GE HEALTHCARE: BREAKIN’ UP IS EASY TO DO

UPDATE 12.22.18: In the months since we first published our recommendation to buy $GE shares, three major events have occurred.

1) Shares continued to plumb the depths of investment hell, falling as low as $6.80 per share at one point. And we thought $GE was cheap at $13!!

2) The Board decided that there were just too many “skeletons in the closet” for $GE to be turned around by a lifetime employee, and unceremoniously fired John Flannery. His replacement, Larry Culp, is the first outsider tapped to run $GE in one hundred years.

3) Just a few days ago, $GE filed IPO paperwork to spin off GE Health. This means that, in some form or another, Culp will continue to forge ahead with the basic plan that Flannery had laid out. Frankly, $GE needs the cash.

 

We believe that these events only strengthen the value thesis that we laid out in our original recommendation; $GE’s current share price is so depressed that the best value for future GE Health investors would be to buy now. An investor with a strong stomach today could wind up with not one, but up to three separate public companies a few years from now. With the IPO paperwork filed, the GE Health spinoff is moving forward; even the left over industrial rump of $GE is such a tangled mess that additional spin offs could be in the works. What we currently know for sure is that $GE’s cash cow medical business will soon be liberated from it’s losing industrial siamese twin. Even $GE’s industrial side is not hopeless with a little good management and a little good luck. So today’s aggressive investor might just get a two for one deal.

Who doesn’t love a BOGO?

This recommendation is not for the faint of heart. But if you just love the idea of getting $1 in assets for just a $.50 investment, this could be your chance. Good luck!

– The Sick Economist


 

Seems like everybody is doin’ it these days. Sayin’ “sayonara,”  pulling the trigger, breakin’ up. Abbott and Abbvie did it, Siemens is doin’ it, and now its GE’s turn for a divorce. GE will go to bed married to GE Healthcare, and in the cold, hard light of morning, these two corporate entities will go their separate ways.

Not that this is totally unexpected. GE, the model of 20th century corporate glory, has been in a tailspin for quite some time. After riding to greatness in the go go days of the late 90’s, corporate titan Jack Welch was replaced by Jeffrey Immelt, who was almost immediately pummeled by the stock market crash of 2001.  During “Neutron Jack’s” reign, GE had been transformed from a slow but steady provider of industrial essentials into a high flying finance venture that owned everything from television stations to trains, to GE Healthcare. It was hard enough for Immelt to recover from the drubbing GE’s share price took in the crash of 2002, but by 2008 GE’s still noteworthy financial exploits left them badly exposed to the financial crisis of 2008. In 18 years under CEO Jeffrey Immelt, GE never really found its footing. Long story short, dedicated GE shareholders have been living in a world of pain for almost two decades, and someone had to do something radical about it.  

That someone is John Flannery, a GE lifer who was promoted to CEO to play the role of “Doctor” to a sick patient. How sick is GE? Well, during the worst of the 2008/2009 financial crisis, venerable stalwart GE tumbled from $40 per share to as low as $13 per share.  If an investor had been bold enough to buy shares in an exchange traded fund that covered the entire S&P 500, that investment would have netted a 253% return by today. However had the same investor purchased shares of GE, a sprawling conglomerate with businesses so disparate that they would seem to cover a similar breath as the S&P 500, today those shares would still be trading at……..the same $13.  During one of the greatest bull markets of the last 100 years, most GE investors have actually LOST money.

The punches just never stopped coming for GE shareholders. While GE appeared to consistently churn out profits during the Immelt years, even if the stock price remained leaden, it slowly became more and more apparent that actual performance was not at all what Mr Immelt would have America believe. By the time CEO Flannery took the reigns, underlying business had deteriorated so badly that GE had to cut the dividend, only the second time since the Great Depression that GE had dared to ask shareholders to tighten their belts. Then Flannery and his new team got slammed by a nasty, multi billion dollar obligation that prior management had always kept shackled down in the corporate basement. With the share price in free fall, the company’s owners had to endure one last, swift kick to the ass; GE, founded by Thomas Edison and a key component of the Dow Jones Industrial Index since 1896, was unceremoniously invited to leave that prestigious group of industrial overachievers. Faced with a global conglomerate on life support, new CEO Flannery decided that radical surgery was in order.

The radical surgery means nothing less than the end of GE as we know it. The logo will endure, and so will the ticker symbol. However the days of General Electric as a corporate octopus will be coming to an end. Much as his predecessor had slimmed down the behemoth by getting rid of its television business and shrinking its finance arm, Flannery decided to break the business into three. One of those pieces, the piece that caught my eye, was GE Healthcare, a business already totally separate from the rest of the beast in everything but name.

If GE has endured every insult that I listed above (and quite a few that I don’t have the space to mention) than surely these shares must be kryptonite for investors, no matter how the new CEO slices and dices……right????    

That might make sense on the surface, but much like good organs can be harvested from a dead body, GE Healthcare is far from a loser. In fact, GE Healthcare has reliably pumped out growing revenues and profits even as the mothership lost her way. Revenues rose three years in a row starting in 2015, from $17.6 billion all the way to $19.18 billion in 2017. Profit rose in a perfect line for three consecutive years in a row, from $2.98 billion in 2015 to $3.48 billion in 2017. What on earth could be wrong with those results?  

Nothing. There is nothing at all wrong with $3.48 billion dollars in profit, almost a 20% net profit on billions and billions of revenue. No one would know this better than John Flannery, whose job just prior to his promotion was…..CEO of the healthcare division. In fact, Mr. Flannery did such a good job growing GE Healthcare that they put him in charge of the whole dysfunctional mess. Poor guy.

John Flannery is a GE lifer. Like anyone who claws his way to the top of a company that has 300,000 employees, this executive has enjoyed some fairly generous pay days over the years, with his compensation stretching well into tens of millions. Not tens of millions of dollars, tens of millions of GE shares. That’s right, the executive received well over 70% of his pay in floundering GE stock, year after year, decade after decade. To use a phrase coined in the 90’s, when GE was still flying high, “he feels our pain.”

So Flannery isn’t lopping of the maker of body scanners and radiation machines because he hates healthcare and prefers to focus on building airplanes. He is liberating a captive eagle that has spent years forced to nest with the other GE turkeys. As author Alex Kacik put it in a June 25th article in the Healthcare Finance Magazine, “GE’s healthcare segment has been a bright spot among the conglomerate’s vast portfolio….across the entire company, GE reported a net loss attributable to shareholders of $6.22 billion, driven by significant declines in its power and renewable energy segment…..Healthcare has been one of GE’s healthier businesses even though its success has been diluted by the company’s struggles……”

Flannery, the board, and GE Healthcare’s current leadership understand that shedding excess corporate baggage, failures unrelated to GE Healthcare’s bright prospects, could totally change the narrative around the business. And good narratives drive good stock prices.  

Remember that large financial shock that served as one of Mr Flannery’s swift kicks to the ass?   It was an ironic one for a former president of the healthcare division. The company’s audit team came to the horrifying realization that they would have to book a massive $4 billion charge caused by Long Term Care Insurance policies that GE stopped selling years ago. Remember 1990’s, high flying GE, the daring risk taker in the world of speculative finance?  Well, they bet that America’s Seniors would get sick and die promptly, just like every human generation before them for millions of years. They bet wrong. Very wrong. GE’s aging clients certainly did get sick, but they certainly did not die. Like something out of a zombie movie, these sick, old clients of GE’s long term care insurance just kept breathing, if barely.  The irony, of course, is that many probably used payouts from GE’s insurance policies to pay for expensive, repetitive treatment with the high tech medical machines that GE Healthcare manufacturers. Flannery and his anxious accountants don’t have to be geniuses to understand which business got the better end of this deal.

So Flannery will liberate the lovely bird that he helped groom and raise. As has been proven by the division’s solid results over the last few years, both demographics and market conditions are very much on GE Healthcare’s side as it becomes a freebird. This seems very appealing to a long term healthcare investor such as me. But what would be the right price to pay for this new company?   As the old adage goes….”You don’t make money when you sell…..you make money when you buy.” If we buy it at too high a price, it won’t matter how well the company does over time.

There are two ways to acquire shares of whatever the new company will be called. As GE’s press briefing announced, “GE Healthcare will become a stand alone company; GE expects to monetize 20% and distribute remaining 80% of GE Healthcare to shareholders tax free.”  The first way is to wait until GE sells 20% of the division’s shares to the public. This move will establish a “float” or a quantity of shares out in the market that freely fluctuate up and down depending on what value the market gives the shares at the moment. For the first time, the fledgling division will have a share price that, extrapolated out to 100% of the company, will give the young company a concrete price, probably well into the billions.  This 20% float may, or may not, be reflective of the new company’s growth and cash flow prospects down the road.

The more adventurous way is to buy GE shares today.  You see, Flannery loves GE Healthcare, he doesn’t hate it! In fact, of the many millions of dollars worth of GE stock that he now holds, all that will happen is that he will double his shareholdings. In fact, he will actually be tripling his shareholdings, because he also plans to uncage Baker Hughes, and oil services business that GE built up over the years.  The idea is that, free from the disgraced GE brand, these healthy underlying businesses will flourish and begin a “fresh start” in life…..not operationally, but in the eyes of the investing public. While very little may actually change (current divisional president, Kieran Murphy, also a GE long timer, will continue to lead) the fledgling company may now look much more like a technology play in a rapidly growing global market for very necessary services.  Sounds much sexier than a stodgy industrial behemoth left over from a 1980’s film about light bulbs…..doesn’t it?

But doesn’t  basic mathematical logic preclude much gain from simply dividing an existing company?  For example, if GE were a chocolate cake, we wouldn’t suddenly have more cake just by cutting it into three. If GE’s current share price is $13, then cutting the company into three chunks would just mean that each chunk would be worth about $4.33……right?  

Nope. Amazing to think that Wall Street, an industry obessed with spreadsheets, data, and finance MBA’s, would chose to ignore the simple arithmetic that would seem proper. But as Warren Buffet has pointed out again and again, “Mr. Market” can often yell out seemingly random share prices like a lunatic who forgot his medication.  Over the last few decades, many of the old 20th century conglomerates have gone to the chopping block to “release value.” Sometimes it has worked, sometimes not. Three parts can be worth more than one whole. Look at the example of Abbott Labs, which over the last 15 years has spawned two other publicly traded companies, AbbVie and Hospira (Hospira was later acquired by Pfizer).  Jim Cramer did the math for us on a November, 2017 broadcast……

 

First there’s Abbott’s stock, which has gone from $22 a share to $55 a share under his leadership. Then there’s the stock of AbbVie, which is now worth $94.47 as of Wednesday’s close.

In 2004, White also spun off Hospira, Abbott’s hospital supply segment, which Pfizer later bought for $17 billion. For shareholders who held onto their stake, it added  another $9 per share for Abbott.

“Add it all up, all these different pieces, and you get $159 of value, meaning if you bought Abbott when White came in as CEO and you held it along with AbbVie, you’d have a 623 percent gain,” Cramer said. “In other words, if you invested $1,000 in Abbott back then, your investment would now be worth $7,230. That doesn’t seem like a lot of single-stock risk to me. No, it seems like pure stock price appreciation.

 

No doubt, this is the dream that Mr. Flannery contemplates when he looks at the sad pile of undervalued GE shares that fill his jumbo sized brokerage account.  

We know the market is there. The 85 plus demographic is the fastest growing demographic in the world, and those folks need a lot of scans, pulses, and tests that GE’s technology delivers. Even better, the taxpayer pays for it. The machines that GE Healthcare designs and manufactures cost into the millions and require an advanced understanding of innovations in physics and AI, so your uncle and cousin are not about to compete with GE. The new company will have a big “Moat” to ward off competition, as Warren Buffet would say. GE’s currently anemic market value as a conglomerate is about $105 Billion (and shrinking).  The division made about $3 billion in profit last year (and growing). So, if GE Healthcare were valued like a poorly led, slow growing, mishap prone industrial goliath, then it might be valued at just 10 times earnings, or $30 billion dollars. Or about ⅓ of the GE conglomerate’s total value. Seems fair, given that its about one third of today’s GE         .

However, if GE Healthcare were valued more like Stryker, another medical company that creates high ticket innovative medical machines that service a growing market, then it could be valued at  30 times earnings…..or $90 billion dollars. If Mr. Flannery hits the bullseye just correct, his new spin off alone could be worth almost 90% of depressed GE’s current market capitalization. Talk about a miracle cure!

Jennifer Aniston and Brad Pitt did it.  Gwyneth Paltrow and Chris Martin did it. Now it’s time for GE and GE Healthcare to say their goodbyes. There are a lot of bittersweet memories, hurt feelings, and lawyers involved.  But love shall carry the day……love of rising dividends, stock buybacks, and appreciating share prices!!!

 

  • If you buy the GE depressed stock now and you then get GE Healthcare at a great price…what do you do then with the GE stock you still own?

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