Another very good article from Barron's on investment gains made from certain Internet stocks for GE this year:
(A must-read article IMO)
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interactive.wsj.com
Juggling Jack
Stocks help power earnings at General Electric
By Andrew Bary
General Electric is famous for delivering impressive earnings growth from its
collection of businesses, including aircraft engines, appliances and lighting. But
few investors are aware that GE's earnings have also benefited lately from
gains on its investments in Internet stocks and other technology plays. Thanks
to holdings in more than 250 companies, a unit called GE Equity has become
the top performer among the 28 operations that make up GE Capital
Services, the company's giant financial services arm. In last year's fourth
quarter, GE Equity made nearly $300 million in after-tax gains by selling
shares of such 'Net stocks as Internet Capital Group. More selling in this
year's first quarter resulted in an estimated $400 million of after-tax gains for
GE Equity, according to guidance that GE provided to analysts in recent
weeks. Among the shares GE Equity sold in the first quarter were those of
Commerce One, a firm involved in business-to-business activity over the
Internet.
Further gains are apt to be taken in the
quarters ahead. A recent tally showed GE
Equity to be sitting on about $4 billion in
unrealized gains in the publicly traded stocks
it held. On top of that, the unit has private
investments with a stated value of about $2
billion and a true value that could be far
higher.
The recent stock gains at GE Equity aren't
huge in relation to GE's overall earnings.
Last year, the company as a whole earned
$10.7 billion on revenues of $112 billion. In this year's first quarter, GE is
expected to earn about $2.5 billion. GE Capital typically contributes more
than 40% of GE's overall earnings.
Nonetheless, it can be argued that gains on the stock portfolio at GE Equity
helped GE as a whole meet its aggressive targets for earnings growth. Under
its longtime chief executive, Jack Welch, GE has become synonymous with
profit consistency and has been amply rewarded by investors. The stock,
which hit a record 164 last week and finished Friday at 155 5/8, stands at
more than six times its level of 25 in late 1994. This is superb performance for
an Old Economy stock in today's technology-dominated stock market.
GE officials contend that the company could meet its earnings targets without
the Internet stock gains at GE Equity. In fact, they indicate that in this year's
first quarter, GE Capital will take various discretionary losses and charges that
offset the stock gains. If the stock gains hadn't occurred, the discretionary
losses and charges could have been postponed.
There is nothing improper in this. Companies are fully permitted to take gains
and losses to smooth out their profits as long as those actions are permitted
by the companies' outside accountants and by the SEC.
Nonetheless, on Wall Street, concerns have been voiced that GE Capital's
earnings have become too reliant on gains from Internet stocks. One reason
for the worry: Internet stock prices have been known to melt away quickly.
One person who has noted GE's reliance on Internet stock gains is Merrill
Lynch analyst Jeanne Terrile. Although bullish on GE, she recently wrote that
"investors have just gotten used to GE Capital as a real operating company
only to find that dot.com capital gains are offsetting poor operating performers
in businesses like Equipment Management. Fair or not, it was a surprise."
GE's position is that it's prudent to quickly harvest gains in soaring 'Net
stocks. Given what's happened to such stocks in recent weeks, it's hard to
argue with that logic. GE officials also emphasize that there are many other
strong businesses inside GE Capital besides GE Equity, including overseas
consumer lending, annuities and leasing.
GE's fans on Wall Street downplay the issue of Internet stock sales. "It's not
worth worrying about," says Nicholas Heymann, an analyst at Prudential
Securities and longtime GE bull. "When you have a portfolio as big and
diverse as GE Capital's, there are bound to be some ups and downs in
different businesses. The reason GE Capital has generated such great growth
in earnings is that they have that diversity."
Indeed, GE Capital's net income has compounded at a 17% annual rate since
1980, hitting $4.4 billion in 1999. GE Capital's asset base also has swelled in
recent years, rising to $345 billion at year-end from $186 billion at the end of
1995.
Heymann says anyone focusing on GE Equity's gains on 'Net stocks is missing
the big story at GE, which is the company's overall rate of rising profit growth.
GE is benefiting from broad strength across its key divisions, including medical
equipment, power systems, NBC and even former laggards like appliances.
Heymann says GE's rapid implementation of e-business strategies is
sharpening the company's competitive edge, bolstering its growing service
businesses and positioning GE as a New Economy stock.
GE's stock has been on a roll since the company's announcement March 21
that it expects first-quarter profits to "modestly exceed" the Wall Street
consensus expectation of 75 cents a share. This excited investors because GE
generally hits Street profit targets exactly, suggesting that current momentum is
especially strong.
GE's news prompted several analysts to lift their
2000 earnings estimates by a nickel, to $3.75 a
share, and raise their expectations for the stock's
performance. Heymann's target now is 210. The Street now sees GE's
per-share profits rising 16% this year, up from a 15% gain in 1999 and a
14% advance in 1998. Heymann says even better earnings gains could lie
ahead.
GE now commands one of the highest price-to-earnings multiples among big
stocks outside the technology sector, trading at 42 times projected 2000
profits. This means that GE Capital alone is effectively valued at more than
$200 billion, based on GE's P/E of 42.
By contrast, Citigroup, at 60, trades for 18 times projected 2000 profits, and
has a market value of around $200 billion. Citigroup generated $9.8 billion in
net income last year, more than double the profits at GE Capital. Is Citigroup
only half as good as GE Capital? That's what the stock market seems to be
saying.
Evaluating GE is difficult, in part because the company generally doesn't
publicly distinguish between gains from operations and gains from investments.
GE does, however, provide some of this detail to analysts. Based on such
disclosures, which the company shared with Barron's last week, it appears
that GE Equity is likely to offset its $400 million gain on its Internet
investments in the first quarter with a $150 million loss from the sale of a $1
billion stock portfolio held by the Employers Reinsurance division of GE
Capital. In addition, there could be a restructuring charge of $100 million or
more for some parts of GE Capital. After the financial maneuvers, GE Capital
is expected to show first-quarter net income of $1.2 billion, up 17% from a
year ago. GE's first-quarter results are expected to be reported in mid-April.
GE doesn't say much directly to investors about GE Capital except in its
annual report, and even there it doesn't provide a breakdown of the financial
performance of each of GE Capital's 28 units. Instead, GE Capital groups the
28 businesses into five broad segments (see table). GE typically offers only a
brief summary of GE Capital's results in its quarterly profit reports.
Just as GE Capital did in this year's first quarter, the unit last year took steps
to smooth out its profits. As our table shows, Consumer Services, which
includes GE's huge global consumer-finance division, showed strong profit
growth, buoyed by success in the Japanese market. Mid- market financing,
which includes leasing and asset-backed lending, also performed well. But
equipment management suffered, hurt by tough conditions in Europe.
Specialized financing was the biggest contributor to GE Capital's
performance, with net income rising almost $500 million to $1.245 billion,
largely driven by gains from GE Equity. Employers Reinsurance, the main
division within Specialty Insurance, had a rocky year from an operating
standpoint -- as did most big reinsurers -- because of an unusually large
amount of losses on storms and other catastrophes. The profits at the
Specialty Insurance operation fell only about 10%, to $625 million, because
the operating losses were offset by roughly $400 million in investment gains.
GE also benefited from other investment successes last year, including sizable
gains from its overfunded pension plan, a move required under accounting
rules. GE's pension gain in 1999 was $1.38 billion, up from $1 billion in 1998.
The pension gain last year accounted for about 8% of GE's net income and
added about one percentage point to its rate of earnings growth. Without the
pension gain, GE's earnings in 1999 would have grown 14% instead of 15%.
Larry Callahan, an analyst at Huntleigh Securities in St. Louis, argues that
pension gains aren't of the same quality as operating profits and probably
shouldn't be valued in the stock market at GE's lofty P/E multiple. Callahan
also points out that with interest rates rising last year, GE had a sharp rise in
unrealized losses on its large bond portfolio. This became evident in GE
Capital's net unrealized investment gains, which fell to $100 million at the end
of 1999 from $4 billion a year earlier. This decline was largely due to the
impact of higher interest rates on GE's bond portfolio. GE officials say the
bond losses aren't significant because they are offset by declines in liabilities at
GE's insurance business.
As the above discussion shows, dissecting GE's results is no easy task. Many
investors simply don't bother, taking comfort in the strength of the company's
businesses and GE's record of consistent profit growth. Still, given GE's hefty
gains on the sale of 'Net stocks, don't be surprised if the company's earnings
come under greater scrutiny in coming quarters. |
