Wednesday, November 5, 2008
'The deal was done, but the news wasn't yet out, and in the meantime, GE's world was deteriorating fast. ... Finally, at 1:44 P.M., GE announced its deal with Buffett and said it would sell $12 billion of common stock to the public the following day. The statement contained an important sentence from Buffett: 'I am confident that GE will continue to be successful in the years to come.' ... After all, this is history's most famously well-managed company. But the stock trades for less than half its price 12 months ago. ... To see how GE got so badly beaten up, consider first what the company really is. Its strength and curse is that it looks a lot like the economy. ... It is by far the largest company in [the services] industry group. The next biggest--and here we begin to glimpse GE's troubles--are Fannie Mae and Freddie Mac. The reality is that for years, almost half of GE's prodigious profits have come from General Electric Capital, a 100%-owned affiliate that files its own reports with the SEC. ... But GE's cost [of capital] is only 7.3%, and in businesses where hundredths of a percentage point make a big difference, that's an enormously valuable advantage. ... GE Capital also performs another critical function: It helps GE manage earnings. ... Managers thought they were being bold in stress-testing their model against a percentage-point jump in rates, but didn't conceive of a sudden and nearly complete stop to interbank lending, a total absence of buyers for some securitized debt, and investors so panicked they're willing to accept negative interest rates to gain the safety of T-bills", my emphasis, Geoff Colvin and Katie Brenner at Fortune, 27 October 2008.
I don't see GE as "history's most famously well-managed company", but a hodge podge of operating entities and a pile of accounting chicanery, GE Capital (GEC). Imagine, GEC holds aircraft leases! It leases capital equipment to an industry that loses money most years. GEC "helps GE manage earnings". Attention KPMG, did you read this? Eventually people may agree with me, GE is a junk pile. GE is so tenuously balanced that "hundredths of a percentage-point" can make a difference? Did anyone at GE ever work in a real business and see how much can happen you don't anticipate? A "percentage-point jump in rates" is a stress test? In 1981 30-year Treasury paper yielded 14%, only 9.8% more than today. And this is GE's idea of a stress test? How's this for an insult: GE is a company run by, drumroll please, accountants!
In about 1989, I read a Fortune article about Amax. Amax's CEO was Alan Born (AB). AB was an old school manager. He was called by some Australians that offered $168 million for Amax's Australian coal operations. AB asks, A or US dollars. After being told US dollars, he says, that sounds like an attractive offer. I'll have my sharp pencils look at it and get back to you in two weeks. Two weeks later he calls back saying his sharp pencils say it isn't worth $168 million, is the offer still good? AB is told yes. OK, we'll have the lawyers draft the paperwork. Good luck with your new coal operations. AB warned his subordinates of excessive precision in their estimates saying if we have to go to two digits, stop, it's too close to call. My kinda guy.