Speaking with a hedge fund manager in Princeton last week, he commented “There is probably no other large firm that has as much negativity surrounding it as GE.”
Indeed, the story looks pretty bleak. The stock price has made a steady traverse downward since late last year, despite initial excitement about Immelt’s stepping aside in favor of John Flannery as CEO.
One of the logs fueling the fire of GE’s decline is JP Morgan’s analyst, C. Stephen Tusa, CFA, who issued a 130-page report detailing his reasoning why GE was in trouble. Joe managed to find the report on a public bulletin board, and I’ve spent the last day reading through. We’re posting the report here so all of you have an opportunity to see the bear case for yourselves and so we can discuss our valuation and investment strategy during this week’s Office Hours.
Long story short, Tusa makes some good points and has a lot of good information about the business from industry sources. I found the information helpful and his points also reasonable.
However, the one difficulty with sell-side reports, in my opinion, is that while they usually contain great anecdotes, they are not built on a framework that shows the value creation process. Because of this, and because of the sheer overwhelming amount of data included in the report, it is hard to see what is really driving the underlying economics.
Analyzing Tusa’s report, it’s clear that most of the divergence in short-term projections between JP Morgan’s model and Framework’s is Tusa’s bearishness on the Power market – especially the market for large gas turbines. Tusa – like most sell-side analysts – focuses exclusively at what we would term the “Explicit” valuation period (which he defines as the next four years). However, his comments regarding GE’s prior investments also speak to what we consider to be “investment efficacy” – a factor tied to medium-term growth.
Another thing that stood out to me right away is Tusa’s adjustments to what GE calls “Industrial CFOA” (Cash Flows from Operating Activities). Tusa strips out dividends paid to the Industrial business from the divestment of parts of the Finance business – reducing his calculation of cash flows – while not adjusting for the one-off tax hits and other balance sheet account disturbances caused by the divestitures. This selective adjustment process makes it appear that GE’s industrial business’s cash flows have been in constant decline for four years – a position that I believe is not supported by the facts or by common sense.
I will make more detailed and structured comments about this report during Office Hours, and this report is voluminous, so do not be too worried if it seems overwhelming. If you see something in it that particularly worries you, please drop me a line and I’ll be happy to address that issue during Office Hours.
(Note that while we pulled this off of a public source – Reddit – it is copyrighted work. We do not want to get on the bad side of a deep-pocketed investment bank, so if someone asks, you got this report from Reddit!)