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Morningstar | The Great Unwind Continues; GE Pares Down Energy Financial Services

In a move that surprised no one, GE continues to pare down assets in GE Capital, specifically in Energy Financial Services. As such, we are leaving our $15.70 fair value estimate intact. EFS, among other things, provides underwriting for Power, Renewable Energy, and Oil & Gas.

As part of the deal, Barry Sternlicht’s Starwood Property Trust agreed to purchase GE’s debt financing business for $2.56 billion, which includes unfunded loan commitments of $400 million. The remaining portion of the deal includes approximately $2.1 billion worth of 51 loans. Assets backing these loans include pipelines, power plants, and wind farms, among others. GE previously telegraphed its intention to pare down its exposure to GE Capital, in addition to efforts it has undertaken in the past to shrink Capital (including exiting real estate debt and what today is Synchrony Financial in 2015).

Recently, in an 8-K filing dated June 22, 2018, the John Flannery-led conglomerate reiterated its commitment to make GE Capital smaller and more focused on its core industrial businesses, following up to his commitments in a special call on Jan. 16, 2018. In the June 22 8-K filing, the company specified tactics to derisk the balance sheet, including targeting a total $25 billion worth of sales between EFS and its Industrial Finance businesses. While the timing of these asset sales is inherently uncertain, we had previously modeled this derisking plan in our model for both businesses. We are projecting EFS assets will reach an asset level of about $7.8 billion total by the end of 2018, down from $10.9 billion by the end of 2017 (and greater than the delta from the most current round of sales).

The market also didn’t react much to the news, with most financial publications ignoring it (with the exception of The Wall Street Journal and Bloomberg) and most other publications focusing on the firm laying off 200 workers at a turbine plant. We’re also not surprised by the latest job cuts in Power given Flannery’s plan to rightsize the business’ cost structure and overcapacity in the industry. This plant particularly had suffered a 45% drop in volume. We think both moves make sense, even as they don’t change our views on the firm. We reiterate our view that the firm should expand segment profit margins by 3 points by the end of our explicit forecast from 2017 levels. Even so, this falls short of the 10% segment profit margin management is targeting.

As for the EFS deal, Starwood gains a portfolio of floating-rate loans in a slowly rising interest rate environment which offsets its real estate-cycle exposure. GE also improves its Capital mix with greater exposure to better portions of its business like GECAS, its aviation financing unit widely considered Capital’s crown jewel. Even so, we don’t think this solves the fundamental issues at Capital, causing an overhang on the stock--namely, the firm’s exposure to legacy operations like reinsurance, WMC Mortgage (U.S. subprime mortgages), or its $3.1 billion in floating-rate Polish residential mortgages that are mostly denominated in Swiss francs. In conclusion, we continue to assign essentially no equity value to GE Capital.