We all knew this day was coming, but few of us could have guessed it would have happened this quickly. In an announcement made public on its investor relations page, the management team at General Electric (GE) announced a major acceleration of its strategy to unwind from it its current ownership of Baker Hughes, a GE Company (BHGE). Not only that, the firm also announced plans to deepen its ties with BHGE in an effort to preserve synergies now that they will be moving closer to becoming fully separate from one another. These developments, while disappointing in a sense, should generate value for General Electric and its investors in the near term and push the business closer to the good standing it yearns.
A look at the deal
When the management team at General Electric announced plans to spin off its oil and gas business back in 2016, I was intrigued. As part of the transaction, the firm had agreed to contribute to Baker Hughes $7.4 billion in cash that would be allocated to that company’s shareholders in the form of a special dividend totaling $17.50 per share. In addition, General Electric contributed all of its oil and gas business and, in return, received a 62.5% ownership stake in BHGE. The remaining 37.5% of BHGE was allocated to shareholders of Baker Hughes.
Since this transaction was completed back in 2017, there has been considerable speculation swirling around that management at General Electric might eventually sell off or trade its stock in BHGE in an effort to simplify the conglomerate and, sure enough, they announced plans to do just that when they stated that they would be completing restructuring of the firm. At the time this decision was announced, I wasn’t surprised, but I was disheartened because over the next several years BHGE has the potential to generate significant value for shareholders, especially since oil and gas production continues to rise.
It should be mentioned that originally there would be a delay in the timing of General Electric’s divestiture of BHGE’s shares. Previously, management had agreed not to sell any of its shares in the business (except for what BHGE would buy from it) until July of 2019. That idea has now been shelved as new management, led by CEO Culp, has pushed to reinvent the firm by taking drastic actions.
Now, in its latest press release discussing its ownership of BHGE, General Electric has announced that it will now be allowed to sell off its ownership to the market, plus it will see some of its ownership acquired by BHGE itself. Reports on the matter seem to indicate that the deal will bring in gross proceeds, at current prices, of around $4 billion; but that is, I think, off a bit. You see, as of the end of last year, General Electric did own around 706.98 million shares of BHGE, but in the first three quarters of this year, the firm sold back to BHGE stock valued at $638 million.
Because BHGE continued to reduce its stock outside of what General Electric owned of it, General Electric’s ownership of the firm still remained at about the 62.5% threshold, but the newest trigger now appears to be a 50%+ stake in BHGE. Assuming BHGE does not buy back any of its common stock outside of the units it has already purchased, General Electric should be able to reduce its share count in BHGE by around 136.39 million shares from 687.46 million to just north of 500 million units. Put together, and considering that BHGE’s share price as of the time of this writing is $23.80, this implies total sales proceeds, on a gross basis, of around $3.25 billion. This, combined with management’s decision earlier this year to slash the distribution to close to zero, should help the business in its goal of paying down debt.
There’s more to the deal than just that
Although I would love to see General Electric retain its ownership in BHGE, one part of the deal excited me: the notion that the two companies are positioning themselves to collaborate with one another for the long haul. You see, upon the later of either General Electric’s ownership in BHGE dripping below 50% and July 3rd of 2019, certain agreements to collaborate together will come into force.
First and foremost is that the two companies will form a joint venture in order to provide aeroderivative engine services and product management that will be applicable in the oil and gas space. You see, BHGE benefits from General Electric’s jet engine technology due to overlap between the conglomerate’s Aviation segment and how said technology can be used in the LNG, on-and-offshore production, pipeline, and industrial segments within BHGE’s TPS segment. Another part of this arrangement will involve supply and strategic coordination between the firms, plus they will work together to ensure that current pricing levels for heavy-duty gas turbine technology will remain unchanged. The last piece appears to be continued work regarding General Electric’s digital operations and the conglomerate essentially allowing those to be used by BHGE as well.
With the digital operations aside (that continuation is mostly due to integration and offering reasons), all of these agreements really center on one thing: shared buying power. In the past, whenever I have written that General Electric should divest of all or most of its Power segment, a frequent criticism I’ve heard is that the tie-in between Aviation and Power will harm Aviation’s margins, perhaps to the extent that the high-quality segment would no longer be attractive like it is today. What this agreement with BHGE proves is that, while a loss of synergies can be real during a divestiture, my thesis regarding the firm’s Power segment being a good candidate for the axe still holds. You see, through these joint ventures, General Electric and BHGE will both benefit as if the two firms have remained tied together in the way their assets have been. This also means, then, that this kind of strategy is viable for other parts of the firm moving forward.
General Electric’s deal with BHGE is significant for a number of reasons. First and foremost, it allows the conglomerate to extract cash from a valuable asset sooner than previously planned, and the second is that they are using joint venture arrangements to maintain the same kind of buying power that they would have had if General Electric had either kept all of its own oil and gas assets or if it had at least continued to hold a significant majority of ownership in BHGE for the long haul. All of this is incredibly valuable for shareholders, but perhaps just as important is the prospect that this confirmation and successful deal structure might prove to be a roadmap for shareholders to get the best of both worlds: a monetization and optimization of assets, while maintaining the same kind of market power that helps to grow and hold together the behemoth for so long.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
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.