GE & Investing in Environmental Technology

GE & Investing in Environmental Technology: “Green is Green”
A Daily Reckoning White Paper Report
By Justice Litle

ExxonMobil is America’s largest conventional energy company. But General Electric is fast becoming America’s largest non-conventional energy company. Strange as it may seem, thesetwo corporate giants (GE: NYSE and XOM: NYSE) are on opposite sides of the same coin. As super-major oil companies like Exxon struggle to replace their oil reserves at a reasonable cost, the demand for alternative energy and clean technology will only grow stronger. Furthermore, due to the growing anxiety about global air quality, clean energy sources seem certain to steal market share from fossil fuels.

GE & Investing in Environmental Technology: “Ecomagination”

GE is positioning itself to take full advantage of this shift. General Electric CEO Jeffrey Immelt is moving the company out of the financial engineering business and embracing the environmental technology business. Immelt’s new catchphrase, “Green is green,” captures the spirit of GE’s aggressive push into clean technology, alternative energy and eco-friendly infrastructure.

The all-encompassing tag line for GE’s new strategy is “ecomagination,” but the green reference (as in the color of money) is perhaps more descriptive. This is not just about doing well by doing good; the shift is rooted in hard-nosed business sense. There is money to be made in the environmental space: Getting out in front means leaving rivals behind, and all 17 of the various initiatives have been deemed commercially viable independent of their “green” angle.

Is the change meaningful, you ask, or is it just smoke and mirrors? The question is a fair one. Many industrial companies have tried casting themselves as green-friendly over the years, in a cynical effort to improve their public image and generate positive press. But in General Electric’s case, this is no mere PR posturing. Words are being backed up by visible action, coherent long-term strategy, and some very big bets. In regard to the new “green is green” direction, The Economist observes that “Mr. Immelt is embarking on the most ambitious and risky strategy for GE since the 1980s,” when Immelt’s predecessor Jack Welch earned the nickname “Neutron Jack” for laying off 100,000 workers and rebuilding the company from theground up.

GE & Investing in Environmental Technology: Fewer than the Vatican

GE has a long history of creative destruction and strategic rebirth. Based on the company’s history, it is practically an obligation for each new leader to dismantle and recast the vision that came before him. Jerry Useem of FORTUNE expounds on this venerable tradition:

“During its 125-year existence, the General Electric Co. has glowed as steadily as Edison’s lamp – even while continually overturning its own legacy. The only companyremaining from the Dow Jones index of 1896, GE has had fewer leaders since then – eight – than the Vatican has had Popes. Each man stepped into the shoes of a predecessor who, in most cases, was considered the leading industrialist of his day. Each abandoned the approach of his predecessor. And each chose a successor who would change the company’s course yet again – a remarkable record of continuity achieved through periodic revolution. ‘What GE seems to have a genius for,’ says Jim Collins, a business researcher and author of Good to Great, ‘ispicking the right person for the right time for more than 100 years.'”

GE & Investing in Environmental Technology: Jack Welsh

Has GE once again picked the right man in Jeff Immelt? It would seem so. While Jack Welch was perhaps the most celebrated CEO in history – deemed “Manager of the Century” and “Princess Diana of the business press” – his track record is not without flaws. Under Welch’s reign, GE developed a reputation for managing earnings, a process in which detailed estimates and aggressive growth targets were met like clockwork quarter after quarter. Throughout the’90s, GE’s can’t-miss performance was the financial equivalent of an Olympic archer hitting dozens of bull’s-eyes in a row. Such perfection was clearly artificial, i.e., too good to be true, but Wall Street loved it. To explain the silky smooth performance, there was talk of “long cycle” and “short cycle” businesses blending into perfect synch with each other, meant to convey the image of GE as an analyst’s perfect dream.

After the dot-com debacle and telecom implosion, artificial precision went out of style. Spectacular flameouts such as Enron soured the public on shiny front ends hitched to murky back ends. It was during this hostile time when questions about Welch’s legacy arose. GE’s stock price went from a high of $60 in August 2000 to a nadir of roughly $22 in 2002. Part of that decline could be assigned to the broad market, but there were also growing accusations offinancial hanky-panky.

The company’s powerful financial arm, GE Capital, was looking too much like an opaque hedge fund for some investors’ taste, and Welch’s aggressive insurance acquisitions were smelling more and more like an earnings-smoothing tool. (Insurance companies are ideal for managing earnings, because it is so easy to overstate profits by underestimating future claims.) Bill Gross of PIMCO Asset Management, an influential money manager known as “The Bond King,” rubbed more salt in GE’s wounds by making public accusations of dishonesty and refusing to buy the company’s commercial paper.

GE & Investing in Environmental Technology: Shock and Disgust

There was more legacy tarnishing yet to come. GE investors looked on in shock and disgust as the details of Welch’s lavish retirement package were revealed by the courts. His nonfinancial “perks” were estimated to be worth more than $2 million per year, in the form of private jets, corporate apartments, financial services and so on. Welch voluntarily rescinded the perks to spare his company from further grief. Fittingly, the legendary manager and erstwhile earnings smoother ultimately decided shuffleboard was not for him; he wound up at a private equity firm, Clayton, Dubilier & Rice.

Welch’s track record of shareholder wealth creation surely counts as one of the greatest business achievements of all time, but the company he handed over was not in the best ofsorts when he left. The new CEO inherited all the headaches. As if that were not enough, Immelt happened to take the reins three days before Sept. 11, 2001.

An early point of order for Immelt was paring back the insurance side of things, an area that Welch had aggressively built up through acquisitions. It has taken a few years to get rid of the undesirable bits, with the biggest chunk – a property and casualty reinsurance outfit– bought by Swiss Re in November 2005. While a few small pieces remain (slated to be sold), Immelt was visibly pleased to be mostly out of insurance, a business he described as “a real burden” for GE.

In further effort to restore GE’s reputation, Immelt jettisoned the “long cycle/short cycle” jargon and the high-precision earnings targets of the Welch era, choosing to emphasize longer-term strategy instead. As a key part of that effort, Immelt embarked on an ambitious plan to recastGE as one of the world’s leading environmental technology companies…

GE & Investing in Environmental Technology: The “Green” Transformation

In 2002, General Electric’s newly minted CEO, JeffreyImmelt, snapped up Enron Wind for the bargain-basementprice of $300 million (give or take; estimates vary). Thusbegan GE’s “green is green” transformation. Since then,GE’s wind division revenues have quadrupled, from $500million to over $2 billion. The rapid growth of the winddivision illustrates GE’s commitment to emerging markets aswell as alternative energy: Two of the firm’s fourtechnology R&D centers are located in Bangalore andShanghai (the other two are in Munich, Germany, andNiskayuna, N.Y.).

“GE has ramped up development of the towering 92-tonturbines by seeking expertise from all four labs,” FortuneMagazine reports. “Chinese researchers design themicroprocessors that control the pitch of the blade.Mechanical engineers in Bangalore devise mathematicalmodels to maximize the efficiency of materials in theturbine. Power-systems experts in Niskayuna (which hasresearchers from 55 countries) do design work. Andtechnicians in Munich have created a ‘smart’ turbine thatcan calculate wind speeds and signal sensors in otherturbines to pitch their blades to produce maximumelectricity.”

Sharing the wealth is good business and good politics:Goldman Sachs estimates that more than half of GE’s revenuegrowth could come from India, China and the like over thenext decade. (South America could also play a significantrole.) Eco-friendly and alternative energy infrastructurewill certainly be a major portion of the bottom line.

Next to civil unrest, pollution and water issues are thetwo biggest problems that China and India face. Becausepollution and water issues are prime causes of agitation,they sit right at the top of the “urgent concern” list, nomatter how you slice it. The developing world’s pollutionproblem is also fast becoming the rich world’s problem; forexample, the U.S. Environmental Protection Agency reportsthat a third of California’s air pollution could eventuallybe traceable to China. Bad news for the planet, good newsfor firms seeking to solve the planet’s problems on anindustrial scale.

GE & Investing in Environmental Technology: Strict Environmental Regulations

General Electric has another motive to get ahead of thecurve: the inevitable squeeze of tighter environmentalregulations. By committing to an aggressive greenhouse-gasemissions reduction program, GE simultaneously putspressure on its rivals, prepares in advance for the arrivalof a strict regulatory environment, and establishes its“green” credentials early in the game. The experience andreputation gains of such an ambitious program could alsolead to future business opportunities, like environmentaltechnology consulting and energy infrastructuredevelopment. As an added bonus, global warming concernsgive a boost to GE’s nuclear power activities. As thedeveloping world blooms and the rich world places a higherpremium on clean fuel alternatives, GE’s opportunities forrapid growth will bloom alongside.

Now we come back to the concepts of variant perception andstructural change that I mentioned in yesterday’s column.The payoff for Immelt’s strategic shift is still a ways offin the future; though things got started with the purchaseof Enron Wind back in 2002, most of the ecomaginationinitiative is still young. Wall Street has not yet paidheed to this bold change in course. The focus is still onGeneral Electric as an industrial and financialconglomerate, not as an environmental powerhouse.

GE stock recently saw its largest decline in nearly threeyears on news of an earnings shortfall. $2.9 billion wasplugged into the reinsurance unit to shore up reservesbefore the Swiss Re handoff – a tacit admission thatfinancial claims may indeed have been understated in pastyears – and analysts were disappointed by slowing revenuesand lower-than-expected profits in plastics and real estatesales. Revenue weakness and disappointing growth were theprimary areas of concern.

With the energy and metals markets getting so muchattention from investors and speculators, it is rare thesedays for a new Outstanding Investments recommendation to beavailable at any type of short-term discount. GeneralElectric may be a rare instance of this. As a long-terminvestment, GE is attractive for two reasons:

First, Immeltis putting GE’s financial engineering past behind it,positioning the company for strategic growth in emergingmarkets and eventual dominance in alternative energy andgreen infrastructure.

Second, the general consensus stillviews GE as “The House That Jack Built” and has not yetrecognized the long-term wisdom behind Immelt’s creativedestruction. For the patient investor, the ultimate payoffshould come in the form of both accelerated earnings growthand a “perception premium” that kicks in when Wall Streetsees the beauty of  “green is green.”

Justice Litle
For The Rude Awakening

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