market, but would be better off simply letting another company manufacture under the G.E. name. “G.E. should just get out of the consumer business,” he said.
Even investors who like the portfolio as it is now are anticipating a shake-up within G.E.’s executive suite. “I believe there will be discussions of accountability behind closed doors at G.E., and I believe someone’s head will roll,” said Richard D. Steinberg, the president of Steinberg Global Asset Management, another institutional shareholder.
Although investors were reluctant to name names, many seemed particularly irked with management at G.E. Healthcare, the business run by Joseph M. Hogan. “If anyone loses their job, it should be in Healthcare,” said Daniel J. Rosenblatt, an analyst at Marble Harbor Investment Counsel, which holds G.E. shares. In response, a spokesman for G.E. pointed out that the health care business has averaged double-digits earnings growth over the past five years.
Despite their very different styles, Mr. Welch was quick to praise his successor as “a hell of a manager.”
And while Mr. Immelt has been apologizing for the shortfall, Mr. Welch was as quick as ever to defend the conglomerate he helped build, while firing back at critics. He noted that with financial giants like Lehman Brothers, Merrill Lynch and Citigroup writing off billions, G.E. is projected to earn over $20 billion in 2008.
Indeed, despite the turmoil in the financial sector, G.E is still likely to grow this year, Mr. Welch says. “This shows the strength of the G.E. model,” he insisted. “This is a massive overreaction and it will pass.”