Financial Times, February 25, 2007 article and commentary

“When I took the job GE’s price/earnings ratio was the same as Google is at present. But today our company makes twice as much [profit] as it did then”.

It is not often that a consummate schmoozer like Jeffrey Immelt, General Electric’s chairman and chief executive, allows annoyance to creep into his affable public persona.

But when asked about the performance of GE’s shares during his six-year tenure, Mr Immelt could not hide behind chief executives’ usual platitudes on not caring about the stock price.

His disappointment is shared by most investors in the US conglomerate, but for Mr Immelt the issue is personal.

As long as the share price underwhelms, it will be tough for the 50-year-old executive to come out of the overbearing shadow of his predecessor Jack Welch.

Mr Welch’s own brand of ruthless cost and employee cutting, daring acquisitions and self-promotion contributed to a 38-fold rise in GE’s shares during his two decades at the helm.

Since Mr Immelt got the top job the shares have failed to respond to his strategy of refocusing GE on high-growth industries in order to increase profits and revenues.

“Jack made GE into a financial institution with a manufacturing arm and Jeff is taking it back to the core,” says William Rothschild, a former GE corporate strategist and the author of The Secret to GE’s Success. “But he has to show he has picked the right shots. He is still earning his stripes.”

Investors’ willingness to give Mr Immelt time – nobody on Wall Street has yet called for his head – is partly driven by their respect for a personality and management style that are near-polar opposites of the “imperial CEO” qualities epitomised by Mr Welch.

Aside from his ability to charm shareholders with a mixture of hard facts and personable manners, Mr Immelt has won plaudits for his efforts to bring one of America’s oldest conglomerates into a new era.

While Mr Welch strengthened GE’s focus on finance, defence and other heavy industrial sectors, Mr Immelt launched GE’s “ecoimagination” drive, a commitment to invest more in, and derive more revenues from, greener technologies.

The initiative has been praised by many of the activists who used to lambast GE for its polluting activities and put the company at the forefront of an American business community that remains ambivalent about environmental policies.

Similarly, Mr Immelt has not shied away from the most controversial corporate governance issue: executive compensation.

In stark contrast to Mr Welch, who famously asked GE to pay for Wimbledon tickets and laundry bills after he stepped down, Mr Immelt told the FT in November that US corporate leaders should do away with employment contracts and exercise restraint.

A nice-guy image and an enlightened long-term vision have stood Mr Immelt in good stead so far. But in today’s harsh climate, they will not be enough to ensure success unless they are complemented by a share price that is much closer to Google’s current heights.

Could 2007 be the “break-out year” for General Electric?

The question, usually directed at up-and-coming sport stars, may seem inappropriate for a 128-year-old conglomerate that is the world’s second-largest company by market capitalisation.

But despite having long commanded a place in the pantheon of world’s most admired companies, the US industrial group enters the year having to prove its worth to capital markets.

GE’s shares have underperformed the S&P 500 index by more than 20 per cent in the past six years, missing out on a rally that has propelled the market to new highs.

With investors growing increasingly restless at such mediocre showing, the challenge facing the company is disarmingly simple: to make a convincing case that its strategy to drive profit growth across its sprawling portfolio warrants a higher stock market valuation.

The task looks all the more daunting because the shares’ underperformance has come while GE met demanding financial targets, expanded in fast-growing sectors such as infrastructure, and increased its exposure to booming emerging markets.

“Sometimes you have to wonder what investors want GE to do to command a re-rating,” says a long-time observer of the company, noting that not a single Wall Street analyst is currently advising investors to sell GE’s stock.

The market’s scepticism over the future is summarised in a phrase often repeated with concern by GE executives: “quality of earnings”.

Investors fear that GE will not be able to meet its target of 8-10 per cent annual profit growth without the help of ephemeral factors such as a low tax rate and the favour-able conditions enjoyed by its financial arm in recent times.

The picture has been further clouded by the fact that, since Jeffrey Immelt took over as chairman and chief executive from Jack Welch in 2001, GE’s hulking mass of businesses has been in perpetual motion.

In an effort to move away from low-margin industries such as reinsurance and add to faster-growing businesses such as healthcare, Mr Immelt embarked on a $70bn deal spree – the last $15bn of which came in two heady weeks last month.

“One of the big criticisms of GE is that strong organic growth hasn’t translated into significant margin expansion but that will come once businesses get scale,” says Nicole Parent, an analyst at Credit Suisse. “It’s the cost of diversifying businesses and reshaping the portfolio that is depressing margins.”

GE insiders admit the radical reshuffling of the portfolio has been disruptive but argue that it was crucial to ensure the company did not become a prisoner of low-growth businesses.

“When you see us do. . . $15bn in two weeks, sometimes you say: ‘Is he crazy?’” Mr Immelt told analysts recently. “But this is all part of a five-year disciplined, diligent, long-term focus on the company.”

Mr Immelt’s lieutenants say that the transformation is almost over. After the sale of the plastics business – expected this year – GE claims that almost all of its businesses will be in high-margin, high-growth industries where the company has a large market share. By contrast, six years ago, more than a third of the portfolio was in businesses that could not meet GE’s own growth targets.

But the portfolio overhaul may not be enough to kick start the share price, especially if it is overshadowed by negative short-term news. In this respect, last month’s revelation that a dispute with US regulators had forced GE to restate earnings for the second time in 18 months did little to help the company’s cause.

An even more recent court decision that forced GE to take a $115m charge to settle a decade-long asbestos litigation was also unwelcome news.

Keith Sherin, chief financial officer, acknowledges that the company should do more to address investors’ short-term concerns but maintains that the big picture is a positive one.

“Jeff and I can do a better job of explaining our performance quarter by quarter. Investors don’t like it when the composition of earnings is different from what they expect,” he told the Financial Times.

“[But] I think we are doing a good job in communicating strategy.”

But unless good strategy translates into a good share price, investors will start to think the unthinkable: whether the conglomerate needs to shed a major division – such as its troubled NBC entertainment unit or its appliances business – to regain its appeal.

The stakes are such that if 2007 does not prove a break-out year, there is a risk that capital markets may turn one of the following ones into GE’s break-up years.