ADAM SMITH SPOTTED blood in the water.
It was the fall of 2012, and Smith (a pseudonym used here to protect this individual’s identity) was a member of the business development team at GE’s massive Power and Water business unit, the oldest and largest industrial unit in the company. “Business development” was just another of way of saying the deals team—the squad working as mergers and acquisitions bankers embedded inside the company, figuring out pieces of GE that could be sliced off and sold to generate more money than GE made from operating them. The team also kept an eye out for weaknesses in outside firms that might signal a potential acquisition of an external business for a sweet price.
Here was the blood: Alstom, the French conglomerate that competed with GE in the power turbine business and also made passenger trains, had quietly sold €350 million in new shares to private investors, just months after buying back its own stock and reporting earnings that had shown no sign that the company would need to raise money. To Smith, the sale was a clear sign of a cash crunch that one of GE’s biggest rivals in the power business clearly didn’t want anyone to know about.
The deals team dug down further. Alstom was heavily bloated by American standards, GE’s analysis found. Compared to GE’s Power business, Alstom had four times as many workers for every dollar of revenue it brought in. And yet, though it seemed to be in need of cash, it wasn’t laying off workers or closing facilities. Layoffs and closures—restructuring, in accounting speak—are cost-cutting measures taken with an eye to the long term, but because of costs like workers’ severance, they require cash to complete.
It seemed to Smith that Alstom would be a prime target for the cost synergies that GE loved, namely, excess workers and factory “rooftops” that could be shed to boost profit margins. But the company was so dangerously low on cash that it couldn’t do its own restructuring, not even to save itself. Buying Alstom to restructure its operations and fold it into GE’s own Power unit would make sense—but only if it could be had for the right price. Any bid needed to be carefully and precisely calculated; overpaying for a limping business could hamper a buyer for years.
Smith watched his screens for days, waiting for a sell-off in Alstom shares to drive down the company’s stock price. It was only a matter of time before the market saw what he had seen, and the moment that happened would be the right time to swoop in with a lowball offer to take some of the company’s business units off management’s hands.
But the big sell-off never came. Instead, Alstom’s shares dipped, but then soon started to climb again as investors speculated about the company’s plans. The market seemed to think that Alstom had raised the cash for a big move of its own. Regardless, other investors weren’t seeing what Smith was seeing—a big industrial company quietly trying to manage some big internal problems.
Smith and his colleagues sent their pitch to the business development team for the entire corporation at GE headquarters in Fairfield. But corporate filed the report away for the time being. Something was obviously wrong with Alstom. Perhaps one day they would find out how bad it was.
It was April 2013, late in the evening, and Jimmy Lee was in a bar on Bourbon Street, finally getting his chance to meet the new deal guy for General Electric. Lee, the irrepressible deal fanatic of JPMorgan Chase, was the kind of fellow who could happily extemporize at length about 150 percent of the transactions that might happen in any given year on Wall Street. But GE, in recent years, had been a frustratingly sparse source of deals—and bankers’ fees—for Jimmy Lee and Morgan.
GE was just the sort of sluggish and complicated colossus that Lee believed, with every fiber of his being, would benefit the most from the skillful slicing and dicing of the nation’s most august investment bank. GE was, to a banker’s mind, a web of locks to be picked. Unlock them, and all-important “value” flowed out: higher returns for the rest of the company that remained, a shot at a more focused business and profits for the unit that was sold off, a surge in trading by investors eager to see something change, and a slew of fees for the bankers and lawyers who turned the notion of the deal into a reality.
It was no surprise, then, that a furiously energetic, upbeat banker like Lee could find a willing audience in a chief executive like Immelt, who was so eager to transform—and to get credit for transforming—his massive portfolio without giving up the otherworldly scale of a conglomerate in a world from which conglomerates had largely disappeared. Lee had already helped prod Immelt into selling GE’s stake in NBC Universal to Comcast, a massive two-part deal. Now, in the spring of 2013, he saw a chance to bond with the new head of business development, just arrived from a posting in India, to impress on him the value that JPMorgan Chase—and in particular Jimmy Lee—were prepared to unlock for General Electric.
So James B. Lee and John Flannery, along with Geoff Beattie, a member of the board of directors, settled into the bar.
Lee’s message was about playing defense. Activist investors were looking for bigger and bigger targets, he said. What defenses was GE preparing? What would they do to fend off an attempt, however unexpected, from an interloper that might try to buy into GE’s stock and force management’s hand about changing its portfolio?
“Look, man,” Jimmy Lee said, “there’s some big trends going on here and you’ve got to be dialed in to it.”
Flannery cut Lee off. They had an idea already in motion, he told the banker. GE was ready to cut a profitable chunk of GE Capital loose, throwing a little over the side to show investors that they were serious about reducing its dependency on the financial services unit that had led to such lingering disgust.
Actually, a giant spin-off was in the making. What had been a unit of GE Capital that funded store-branded credit cards and layaway financing plans at outlets like Walmart would become its own company, with shares of stock swapped out to GE shareholders. By creating a new public company, Synchrony Financial, out of the old GE Capital, GE would lose the money it had been making from the unit, but it would also shave off some of its financial risks.
To no one’s surprise, when the move went public, Jimmy Lee and JPMorgan Chase were in on the deal.
Then, in late 2013, the word went out to the business development teams at all GE units: send your biggest industrial deal ideas to Fairfield. There, on GE’s blandly imposing corporate campus, Jeff Immelt and his lieutenants were in the mood to do something big. Incremental gestures toward reorienting the company—even relatively large deals like Immelt’s acquisitions in oil and gas—weren’t convincing the market that GE was really serious about kicking its reliance on finance.
In the years since the financial crisis, the consensus view of GE had hardened into what had once been the wry, cynical view: America’s most famous industrial company was actually more of a bank with profitable jet engine and power businesses grafted onto it. And being viewed as a bank spelled trouble for one of the most important metrics confronting Immelt and the other GE executives: the multiple.
The multiple, or price-to-earnings ratio, is a crude metric used to find the relative value of a company’s stock. In its most basic form, the stock price is divided by the annual per-share earnings to determine how much investors are paying per dollar of company profit. Investors tend to pay up for earnings if they think a lot more are coming; they pay less for slower-growth companies or for those with an uncertain future. Unlike the share price, the multiple allows comparisons to similar companies.
For all of GE’s growing reliance on financial services profits in the Welch years to drive its earnings up, the company had enjoyed the benefit of a double standard. It raked in cash from its lending business, just as big banks did, but investors trusted it for the stolid and secure industrial business it also was. GE had the high-efficiency profit margins of leveraged finance, but the price-to-earnings multiple on its stock price was that of a much less risky industrial conglomerate, where sales are forecasted out by years, not just quarters. Huge backlogs of heavy equipment orders and service contracts had made the company confident that even sharp economic downturns would be manageable and require no deeply painful moves. Its rich dividend in particular seemed safe from reductions.
GE’s financial crisis swoon and slow recovery had changed all that. The black box of GE Capital had been acceptable to a certain cohort of big investors, sell-side analysts, and financial journalists for as long as it remained a caveat to the larger story—that of an impregnable industrial company with a knack for setting and beating targets for Wall Street. When a real financial calamity occurred, GE Capital—along with the belated panic on the part of investors about how little they understood its inner workings—had nearly taken the entire company down. Although Keith Sherin in particular had helped to stanch the bleeding in the now-legendary investor meeting with GE analysts in March 2009, during the depths of GE’s crisis, and its stock price was back from its single-digit lows, there was one thing that wasn’t coming back: that irksome multiple.
GE’s price-to-earnings ratio now clung stubbornly to the levels of other financial services companies. To investors, the risk in GE shares was more comparable to JPMorgan Chase and Wells Fargo than to industrials like United Technologies and 3M.
For Immelt, the unchanged multiple represented a series of short-term problems. Millions of GE stock options earned as compensation by managers, executives, and board directors, both current and retired, remained underwater. Nevertheless, GE’s communications department took pains to instruct reporters that Immelt, his lieutenants like Sherin and Jeff Bornstein, and the rest of the leadership team paid no attention to the share price.
This assertion was easily contradicted over cups of coffee with GE people in Midtown, and in phone calls to offices around the country. The stock price was a daily grade of Immelt’s and the company’s performance that could bring on a lambasting by Jim Cramer and various annoyingly well-read financial columns and blogs. Such criticism could be dismissed by Fairfield as short-termism that failed to consider the long view of the industrial company, but for scores of people critical to GE’s fate, the stock price was ultimately their money.
It was one thing to abide by the principles of performance-based stock compensation when the company could take a hit over a quarter or two, get its stride back, and rise again, bringing the price back up to a range where the options that executives had earned would be worth more than they cost to cash in (the deal tacitly on offer when the options were priced in the first place). GE’s inability to climb back to the multiples it had once enjoyed didn’t just incite grumbling from former board members and retired executives whose options were dying unexercised. It threatened to have a major impact on the recruitment and retention of the best prospects.
Still worse for Immelt, the apparent reclassification of the company by Wall Street hinted at a more dire judgment. It wasn’t just that investors, in assessing their risk of losing money, saw GE as more akin to a major bank than a major manufacturer. The fact that investors made that judgment was a signal of their unwillingness to believe the company’s near-daily protestations that it was an industrial company that happened to have built-in financial advantages. GE’s investment proposition demanded faith in its ability to keep financial risks as firmly in check as the risks of failure in any of its industrial lines. Any jet engine maker would take a hit if a turbine blade broke loose and spun free from a plane in flight. A nuclear reactor meltdown would ding the stock of its manufacturer. An MRI magnet recall would incur a big charge to earnings for a healthcare equipment maker. The premise of GE’s every communication to investors was that its management was so strong, and its vision of the entire conglomerate so penetrating and expansive, that its stock was a gamble worth taking. Even in the inevitable event that something somewhere went wrong, its protocols for working out of trouble would limit the amount of long-term damage and preserve its investors’ money.
The security in a smaller, more stable GE Capital that Immelt now promised was that the financial services arm would be managed in just the same way: the risks it posed to a GE shareholder would not be significantly different from those posed by, say, the century-old locomotive division.
If Wall Street had given the postcrisis GE the industrial multiple that Immelt wanted, it would have meant that investors trusted GE to manage all the arms of its conglomerate to the same degree of risk and security. But Wall Street in 2013 wasn’t offering that kind of multiple because, to some extent, investors just didn’t quite believe what Immelt was promising.
In late 2013, Immelt wasn’t yet publicly using the term that would become shorthand for the maneuver he decided on to get GE out of its middling funk. Like a bulky forward under a basketball hoop who finds himself face to face with a double team threatening a trap, Immelt needed a way to change in two directions at once, to swing away from what wasn’t working and then lunge toward what might.
He needed to pivot.
Even though the tactic he chose had failed him many times before, Immelt decided to essentially double down on it. He wanted to do a giant industrial acquisition that would ramp up the money GE earned from machines and services, opening a new stream of cash into the corporate treasury. That cash, and those earnings, could then be used to make an even bigger move that wasn’t even discussed yet outside of the small groups that regularly huddled at headquarters in Fairfield and GE Capital’s nerve center down the road in Norwalk. If the industrial deal worked, GE would have the financial cushion to move even further to wean itself off financial services. Instead of simply promising a smaller and more secure GE Capital, GE could make a fundamental shift away from the dependence on finance that had defined it for a generation.
But first, the Jeffs—Immelt and Bornstein—and John Flannery, the head of corporate M&A, needed a suitably big target. They needed a whale of an industrial deal, something as large as the acquisitions of Amersham and NBC Universal had been. But unlike those deals, they needed one that Wall Street would actually like.
So word went out from Fairfield to Atlanta and Chicago and Schenectady, to Cincinnati and London: send us the biggest targets in your sights.
Adam Smith and the Power team immediately thought of just such a large target—not that they thought much of the property. Still, a call for pitches was a call for pitches, and there could be much value for GE’s vaunted cost-cutting machine to reap from a declining French conglomerate with assets strewn across three continents, provided they could snap it up at a buyer’s price. The Power and Water division’s business development team dropped their idea into the stream of proposals now flowing toward Connecticut.
What if GE bought Alstom?