EUR 850.00 For Business Accounts Only

Morningstar | GE and Wabtec Amend Deal Terms; Merger Expected to Close in About One Month

In a Form 425 filing filed with the SEC on Jan. 25, GE and Wabtec announced amended deal terms to the GE Transportation-Wabtec merger expected to close at the end of February. After valuing the various puts and takes of the deal in our model, we slightly reduce our fair value estimate to $13.80 from $13.90. Based on Wabtec's Jan. 24 closing price of $71.03, we reduce our assumed combined Wabtec-GE Transportation equity value, but that’s offset by a slightly higher amount of cash we assume will come into GE’s coffers.

As part of the deal, GE (the firm, not the equity shareholders) will now seek to monetize an eventual 24.9% of the combined entity, which we estimate is just shy of $3.4 billion (consistent with the calculated value in the news release). GE shareholders, moreover, receive a 24.3% interest in the combined entity, and the spin-off is considered a taxable dividend for U.S. federal income tax purposes (at 15% or 20% depending on taxable income levels). Contrary to the prior deal terms, which contemplated GE and GE shareholders holding a majority stake in new Wabtec (at 50.1%, with GE firm owning 9.9% and GE shareholders owning 40.2%, respectively), these ownership levels mean current Wabtec will now own 50.8% of future Wabtec. One deal term that remains the same, however, is that GE will still get an upfront cash payment of $2.9 billion immediately in the door, exclusive of the firm monetizing its interest.

We’ve also updated our sum-of-the-parts valuation based on pro forma 2019 estimates as of the end of February 2019 to approximately $15.50. Our sum-of-the-parts valuation uses our industrial net debt calculation from the end of the third quarter of 2018 and subtracts the monetization of nearly 20% of GE’s prior interest in Baker Hughes, a GE Co., based on an agreed-on price of $22.48 (after investment banking fees), as well as the $2.9 billion with the Wabtec merger, and the $3.4 billion equity interest in new Wabtec. While this metric admittedly has its shortcomings given GE’s earnings quality, we continue using forward enterprise value/EBITDA multiple in our sum-of-the-parts valuation. We believe that GE’s franchise businesses – aviation and healthcare – collectively are worth approximately $11 per share, even when deducting all of GE’s liabilities, including its beleaguered capital unit. Investors can feel a higher degree of confidence in the healthcare unit’s earnings quality, for example, as it lacks the contract assets (the difference between booked revenue and cash received on service contracts) that makes up a large proportion of GE power’s business, for instance. GE aviation, in our view, is the highest-quality aerospace engine maker on the market with its massive installed base in the wide-body and narrow-body markets (the latter in tandem with Safran as part of its CFM joint venture).

Even though we believe GE currently trades 66 cents on the dollar to our updated fair value estimate, we continue encouraging a wide margin of safety in the stock given its very high uncertainty and a wide range of potential outcomes. These liabilities, including in both insurance and mortgages at GE Capital, among others, are in flux and management has done little to nail down hard figures. While we’ve estimated these “stranded” liabilities, we remind disciplined, long-term investors that our 5-star entry point is currently just under $7 (or 50 cents on the dollar). At various points during December, the stock has traded under $7. Since we released our piece on Christmas Eve of 2018 entitled, “In Culp We Trust,” the stock has rallied 32%. Before today, these gains, however, have come on little material news flow (like a rumored GECAS deal) since GE monetized its Baker Hughes interest last November. It will now be up to CEO Larry Culp and company to execute the broad strategic road map laid out by John Flannery on June 26, 2018, as well as address what we believe is GE Capital’s negative equity value.

We believe strongly in Culp’s leadership. One bright spot, for example, is the hiring of Steve Winoker as head of investor relations earlier this week. As a reminder, catalysts we see in the stock include: 1) today’s announced deal 2) GE's separations of healthcare and Baker Hughes; 3) a potential deal combining the sale of GECAS, along with the transfer or "ringfencing" of insurance liabilities at GE Capital; 4) potential asset sales in less desirable portions of GE Power; 5) a separate sale of GE Healthcare's Life Sciences division; and 6) facility and headcount reductions at the remaining portions of GE Power and corporate in line with peers.