General Electric Company (NYSE:GE) will spin-off its GE Capital in an open-market IPO, according to Bloomberg. When the news provides coverage on a spin-off, there’s not a whole lot of substantiating detail that is provided to us, the investors.
Well, I am going to make an attempt at evaluating the GE spin-off. The analysis is an estimate using financial data that comes from the company’s annual report.
Fundamental assumptions
]
Source: General Electric Company (NYSE:GE)
In Generally Accepted Accounting Principles a company must record an asset and a liability when lending money. So, for every one dollar in assets GE capital has, it also has a liability equivalent to it. To understand the total number of liabilities attributable to GE Capital’s lending we have to measure the total number of assets excluding cash and equivalents. It is an estimate though, so we have to be careful when making these assumptions. However it can be assumed that because GE Capital has $418.6 billion assets excluding cash and equivalents, the company also has $418.6 billion in long-term liabilities. Therefore, if the company were spun-off, the parent company would effectively reduce the amount of debt and assets on its balance sheet by $418.6 billion.
This means that GE capital is worth around $61.9 billion when you focus solely on cash and cash equivalents. Remember, cash and cash equivalents are assets that aren’t tied to debt (well at least it shouldn’t be as we have isolated the debt and assets to the $418.6 billion).
Deal structure
For illustrative purposes, I hoped to simplify the spin-off strategy to something fairly simple and intuitive to understand.
1. General Electric Company (NYSE:GE) will pay itself a special dividend of $61.9 billion (roughly equivalent to GE capital’s short-term cash, and equivalents). General Electric wouldn’t pay any taxes on the dividends because according to IRS tax code the dividend received deduction reduces taxes on dividends to 0% so as long as a company has an equity interest in the company that is greater than 80%).
2. General Electric Company (NYSE:GE) forfeits all of its shares in GE capital to GE capital after the special dividend.
3. GE capital will borrow an additional $61.9 billion to keep the amount of assets on its balance sheet equivalent to what it had prior to the spin-off. This will increase liabilities by a proportional amount.
4. GE Capital earns net income of $7.4 billion, so a $61.9 billion market capitalization would most likely float on the open stock market as the company would be priced at an 8.36 earnings multiple.
5. GE capital will raise $61.9 billion in capital by selling its stock onto the open market. This will offset the increase in liabilities. Because capital raised in public offerings, does not have to be repaid it would off-set the $61.9 billion increase in the companies liabilities.
6. GE capital after raising $61.9 billion in capital plus borrowing $61.9 billion would have a total of $125 billion or so in cash. GE capital can pay down the $61.9 billion in liabilities it incurred prior to IPO, to return the businesses balance sheet to the way it was prior to the spin-off.
The result for GE shareholders
The end result is that GE Capital is its own separate publicly traded entity with a similar amount of assets and liabilities prior to the company going public. General Electric Company (NYSE:GE) gets to shed $418.6 billion in liabilities off its balance sheet.
Currently, General Electric has $685 billion in assets and $562 billion in liabilities. After a successful GE capital spin-off, the company would have $266.4 billion in assets on its balance sheet, along with $143.4 billion in liabilities. The company’s shareholder equity would stay the same at $123 billion.
What does General Electric gain from spinning off GE Capital?
The advantage to General Electric Company (NYSE:GE), the parent company, is that the $61.9 billion that was set aside as a reserve for loan losses can be re-purposed for investment activities relating to its industrial segment.
General Electric can earn a 20.22% return on invested capital from its industrial segment (based on United Technologies Corporation (NYSE:UTX)’s return on equity). If General Electric can consistently earn 20.22% from $61.9 billion, the company would earn $12.51 billion in net income per year from the freed up capital.
The freed-up capital could contribute to the company’s pre-existing net income of $13.641 billion by an additional $5 billion in net income, totaling $18.641 billion in net income. Over the course of 5-years, the successful investment of capital from the GE capital spin-off could increase the company’s projected rate of growth by an additional 7.5%. Currently analysts on a consensus basis anticipate the company to grow earnings by 11.03%. So if, we were to combine the added return from freed-up capital with General Electric’s projected rate of growth, it would equate into an 18.5% growth rate on average for the next 5-years.
Peer Comparison
United Technologies Corporation (NYSE:UTX) is an aerospace company that is similar to GE’s industrial segment, and offers investors a 2.25% dividend yield. The company is projected to grow earnings by 13.53% on average over the next 5-years while trading at a 17.6 earnings multiple.
The Boeing Company (NYSE:BA) is another aerospace name that could be a potential alternative to General Electric. The company is projected to grow earnings by 13.92% on average over the next 5-years. The company also trades at an 18.7 earnings multiple, while paying a 1.94% dividend yield to investors.
Conclusion
General Electric Company (NYSE:GE) if it were to successfully spin-off GE capital could beat both United Technologies and The Boeing Company (NYSE:BA) in terms of valuation, growth, and dividend yield. General Electric currently trades at a 16.4 earnings multiple, the lowest against the compared peers. General Electric also pays a 3.23% dividend, the highest amongst the compared companies. Finally, the 18.5% projected earnings growth rate would make GE’s earnings growth superior to the peer group.
I sincerely hope Jeffrey Immelt (CEO of GE) successfully completes the GE Capital spin off.
The article The Implications of Splitting Up General Electric Into Two Separate Publicly Traded Companies originally appeared on Fool.com and is written by Alexander Cho.
Copyright © 1995 – 2013 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.
