Editor's note: Longtime Digest readers surely remember Porter predicting the collapse of General Motors, Goldman Sachs, Fannie Mae, and Freddie Mac. Despite thousands of e-mails calling Porter an "anti-American rumor monger," he persisted. All four businesses eventually failed. And Porter earned national acclaim for his insight.
This year, Porter is calling for the bankruptcy of another economic bellwether... General Electric. Below, we've collected Porter's bearish arguments against "The General."
We've become slightly famous for accurately predicting the demise of several iconic America companies, including the original AT&T, GM, Fannie Mae, Freddie Mac, and (though it hasn't happened yet) Continental Airlines. We may have another business to add to the list: General Electric.
You may not realize it, but one of the largest drivers of profits at GE was its triple-A credit rating. The company's excellent credit allowed it to borrow money in the overnight commercial paper market for next to nothing and then use the money to buy all sorts of higher-yielding financial instruments – particularly credit-card receivables.
This worked like magic and was the fuel behind the earnings management GE's CEO Jack Welch became famous for in the 1990s. (GE could always beat its earnings forecast because it would just use its financing arm to monkey around with the numbers until it came out the way it needed them too.)
GE, of course, wasn't the only company using the commercial paper market to fund all kinds of consumer-related borrowing. Tyco copied GE's business model and used its finance arm, known as CIT, to do the same thing. Once Tyco got in trouble for its phony earnings in the early 2000s, it decided to spin off CIT into a separate company. CIT is now poised on the brink of insolvency. And guess which company is following it down, almost tick for tick? Yep, GE. – July 17, 2009
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Oh boy... Here we go again... Longtime readers may recall my satiric "letters from the chairman" of General Motors. I was predicting the obvious: The company would surely go bankrupt. It was truly obvious, too. The company couldn't even afford its interest payments, much less the health care expenses and union wages it had agreed to pay.
As soon as the company's debt was downgraded, its borrowing costs would rise, its access to capital would be constrained, and it would go bankrupt. There was no way out. However, the cold water of reality took a few years to sink in. When I first recommended shorting the stock, it was still trading for nearly $40 per share.
I told you on July 17 we might soon be publishing "letters from the chairman" of another, iconic American company – General Electric. Judging by today's quarterly report, I think the verdict is in...
GE says it "brings good things to life," but in fact, over the decade, it has mostly been about bringing good debt to life. For many, many years, GE relied on its triple-A credit rating to borrow money cheaply in the 30-day commercial paper market and then lend it out at a much higher rate, via things like credit-card receivables. These kinds of financial strategies worked well during the debt-financed boom of 1995-2008. They don't work anymore. In fact, without a government guarantee backing its debts, GE would have already gone bankrupt.
Here are the core facts: GE owes its creditors $518 billion. That is not a misprint. It owns tangible net assets of only $17 billion. Thus, on a tangible basis, it is currently leveraged by more than 30-to-1. That's unheard of for a major industrial company. A 3.3% decline in the value of its asset base would wipe out all of its tangible equity. But here's the real problem.
Last quarter, the company produced $2 million in operating income. Again, that's not a misprint. On $17 billion in assets, the company earned only $2 million. So... what will happen to GE if (or when) the free market sets its borrowing costs?
GE spent $4.3 billion on interest in the last quarter – thanks to the government's guarantee. So on an annualized basis, GE is now spending roughly $17 billion to service its $500 billion in debt. That's an annualized interest rate of 3.3%. This is not sustainable. Sooner or later, GE is going to have to pay a market interest rate.
Currently, the yield on high-yield corporate debt is around 10%. GE is now rated two slots above "junk" by Egan Jones, the only reliable ratings agency. So let's assume GE could still qualify as an investment-grade credit – which is a generous assumption. GE would pay something like 8% on its debt in a free market.
That would cost more than $41 billion a year. Last year, GE earned $45 billion before interest and taxes – in total. It spent $33 billion of these profits on capital expenditures and necessary investments – expenses required to keep the business going. That left it with about $12 billion in what we call "owner earnings." That's not nearly enough money to pay the interest on its debts – whether they're backed by the government or not.
Imagine if the interest on your mortgage consumed 91% of your pre-tax earnings. Could you possibly avoid bankruptcy? No way, right? But... there's a big difference between owing the bank a few hundred grand and owing folks more than $500 billion.
Last year, even though GE couldn't actually afford its debts and required a government bailout, it spent $12.4 billion on dividends for common stock holders. That's 20% more than it spent on dividends in 2006! (GE finally cut its dividend by 70% in February. It will be eliminated soon, I promise. Its creditors will finally wake up and demand it.)
Today the stock market values GE at $171 billion. In fact, the common stock – every single share – is not worth one penny. Plan accordingly. – October 16, 2009