GE's Jeffrey Immelt: All Boxed In

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THE MOST DARING MOVE

When it comes to transforming his financial operations, Immelt may need to cut GE Capital substantially if he wants the stock to trade at the multiple of an industrial company, analysts say. The most daring move would be to separate the financial and industrial businesses. While that's not impossible, it's highly unlikely. Even if investors were lining up to buy all or part of GE Capital, which they're not, Immelt is unlikely to float the finance unit for several reasons. The stable industrial businesses enable GE Capital to tap its parent's still-enviable credit rating and help support the financial unit's $466 billion in debt.

A split would require GE to inject as much as $32 billion in additional funds to back up the obligations of GE Capital, estimates Richard Hofmann at CreditSights. It would force the finance arm to renegotiate credit lines with some 65 banks worldwide and make its borrowing costs escalate. The credit-rating agencies have given GE a AA+ rating—the second-highest of the 20 grade levels that Fitch and Standard & Poor's can award. GE Capital alone would get a rating no higher than A, forcing it to post up to $15 billion in extra collateral and capital, Hofmann notes, to keep borrowing costs at the current level. "It would have an exorbitant amount of cost associated with it," notes Sterne Agee analyst Nicholas P. Heymann. An independent GE Capital could potentially turn to the government for help as so many other finance companies have in recent months. But bailout fatigue in Washington means a standalone unit might not receive taxpayer support.

Instead, Immelt is committed to GE Capital even if it's likely to drag down earnings through at least 2010 and may never turbocharge them again. Still, the GE chief has reason to keep a stake in the world of finance. GE Capital's businesses could grab market share from worse-off rivals when economies improve. CFO Keith Sherin has said that GE will not need to raise external capital this year, even if economic conditions worsen, adding that the finance arm should make a profit in 2009. Despite repeated assurances from GE that its obligations are under control, though, some suspect the worst is yet to come. Although GE exited the U.S. subprime mortgage business a few years ago, it could see further dips in areas like commercial real estate or leasing as ripple effects of the recession take hold.

While Immelt tries to move away from certain financial businesses, he could look to build up the industrial side. The company's massive cash pile would make it easy to pick up some industrial gems. But the CEO needs to conserve cash to protect against losses in GE Capital. "GE industrial, which is extremely well placed globally, can't augment their position until these finance markets improve," says TIAA-CREF analyst Bob Spremulli. "They can still make small acquisitions, but if something bigger came along that was an opportunity, they would not be able to do that right now." Instead, Immelt is running the businesses as efficiently as possible, cutting $5 billion in costs companywide while beefing up research and investing in areas such as green energy. A GE spokesman says Immelt's strategy is to make small acquisitions and grow them.

One blow: the loss of GE's prized AAA credit rating, the first downgrade in five decades. Although the rating dropped only a notch (or two, in the case of Moody's), Immelt can't afford to let it fall significantly further. Right now the ratings are stable, and the industrial businesses are expected to make enough cash to keep things that way. If GE doesn't get the $2 billion in discretionary cash flow Standard & Poor's (MHP) expects the businesses to produce for 2009, the ratings agency says it could revisit its outlook. Any moves to use cash for acquisitions beyond small-scale targets would not be welcomed by the agencies or shareholders. Says Robert Schulz, a managing director for Standard & Poor's: "We would expect them to restrain actions on the acquisition front."