Tuesday, November 14, 2017

GE and Value Creation (Destruction)

      Perhaps the most common theme of this blog is that value creation comes from lean, well managed companies that have sufficient barriers to entry to be able to produce reliable and growing cash flow streams.  It is much less likely to come from financial transactions and restructurings.  The key is to focus on the details of running each specific business and let the stock market and the macro economy take care of themselves.

       GE seems like a company that should be doing well by these criteria.  It has a dominant market position in a variety of important businesses.  But it has fumbled across the board.  Costs, including overhead and management compensation, were allowed to expand without sufficient justification.  The Board grew to an unwieldly size.  Accounting became so complex that accountability and incentives were compromised.  As a result, in the current year the company managed to see its stock fall 40%.  Quite a miraculous for a large firm in a market that has risen 15%.

      This is a case where stockholders deserve to be angry.  Often collapses in stock prices occur because of factors that management could not anticipate or control like the financial crisis or the drop in oil prices.  But in the case of GE, it is hard to find such explanations.  Management deserves most of the blame.

      In my view, the path forward is not more restructuring, but cost cutting and attention to the details of the individual businesses.  The division that makes locomotives, for example, does not to be sold.  Railroads are four times as efficient as trucks on a ton per mile basis.  As energy costs grow and environmental issues become more pressing, we will need more rail and that means more locomotives.  That is a business that GE should make work.  There are many others.

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