What's going on?
On the same day that General Electric (GE) revealed a multi-billion-dollar hole in its finances, its CEO floated the idea of breaking up the struggling conglomerate – a move that would upend one of America’s most storied companies.
What does this mean?
Despite flogging off most of its financial services businesses in recent years, GE still owns insurance policies that promise to provide care for the elderly (e.g. nursing home expenses). However, the premiums it charged for these policies are, it transpires, insufficient to cover the costs of providing the care. GE said on Tuesday it would wipe $6 billion off the value of its insurance business immediately, and set aside $15 billion more for potential future charges – a significant hit to its profits.
On a conference call ‘fessing up to the news, the CEO said GE may change its corporate structure, turning its various business units into separate companies. Subsequent media reports suggested that such a move was likely and could be confirmed as early as this spring.
Why should I care?
For markets: Investors struggle to understand what’s under GE’s hood.
GE’s share price has plunged 40% over the past year, as some of its business lines struggled and investors became increasingly concerned about the low level of cash that GE generates on an ongoing basis. Tuesday’s news suggests investors have, nevertheless, still failed to fully grasp GE’s complex financial situation – and that there might be yet more skeletons in the closet (next to the electricity meter).
The bigger picture: A simpler structure can promote transparency.
Right now, investors looking for, say, exposure to GE’s industrial business have to risk a disparate business line like its insurance operations denting its profits by billions. But if GE were broken out into different companies, investors would be able to value each on their respective merits. By giving investors more clearly defined options, the sum of the value of a conglomerate’s various parts can be increased.