Wednesday, March 18, 2009 0 comments ++[ CLICK TO COMMENT ]++

GE and its Eastern European problem

I ran across a good article from Bloomberg touching on the problems GE is facing in Eastern Europe. It's a nice article that adds colour to the situation.

General Electric Co.’s future may depend on folks like Yelena Zoshchenko.

GE Capital, the financial services unit of the world’s biggest maker of jet engines and power turbines, gave the Moscow real estate agent a car loan at a 15 percent interest rate in June 2007. Then the Russian currency collapsed.

“The banks here used to literally grab you by your lapels and ask you to borrow,” said Zoshchenko, 58. “But not since the crisis started.”

Sixteen months into a global recession triggered by a jump in defaults by U.S. home-loan borrowers, some investors doubt GE has a handle on GE Capital’s far-flung operations. Those include the world’s largest store-name credit card business and lending in Russia, where late mortgage payments to the company rose 28 percent in the fourth quarter. GE’s stock slumped 61 percent since Sept. 15.

GE Capital, the world’s largest non-bank finance company with consolidated assets of $637 billion, accounted for $8.6 billion, or 48 percent, of the Fairfield, Connecticut-based parent’s $18.1 billion profit from continuing operations last year.

The following graphic accompanies the article and one can easily see why the market has punished GE (as usual, click on image for a bigger one):

I think the left side of the table on the right, store-name credit cards, are manageable. Losses will be higher than what anyone thought a few years ago but it may be contained if the American economy doesn't completely fall apart (it hasn't and I don't think it will.) The problem is on the right column of the table.

Without knowing any details of GE's portfolio, I would guess that the British residential mortgage portfolio is a huge threat. I'm just speculating based on the fact that the British housing bubble was the largest in the world.

I'm not sure about the Eastern European exposure but the market is certainly very bearish on anything in that part of the world right now. As I and others have pointed out over the months, Eastern Europe closely resembles East Asia of 1997. Similar to the Asian Tigers in the late 90's, the once-hot Eastern European countries have relied heavily on foreign financing, often in foreign currencies. Their economies are export-oriented and are unlikely to recover without the importers, America/Canada/Western Europe/etc, recovering first.

For those interested, Bronte Capital also had a bearish post a few weeks ago on the problems plaguing GE. I think the comment by John Hampton that GE's problems are, in some sense, the same as America's problems writ large is quite apt.

I think the GE situation is also illustrative of a shortcoming with putting way too much emphasis on management--a dilemma that plagues small investors who aspire to be value investors. Warren Buffett is one value investor that invests based on management (whereas I'm more like Martin Whitman and don't rely on management.) I'm just speculating here but I think Warren Buffett likely invested in GE primarily due to Jeffrey Immelt. Buffett has said in his past shareholder letters that Jeffrey Immelt is one of the top executives in America. Yet it seems that Buffett misread the situation. The Bloomberg article says that "GE expanded its mortgage business into Asia and Eastern Europe two years ago to keep profits increasing by double-digit percentages" (bold/italic by me), which implies that a lot of the questionable expansion into Eastern Europe occurred under Immelt's oversight.

I'm not saying GE is going to collapse but I think a great company was ruined by turning an industrial giant into a financial company. This is a somewhat popular thing in America--GM and Ford haven't been car companies for years--but the market is going to force GE's hand. I don't know if it's possible or legal to split off GE Capital, or at a minmum GE Money and GE Real Estate (can keep commercial lending and vendor financing since that supports industrial sales), from the rest of the company but that is what GE should be pursuing over the medium and long run. In the short term they probably can't do anything. Management seems to indicate that they will target 30% profit from GE Capital and hopefully they will take that down to 20% or less.


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