Short-Seller Attack On GE Shows Stock Is Still Vulnerable, And Risky
Investing.com | Aug 19, 2019 07:11AM ET
It doesn’t take much to shatter investor confidence in General Electric Company (NYSE:GE). All you need is to add up the problems this embattled industrial conglomerate is facing, publish them in a report, and trigger a crash in its shares.
That’s what Harry Markopolos, the corporate whistleblower who gained fame a decade ago for exposing Bernie Madoff ’s Ponzi scheme, did last week. He issued a damning report Thursday claiming that GE is hiding problems “more serious than either the Enron or WorldCom accounting frauds.”
Investors dumped GE shares after the report, which plunged 11% on Thursday, posting the steepest decline since 2008.
But what spooked investors most about the report was its claim that the worst is not over for GE. According to Markopolos, GE would need to raise its insurance reserves immediately by $18.5 billion in cash — plus an additional non-cash charge of $10.5 billion when new accounting rules take effect. He also claimed that GE was hiding a loss of more than $9 billion on its holdings in Baker Hughes (NYSE:BHGE).
GE’s Chief Executive Larry Culp, who was appointed last year to turn around the company, dubbed the report “market manipulation” aimed at benefiting a hedge fund which is shorting GE shares and for which Markopolos is working.
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Wall Street analysts put up strong resistance against the Markopolos attack, terming the report over-exaggeration of problems which were already known. Citi analyst Andrew Kaplowitz said there were “sufficient shortcomings” in the report itself, and that he continued to believe in CEO Larry Culp’s ability to improve the company.
Another vote of confidence in Culp’s ability to turnaround GE came from a report in Bloomberg that said the two large U.S. institutional investors have been adding GE shares in their portfolios since the CEO took over a year ago.
Fidelity Investments and T. Rowe Price Group Inc. have bulked up on GE stock since Culp was named in October 2018. While neither fund company had much of a stake in GE before he took the helm, the two now rank as its second- and fourth-largest institutional shareholders, respectively, according to regulatory data compiled by Bloomberg.
These positive reports helped GE shares recover most of the losses in the week. The stock rose 10% on Friday to $8.79 a share. A rout in 2017 and 2018 had wiped out more than $200 billion in GE’s market value after demand for the company’s industrial products plunged and cash reserves dwindled.
After the past week’s setback and then recovery, we aren’t hopeful about GE’s reversal in fortunes in the short-to-medium term. The company is in the middle of a massive restructuring: the revival won't be quick, and investors will need to have a lot of patience before they see Culp’s efforts start to bear fruit.
In the first phase, the conglomerate must show that its core industrial businesses can remain consistently cash positive. That goal still seems a distant dream, given the company’s huge exposure to the general health of the economy, which is worsening globally.
The future of the company's aviation group, its largest by revenue, is clouded due to Boeing’s grounding of 737 MAX jetliner. GE is the sole engine provider to Boeing (NYSE:BA) through its joint venture with France’s Safran (PA:SAF) SA.
GE has said it expects adjusted industrial free cash flow for 2019 ranging from negative $1 billion to positive $1 billion, a big range that can go either way.
A further broader message in the Markopolos report is that the deficiencies he pointed out, though not new, are still there and need a resolution. The company is under investigation by the Securities and Exchange Commission (SEC) and Justice Department for potential accounting issues related to its insurance holdings and its power division. The outcome of these probes can complicate GE’s recovery.
Bottom Line
GE’s restructuring remains very much a work-in-progress with little evidence of a turnaround taking hold. That means its stock will continue to trade at close to rock-bottom levels. But for high-risk takers this might be a good time to take a position. Before doing that, though, investors must be firm believers in Culp's leadership. We maintain our neutral position on this stock at this point.
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