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GE Brings Cheap Money to Life



A breakdown of General Electric's (GE:NYSE) revenues and operating income reveals just what kind of company it is; the answer may surprise you.

Forty-four percent of the company's revenue is derived from financial activities: insurance is 19%, commercial finance is 15%, and consumer finance is 20%.

Forty percent of the company's operating income is derived from financial activities: commercial finance is 20%, consumer finance is 10%, and insurance is 10%.

With negative real interest rates it is very easy for finance companies to make money.

GE Capital is headquartered in Connecticut. It is the largest hedge fund in the world.

GE Capital issues corporate bonds. It then takes the money and buys companies that are immediately accretive to its "portfolio", which is not hard to do when interest rates are this low. They just bought a company named HPSC (Health Professional Services Corp.) which specializes in making loans to doctors, dentists, and other health care professionals. The revenues and profits from this activity flow to commercial finance.

We believe that GE writes-down the value of these acquisitions up front, which allows it to show better and improving earnings in the future. These up-front write-offs are offset by improving earnings from existing acquisitions. This helps the company manage earnings, but also requires a steady stream of new acquisitions to perpetuate the cycle. Acquisitions of this size (under $5 billion market capitalization) are not broken out, so it is very difficult to get a handle on exactly what is going on in this portfolio.

I am not suggesting that what the company is doing is subversive; I am just pointing out that this process is very similar to that of an equity hedge fund, which borrows money to buy stocks. The difference is that what GE Capital does is much less liquid and financed not by outside investors directly, but indirectly by bond and stock holders.

Today Reuters is reporting that Japan's fourth-largest bank, UFJ Holdings will strike a $918.6 million deal to sell its consumer financing arm Aplus Co to GE Capital early next week.

Sixty percent of the GE's operating profits still come from manufacturing activities like power plants, jet and locomotive engines, and consumer products.

But GE Capital is approaching being half of the company and its activities are growing. It incorporates bank level leverage (more than a hedge fund) in running its business. If you own the stock, just realize that you probably really own a bank stock and may even be a hedge fund investor.

In GE's annual report there are numerous instances where the company expresses "tremendous growth opportunities". At 1% of our country's GDP, just the size of the company will be a limiting factor to growth. The source of growth is even more disturbing: it is likely to come from continued increases in their balance sheet: borrowing more money to buy accretive companies, or more accurately, sequentially accretive companies.

GE stock price at $32 trades at a 21 multiple to earnings. Citigroup(C:NYSE) trades at a twelve multiple. If we apply a bank type multiple to the GE Capital portion of their business, the stock price would drop 25% to $24.

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