Latest back of the envelop look at GE?

Yesterday evening, after having witnessed the GE stock price tank for a week, I decided to take another look at the company and try to come up with a rational “back-of-the-envelop” valuation.  My basic premises were that (1) the company had valuable businesses, (2) the world appetite for electric energy would keep growing, and (3) for the foreseeable future, renewables couldn’t displace fossil fuels, in particular natural gas.

My conclusion was that, under this set of assumptions, GE seemed undervalued by a wide margin.  The announcement today that a new CEO with successful experience at running an industrial conglomerate had been appointed only reinforced my views.

The valuation methodology was as follows:

·        Using market value for Baker Hughes  A GE Company since its stock is publicly traded,

·        Looking at competitors for the Aviation, Healthcare and Renewable Energy divisions,

·        Taking a mixed approach for the Power division,

·        Valuing GE Capital at zero.

Baker Hughes

I applied a modest 15% control premium since GE owns 61% of the company.  This yields a $26 billion value for GE’s stake.

Aviation

The comparable here was Safran, the French company which is also a 50/50 partner with GE in the commercial jet engine business.  The benchmark used was Enterprise Value (that is market capitalization + debts – cash) to Revenues.  For each division, I had to come up with an estimate of each division’s debt.  I am sure that my allocation of GE’s debts of $34 billion, ex-GE Capital, among each division was wrong, but overall, it probably doesn’t substantially change my conclusions.  Aviation was thus valued at $74 billion.

Healthcare

This was the most critical valuation, as it assumes that GE will successfully develop its imaging, life science and IT activities.  If it does and commands the same kind of valuation as companies such as Baxter International, Medtronic or Stryker, then I put its potential value at $82 billion.

Renewable Energy

Real difficulties start here as international competitors such as Vestas, Siemens Gamesa and Nordex carry widely different valuations.  In the end, I chose Siemens Gamasa as the more comparable given its size and low profitability.  This gave me a $4 billion valuation.

Power

The most difficult division to value given its gloomy medium-term prospects and the excessive price that GE paid for the power assets of Alstom.  Still, the assets of that division were listed at $71 billion.  Today GE announced that it was writing off $23 billion of goodwill, a good deal related to the Alstom acquisition.

Possible valuations using estimated book value, multiples of revenues and p/e multiples based on future estimated normalized profits range from $49 billion to as low as $8 billion.  In the end, I thought $15 billion was a reasonable number.

This sum of the parts exercise gets us to $201 billion, or $23/share.  Again, this is not a measure of GE’s performance today, or of its best long-term potential; it is a rough estimate that incorporates a moderate turnaround at Power and a market valuation for a stand-alone Healthcare.

Indeed, if I am correct, there may never be a spinoff of Healthcare; for that reason, and unless the new management can convince investors that they will be very successful at allocating capital and running a multifaceted company, the market may impose a conglomerate discount of 10% to 15% on GE.

I also didn’t make any adjustment for yet unfunded pension liabilities, but I didn’t take into account any cash holding either.  Could this and other as yet unidentified pitfalls subtract from our estimate?  Yes.  Would a $20 billion provision cover such “unknown”, I would think so.

In summary, GE’s reasonably optimistic medium-term valuation should range between $201 billion ($23/share) and [$201 bn - $20 bn]x85%, i.e. $153 billion ($17.6/share).  The current share price of $12 seems low to me.