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GE: Notably Undervalued After Blockbuster Biopharma Deal

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Source: Assemblymag.com

Notably Undervalued After Blockbuster Biopharma Deal

General Electric (GE) recently announced plans to sell its biopharma division to Danaher Corporation (DHR) in a deal valued at $21.4 billion. However, GE’s biopharma division is only accountable for about $3 billion in revenues, and the GE Healthcare business of which the biopharma division is a part of delivered nearly $20 billion in revenues last year.

Past appraisals of GE’s Healthcare unit ranged widely, with a Bloomberg intelligence analyst estimating its worth to be around $65-70 billion, I estimated the unit to be worth around $50-60 billion in my last GE article, and other estimates have ranged from anywhere from $40-80 billion

However, given that GE just struck a deal to sell a relatively small segment of its healthcare business for $21.4 billion implies that GE Healthcare is likely worth more than previously thought.

Furthermore, GE’s other businesses are quite valuable as well, and appear to be worth much more than the market is currently giving GE credit for. Ultimately, the sum of GE’s parts greatly outweighs the company’s depressed enterprise value.

Consequently, as GE continues to execute its strategy to sell-off various businesses to reduce debt, the company should proceed to unlock substantial value for shareholders, and GE’s stock is likely to go significantly higher as a result.

Implications of Biopharma Deal

The biopharma sale is a big deal for GE because it illustrates just how undervalued the company is right now. With roughly $3 billion in revenues, the biopharma segment represents just 15% of GE Healthcare’s overall revenues. Yet, this segment alone is being sold for $21.4 billion.

This segment is just a small part of GE Healthcare, and after it’s gone GE will still have the rest of Life Sciences, which generated about $1.9 billion in revenues independent of biopharma last year. Moreover, GE still has the Healthcare Systems business, which generated $14.9 billion in revenues on its own last year.

GE’s healthcare business is quite profitable, and is substantially undervalued in my view. First, we can see the nice revenue expansion of 4.2% YoY. Next, we can see that the business has a great, rising profit margin of 18.7%, which has increased from 17.6% in 2016, and 18.3% in 2017. Total segment profit was $3.7 billion last year, up from $3.2 billion in 2016, and $3.5 billion in 2017.

GE Healthcare may not be worth $100 or $120 billion, but it appears to be worth substantially more than many prior estimates suggest (picture source: GE.com).

So, what is GE Healthcare worth?

If we factor out the biopharma segment GE Healthcare will be left with the remainder of Life Sciences, and its core Healthcare Systems business. The combined unit produced about $16.8 billion in revenues last year, and likely grew revenues by about 2.8%. Assuming the remaining business produced a segment profit margin of around 18.7%, the unit produced approximately $3.14 billion in segment profit last year.

If we compare the remainder of GE Healthcare to comparable businesses like Medtronic (MDT), we see that Medtronic trades at a trailing P/E of 25.72. In comparison, Medtronic’s revenue growth rate is expected to be just 2% this year, and the company’s profit margin was about 15.8% last year.

If we apply a trailing multiple of 25.72 to GE Healtcare’s profit of $3.14 billion we arrive at a valuation of approximately $80 billion. When we adjust the unit’s profit by 25% to account for interest, tax, depreciation, amortization ITDA the remainder of Healthcare would be valued at roughly $60 billion based on a 25 times trailing multiple.

Also, if we look at another comparable business Boston Scientific (BSX), the company trades at an even higher trailing P/E of 34 times earnings. In my view, there was little reason to value GE Healthcare at 10, 12 or even 15 times segment profit, and the biopharma sale substantiates this assertion.

Given that GE just sold 15% of its healthcare business for a whopping $21.4 billion, I think it is fair to say that the remainder of GE Healthcare could be worth $60 billion, if not more, bringing GE Healthcare’s total valuation to roughly $81.4 billion.

GE: Valuation by Segment

GE Healthcare is not the first segment to be significantly undervalued by the market. GE’s Transportation unit, which delivered $3.9 billion in revenues, and about $600 million in profits last year was valued at just $7 billion by Bank of America Merrill Lynch last year. Other analysts, myself included put a similar valuation on the business prior to its breakup (my previous estimate range: $7.5-10 billion).

Still, the deal with Wabtec (WAB) actually valued GE’s transportation unit at $11.1 billion, roughly 60% higher than Bank of America’s analysts envisioned the business to be worth. Also, with a valuation of 18.5 times segment profit it is quite a bit higher than most analysts envisioned, not just BAC’s.

GE’s two major deals speak volumes about the company, as they are both significantly higher than many market participants had anticipated, highlighting the undervalued and underappreciated nature of GE right now.

The thing about GE is that there is no fire sale going on at the company. Assets are not being spun-off on the cheap, and probably never will be. To the contrary, General Electric is an iconic company with numerous highly coveted, and very valuable businesses.

Moreover, management is doing a great job orchestrating lucrative deals for shareholders, and this trend is very likely to continue going forward with Larry Culp at the helm.

So, What is GE Worth?

GE Aviation

The company’s crown jewel, Aviation. This business is extremely strong, as Aviation grew revenues by 13.33% to $30.57 billion last year, had a profit margin that surged YoY from 19.9% to 21.2%, and delivered a whopping $6.5 billion in segment profit, a YoY increase of 20.37%.

I know people like to value GE Aviation at $100 billion, and I’ve valued the business at this figure before, but 2018’s results were blockbuster, and this business is likely worth more.

When we adjust Aviation’s profit by 25% to account for ITDA, we arrive at a segment income of approximately $4.88 billion. Now, if we look at some of Aviation’s closest competitors like Boeing (BA), the company trades at about 25 times trailing earnings.

However, Boeing grew revenues by only 7.4% last year, slightly more than half of GE Aviation’s 13.33%. Also, Boeing’s profit margin was only 10.3% vs Aviation’s estimated 16% profit margin. Therefore, a 25 times trailing multiple appears relatively conservative for Aviation, and a 25 times multiple on $4.88 billion in projected segment income equates to a unit value of $122 billion.

GE Oil & Gas

This business brought in $22.86 billion in revenues, $1.05 billion in adjusted profit, at a margin of 4.6%. YoY revenues surged by 33%, and profit rose by 25% on a YoY basis.

An efficient way to evaluate the value of this unit is to derive the value of GE’s 62.5% stake in the Baker Hughes Company (BHGE), which is just about $17 billion per BHGE’s current valuation of $27 billion.

$17 billion seems very depressed, and it is due to the relative underperformance of the entire sector in recent years. Also, BHGE has lots of exposure to offshore drilling, which is not a great thing with oil prices below $60.

BHGE’s price has fluctuated wildly over the last two years, ranging from around $60 – $20, and is currently at around $26, near the bottom of this range. While GE could plausibly get a deal slightly north of $20 billion for its oil and gas assets, for the sake of remaining conservative I will value GE Oil and Gas at $17 billion.

GE Renewable Energy

Renewable Energy brought in about $9.5 billion in revenues last year, a 4% YoY increase. However, it was generally a very difficult year for the businesses due to various issues like rotor blade problems. Thus, profitability was impacted substantially at the unit, as segment profit fell by 51% YoY to just $287 million. Profit margin cratered from 6.8% in 2017, and 6.7% in 2016, to just 3% last year.

However, the bulk of the profitability issues at GE Renewable Energy segment were likely a result of temporary phenomenon, like the rotor blade problems, and other technical issues. Thus, revenue growth and profitability are likely to bounce back in 2019 and beyond.

Typically, the business has delivered a profit margin of 6.5% or higher in recent years, and its revenue growth had expanded by more than 10% YoY in recent years. Therefore, if we assume Renewable Energy can return to a profit margin consistent with at least the lower-end result in recent years, 6.5%, and grows revenues by a relatively modest 5% this year, Renewable Energy will generate roughly $10 billion in revenues, and will deliver a segment profit of about $650 million this year.

Adjusted for ITDA Renewable Energy could deliver a net income of about $488 million this year. Comparable businesses such as Vestas Wind Systems (OTCPK:VWDRY) trade at about 20 times earnings. Hence, if we put a 20x multiple on Renewable Energy’s projected income we arrive at a valuation of roughly $10 billion for the unit.

GE Power

Despite Power being GE’s biggest business by revenues (up until 2018) the unit has been in a state of decline for several years. There have been various issues at the unit, like increased competition from renewable energy products, lower energy prices, problems with turbines specific to GE Power, and others.

All of this has weighed heavily on revenues and on profitability. Revenues at the business declined by 22% YoY in 2018. Furthermore, profitability fell off a cliff, as Power reported a loss of $808 million, delivering a negative 3% profit margin for the year.

Additionally, some problems at GE Power run deep and cannot be attributed to transitory factors or one-time events. Nevertheless, that does not mean Power will remain profitless for long. In fact, this is likely an extreme low point in the business, and profitability should gradually return in future years.

The question is how much profit can Power generate on a sustainable basis. Before the power debacle started the unit was quite profitable, delivering 16% profit margin in 2015, and about 14% in 2016. Then when the “issues” started to pile up profit margin plummeted to 7% in 2017, and ultimately to negative 3% last year.

However, once the transitory factors like turbine troubles, and other issues get alleviated from the equation Power should begin to return to profit, possibly as early as this year or next. I don’t expect GE Power to return to the high profitability days of 2015/2016, but GE Power could probably generate a profit margin of around 8-10% in future years, comparable to competitors like Schneider Electric (OTCPK:SBGSY), Emerson (EMR) (profit margin 12.8%), Eaton (ETN) (profit margin 10%), etc.

Thus, if we presume revenues can stabilize and stay around current levels ($27 billion), at GE Power, and we apply a comparable profit margin to those revenues of about 9%, we arrive at a possible segment income of about $2.43 billion in future years.

It may take some time for GE Power to ramp up to such profitability, and I don’t expect such a profit can be achieved this year or the next, but in early 2020s, it’s possible. Now, the competing companies mentioned trade at P/E multiples of around 14-18. However, given Power’s growth issues and the uncertainty around the business, let’s assign a multiple of just 12 times earnings to the troubled segment. The result provides us with a valuation of roughly $29 billion for GE’s power segment.

GE Lighting

This is a tiny fraction of GE with $1.7 billion in revenues last year, and a segment profit of just $70 million, with a profit margin of 4.1%. Generally, this unit has been value at about $1-$1.5 billion in the past, so we’ll value it at just $1 billion for the sake of staying conservative.

GE Capital

GE Capital is difficult to value, some analysts say it has essentially zero equity value, some say it is worth as much as $15-20 billion according to 1-1.5 x book value.

I think the true “value” of GE Capital lies somewhere in the middle. It is likely not worthless, and to the right buyer could potentially represent some notable value, but it is also not worth $15-20 billion in its damaged state.

The unit could conceivably be sold-off for $3-5 billion to the right buyer in my view. So, we’ll assign a value of $4 billion to GE Capital.

The Sum of GE’s Parts: Much More Valuable than the Whole

GE has been battered over the years, its stock collapsed, and its market cap had melted to levels beyond recognition. Currently GE’s enterprise value is only about $152.5 billion, but the sum of the company’s parts is worth much more.

GE Valuation Breakdown

  • GE Aviation: $122
  • GE Healthcare ($60 billion + $21.4 billion biopharma spinoff): $81.4 billion
  • GE Power: $29 billion
  • GE Oil and Gas: $17 billion
  • GE Transportation: Transportation $11.1 billion
  • GE Renewable Energy: $10 billion
  • GE Capital: $4 billion
  • GE Lighting: $1 billion
  • GE Total value: $275.5 billion
  • GE Enterprise value + unfunded pension liability ($152.5 billion + $29 billion): $181.5 billion
  • GE Value disconnect: $94 billion

An element to point out here is that valuations in some businesses like Oil and Gas are based on relatively depressed valuations. It is possible, likely even that GE’s Oil and Gas assets could be sold at a substantial premium to the current $17 billion valuation.

The value of other businesses like GE Power and Renewable Energy should also rise over time if growth and profitability improve going forward, and they are likely to improve as GE puts more focus on its core businesses.

Focusing on Core Businesses

As GE continues to implement its strategy to selloff none core assets to reduce debt its balance sheet will continue to strengthen and GE should continue to become much leaner and a more efficient company.

Moreover, we’ve seen the company’s major spinoffs (Transportation, biopharma) to be valued at much higher levels than the market gave GE credit for. This trend may continue, and GE’s assets may continue to fetch top dollar from interested parties. This phenomenon will likely continue to unlock substantially more value for shareholders going forward.

Additionally, as GE becomes stronger financially the company will focus more on its core segments, Aviation, Power, Renewable Energy, and parts of other remaining businesses. The result should make for a much more efficient enterprise, unburdened from crippling debt, thus able to produce much higher margins.

The Bottom Line

Currently, the stock appears to be significantly undervalued based on “the sum of its parts assessment”, as GE’s businesses appear to be worth approximately $275.5 billion, while the company’s enterprise value combined with its pension shortfall equates to only about $181.5 billion.

Therefore, GE appears to be substantially undervalued right now. In fact, the company’s EV would need to rise by about $94 billion, or by 51.8% to better reflect the value of GE’s businesses.

This also implies that GE’s market cap would need to appreciate by $94 billion from just $90 billion today, which represents un upside potential of roughly 104%. Thus, GE’s current stock price of about $10.50 could appreciate to roughly $21.50 going forward to better reflect a more realistic value of the company’s businesses.

Disclaimer: This article expresses solely my opinions, is produced for informational purposes only and is not a recommendation to buy or sell any securities. Investing comes with risk to loss of principal. Please consider consulting a professional before putting any capital at risk.

Disclosure: I am/we are long GE. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.

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