At Marcellus, we look for three characteristics in companies before investing – clean promoters (being fair to minority shareholders), prudent capital allocation and sustainable competitive advantages. The last of them is somewhat widely appreciated by investors (though not the easiest to assess) thanks to Buffett’s moat analogy. The former tends to come into focus in bear markets when the management’s shenanigans tend to unravel destroying significant shareholder wealth only to be forgotten in a runaway bull market such as the one we are in. The capital allocation bit though is perhaps the most under rated when it comes to investors’ focus and attention and yet could make a significant difference to eventual outcomes. Jason Zweig writes this piece for the WSJ using GE as a case study just when the world’s best known conglomerate last week decided to spin off its businesses after a couple of miserable decades. As Zweig quotes about the attitude in GE – “It doesn’t matter what we make; it’s how we manage.” GE was betting that “management technology would always save them,”. GE is known to have given the business world a whole host of management techniques. However, what transpired shows no amount of great management can make up for bad capital allocation decisions.
“GE’s corporate culture prided itself on elevating management to a kind of science. The dissolution of the company, however, points to a reality many executives don’t like to admit:
Management matters a lot, but it doesn’t matter as much as you think (especially if you are management).
Economic and business cycles are often more important to a company than what its managers do. And the struggle to undo what their predecessors did can saddle managers with so great a burden that they can’t accomplish what they otherwise might.”
“GE, formed in 1892, managed to benefit first from the stock market’s love of conglomerates, then later by specializing in the central lines of business that would drive its growth for decades: consumer goods, energy and power, financial services, infrastructure and technology (including healthcare), and media.
The late Jack Welch, chief executive from 1981 to 2001, played it both ways, making nearly 1,000 acquisitions and other deals like a conglomerateur—but, like a focused specialist, ensuring that nearly all were in that handful of segments.
GE Capital, the company’s financial-services unit, boomed as interest rates fell for decades. The firm’s relentless wheeling-and-dealing in everything from railcars and residential mortgages to car loans in Thailand gushed profits.
Quarter after quarter, GE’s earnings rose in almost perfectly smooth progression. The result seemed to be almost unparalleled durability.
Like ITT and earlier conglomerates, GE prided itself on its rigorous training for managers. In 1956, it established a “leadership institute” in New York’s Hudson Valley where thousands of executives have immersed themselves in techniques to improve GE’s operations and strategy. Young rising stars rotated from one business to another and across locations world-wide.
By the early 2000s, the company was spending $1 billion a year on training. Not many problems seemed too hard to solve. “We can sit around a table on any set of issues and say ‘what do you think?’ and arrive at a ‘right answer’ on most of the important ones,” then-Chief Executive Jeff Immelt wrote in GE’s 2001 annual report.”
As Zweig shows, this did work for GE and almost for a century.
“GE’s troubles date back at least to 2000-01, when Mr. Welch delayed his retirement to reshape GE by taking over its rival conglomerate, Honeywell International Inc.
The $45 billion deal ultimately fell through. Honeywell remained independent, but GE had gone off course, says Mr. Heymann. The company had focused all its energies on a giant acquisition just as the economy sank into a severe recession. “When you fall behind like that, how do you catch up?” he asks. “You go long and go big.”
GE undertook a series of disastrous acquisitions, among them $14 billion for film and television assets and almost $10 billion for a biosciences firm.
The struggle to integrate some of those lumbering acquisitions, and sluggish growth elsewhere at the company, forced GE Capital to become ultra-aggressive. Management had no choice; smooth earnings growth had to come from somewhere when other parts of the company were faltering. GE Capital “could get higher returns only by shouldering more risk,” my colleagues Tom Gryta and Ted Mann wrote in their book “Lights Out: Pride, Delusion and the Fall of General Electric.”
Low interest rates and a long bull market made those risks seem latent—until the 2008-09 financial crisis hit and they burst to the surface. Suddenly investors were wary of backing an operation that relied too much on debt. GE Capital had to scale back, constricting the cash that had long helped prop up the parent company’s earnings.
GE has always had a robust risk and deal-evaluation process across its businesses, including GE Capital, says the company.
For much of its life, GE had been in the right place at the right time. Now it was in the wrong place at the wrong time—and management’s vaunted vision didn’t enable GE to see around corners. In 2015 the company paid $10 billion for the French power giant Alstom SA . In 2017, it sank $7 billion into a venture with Baker Hughes, an energy-services company. Starting in 2018, oil prices swooned, and GE sold most of its interest in the energy venture in 2019.”
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