General Electric (GE), that legendary American institution, is in deep trouble. It’s one of the few companies in the US that still retains its AAA rating - but, considering the rating agencies’ track record, that AAA isn’t worth the paper it’s written on.
The virtual crash in GE’s stock price indicates there’s something seriously wrong here. The stock reached $53 at its peak in 2000. It closed below $17 this past week, the lowest level since the mid-1990s. CEO Jeffrey Immelt, who took over from icon Jack Welch in 2001, has made his mark by managing the company into a 68% decline in stock price.
While shareholders have taken a bath, Mr. Immelt, a Harvard MBA, raked in $72.2 million of compensation between 2002 and 2007. A company known for its pay-for-performance mantra evidently doesn’t hold its CEO to the same standards.
The first cracks in this global institution appeared in April 2008. GE had met its earnings projections consistently for decades, and is widely known as a master of legal earnings manipulation. Accounting rules allow for wide discretion in reserves and estimates. GE Capital has always been a black box within the larger company. GE doesn’t provide detailed financial information about this division, which allowed GE to use this division as its backstop for meeting earnings estimates. During a better-than-expected quarter, they take extra reserves to meet estimates (or to beat them by a penny).
The GE Capital division would also sell liquid assets at quarter’s end to guarantee smooth sailing. This earnings management had lulled analysts and stockholders into complacency.
In mid-March, Mr. Immelt publicly confirmed that GE would meet earnings expectations of $0.50 to $0.53 per share for the quarter ending March 31st. When GE reported earnings of $0.44 per share in early April, the world was shocked. The stock, which had reached a yearly high of $37, dropped 16%, to $31. Knowing that GE always has excess reserves to manage their earnings made the magnitude of the miss literally incredible.
Former CEO Jack Welch went on CNBC and said, “I’d be shocked beyond belief, and I’d get a gun out and shoot him if he doesn’t make what he promised now. Here’s the screw-up: you made a promise that you’d deliver this, and you missed 3 weeks later. Jeff has a credibility issue.”
Mr. Welch was absolutely right: Immelt has no credibility left. His excuse? "[GE] had planned for an environment that was going to be challenging...[but] after the Bear Stearns event, we experienced an extraordinary disruption in our ability to complete asset sales and incurred marks of impairments and this was something that we clearly didn't see until the end of the quarter." A top CEO should have a better handle on his business.
On September 25th, with the stock trading at $25.50, Immelt lowered GE’s earnings guidance, suspended its $15 billion stock buyback plan and declared no outside capital was needed. One week later, he convinced Warren Buffet to invest $3 billion in the company by paying him an annual dividend of 10% while granting him warrants to purchase $3 billion of common stock at $22.25. GE then sold $12 billion of additional shares at $22.25 to the public.
These weren’t the actions of a company or CEO in control of its fortunes. AAA-rated companies don’t have to pay 10% interest rates. Credit default swaps protecting against GE Capital default traded as if GE were a junk-bond credit.
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