The Final Domino of the Last Crisis Falls
The final domino of the last crisis falls... The biggest fraud of all, $450 billion in losses... The perils of high-debt, low-return investments...
America has suffered an enormous tragedy. A criminal tragedy... and virtually no one knows what really happened...
At least not yet. But they are about to find out.
This is the biggest financial story of the past 30 years. Bigger than Enron. Bigger than Fannie Mae and Freddie Mac. Bigger than Lehman Brothers. This is a tragedy that has cost investors and American consumers hundreds of billions of dollars, maybe even a trillion.
It's not over yet.
And most of the story is still a secret.
This tragedy was caused, in part, by paper money, financial speculation, and excessive greed. But it was enabled and created by the unholy partnership between big government and big media. That's why nobody gave a warning. And it's why, even now, nobody seems to realize how serious these problems are... or how big the crimes were that led to them.
Well... almost no one gave a warning.
Stansberry Research has consistently warned investors about this company and its inevitable collapse since 2002...
That was back in the early 2000s when this company was the single largest publicly traded company in America, the single biggest component of the S&P 500 Index, and probably the most widely held investment in America.
No one believed us.
What follows in today's Friday Digest is the largely secret story of the massive fraud that occurred at General Electric (GE) from the mid-1990s until the company's collapse in 2009. It's the story of how the government (and GE's media assets) covered up this fraud for almost 20 years. And it's the story of how these lies (and the debts that fueled them) have decimated American investors and gutted our country's pension funds.
GE, because of its size, was the most heavily purchased stock in every S&P index fund for years and years – at the peak of its stock price. Since its pinnacle in 2000 – a peak that was achieved with massive fraud – GE's stock has fallen 76% and led to $450 billion in losses for investors.
Even the most sophisticated investors in the world have been taken in by this fraud. Nelson Peltz, whose Trian Partners investment group manages billions
Please... take a minute and learn what really happened to GE...
More GEs are out there in America's equity markets. But you'll never learn about them from the media or the government.
I'll show you how to find them, below.
Just a reminder: There's no such thing as teaching, only learning. If you really want to understand what happened to GE and why it was inevitable and obvious... then you've got to learn how management teams can defraud investors and the telltale signs that always give them away.
Outside of GE's executive suite virtually no one understands what went wrong at the company...
The government and regulators have never told. And the media never said a word... or even asked the first question.
The problems began under GE's "legendary" CEO, Jack Welch. Rather than wonder how GE could always beat its quarterly earnings estimates by exactly one penny, the financial media turned him into a star. In his books, Welch explained exactly how GE used its various subsidiaries to sell assets to generate "earnings" and make their numbers, quarter after quarter.
That is, of course, exactly what Enron did. But GE had a lot more assets to juggle, and so it was able to keep the game going for a long, long time. It also had a lot more power in Washington, D.C... And it owned NBC, which meant it could largely control how the financial media (CNBC) characterized its strategy. Yours truly has been banned from CNBC for 15 years. It's no wonder why.
Way back in 2002, I began to warn investors about the huge, obvious problems with the balance sheet of General Electric and the ethics of its managers. Despite the collapse at Enron, nobody seemed to notice that GE was doing the exact same things. Rather than earning its "profits" through its large industrial businesses, GE was engaged in a giant financial gamble. It was mortgaging all of its industrial assets and using its AAA credit rating to access immense amounts of capital, eventually leveraging itself more than 30-to-1.
And what was it buying with all of this borrowed money?
That was the most shocking part.
Since 1992, GE has been a net borrower. How could America's best company be a net borrower for ten years? Well, look at what the company is doing to make money, and it's easy to figure out. About 50% of the company's total debt is in the form of short-term paper – the 90-day commercial paper market it can access thanks to a AAA rating by Moody's.
The company uses this debt, which carries a low interest rate, to finance credit cards, which carry a high interest rate. If you walk into JC Penney or Macy's and take out a credit card, chances are pretty good that you're on the hook to GE. In total, GE has spent $43 billion on buying such receivables in the last three years alone.
And here's the scary part. Fifteen times since 1997, the company has sold a large batch of these securities (at a loss?) less than three weeks before the end of a quarter. That's how the company is able to match its earnings forecasts so precisely.
Meanwhile, GE's debts have mounted. Today, its balance sheet stands precariously at four times debt to equity. Why take such risks? Because these debt-laden acquisitions accounted for 40% of GE's revenue growth from 1985 to 2000, according to Merrill Lynch analyst Jeanne Terrile (who retired immediately after publishing her study of GE's use of debt). – Stansberry Research November 26, 2002
As you know, nobody paid attention to what was really happening at GE...
The company wasn't a well-run industrial giant. It was a company with huge, poorly performing assets... one that was borrowing billions and billions of dollars every year to manufacture "earnings" via gambles in the financial markets and using aggressive accounting maneuvers to hide the real, risky nature of its profits. And to keep the game going, it had to borrow more and more money every year.
By November 2009, the house of cards had fallen apart as the "tide" came out of the financial markets with the mortgage crisis. But even so, nobody seemed to realize how big the problems at GE had become. As I wrote in my Investment Advisory that month...
Since 2002 [when I first warned about the company], General Electric has produced $140 billion in free cash flow – real profits. It has borrowed an additional $178 billion (not including unfunded pension liabilities). Thus, it has continued to be a net debtor. GE now owes its bondholders $435 billion. It has another $248 billion in current obligations. That is not a misprint: GE owes its creditors $683 billion.
Today, GE owns net tangible assets of only about $17 billion. Thus on a tangible basis, GE is currently leveraged by more than 30-to-1. That's roughly the same leverage employed by Lehman, Bear Stearns, and Merrill Lynch. A 3.3% decline in the value of GE's asset base would wipe out all of its tangible equity.
As I wrote then, GE showed "all of the signs of an unavoidable bankruptcy."
It's built a long history of net debt accumulation. It carries huge amounts of short-term debt. (Specifically, before the end of 2012, GE must repay or refinance $240 billion.) It has a tremendous pile of average to below-average assets, many purchased at inflated prices. GE's long-term asset base grew $200 billion (or 30%) between 2003 and 2008. GE is now engaged in a desperate effort to sell assets: 145 different divestitures, totaling at least $100 billion.
Finally, there's the "kiss of death." We know GE's funding costs on its debts are about to soar. It has lost its triple-A rating and will most likely continue to be downgraded.
We were wrong, of course, about that 'kiss of death'...
The government did a lot more than just guarantee all of GE's debts until 2012. The Fed manipulated interest rates lower, reducing GE's funding costs virtually every year between 2012 and 2017. Now, of course, interest rates are finally rising. And that kiss of death we warned you about has finally arrived.
Wall Street has suddenly realized that GE doesn't produce enough cash to service its debts. The company will soon be forced to issue new shares, at much lower prices, simply to meet its obligations.
We explained way back in 2011 that issuing new equity was inevitable. It wasn't just the company's poor financial position. It was the deliberate mismanagement of the business.
GE produced a total of roughly $68 billion in free cash flow in 2010. It chose to spend almost $50 billion of that in debt repayment, leaving roughly $18 billion. Then it paid a $5 billion dividend and spent $4 billion on share buybacks...
Why would a company that's so far in the hole spend almost $10 billion on capital distributions to shareholders?
Right now, if GE put 100% of its cash from operations into debt repayment every year and its earnings stayed at 2010 levels, it would take 16 years to pay off its debts. It would take at least a decade to pay down its debts to a more manageable level. No question, if GE were being managed prudently, that's what it would do.
GE holds about $40 billion in tangible equity. I believe its [financial losses] are likely to be at least this large over the next five years, which means, at some point soon, GE could be going to the market for new equity. If that happens, the company's share price will probably fall in half.
Why run the company this way? Because the managers know GE is too big to fail. They're not running the company as though they actually own it. They're simply running it to maximize their own compensation. If it fails, it fails. The stockholders will get wiped out, and the government will bail out the creditors. In the meantime, GE's managers are trying to get rich. They want to keep the company as leveraged as possible. They don't want to repay debts. They want to maximize the company's ability to borrow. – Stansberry's Investment Advisory, June 2011
The company's horrendous management continued...
Despite the company's enormous financial problems, over the last 10 years, GE's management team spent $56 billion buying back stock and another $86 billion paying dividends.
More than $50 billion of this buyback/dividend issuance occurred in 2014, 2015, and 2016... with more than $30 billion occurring in 2016, the last year of Jeffrey Immelt's reign as Welch's successor as chief executive. Clearly, the company couldn't afford these distributions and should have used the capital to shore up its balance sheet and pay down debt.
But buying stock and paying dividends propped up the price of the stock in the short-term and undoubtedly contributed to the value of Immelt's (and other managers') stock options. At the time of his retirement, the value of Immelt's options was estimated at more than $200 million.
What did shareholders get in return?
GE is the worst-performing stock in the Dow Jones Industrial Average over the last five years. It is one of only two Dow companies with a negative total return in the period. The other is IBM (IBM).
Immelt's other legacy?
GE still holds billions in financial assets of dubious quality, financed by more than $130 billion in debt. Meanwhile, the company's cash return on assets is only 1%. In other words, as interest rates rise, the company is going to have a hard time financing its portfolio of financial assets.
But that's not the big problem. The big problem is what lies at the center of this company, hidden in those financial assets, is an enormous fraud.
The latest example is a $6.2 billion charge in its insurance unit... that will require another $15 billion in reserves over the next seven years. The charge and the demand for new reserves came from a Kansas Insurance Department investigation.
State insurance regulators require companies to post collateral to prove that they can fulfill their promises to pay. Essentially, Kansas called GE out for having preposterously little capital… and required it post another $15 billion in
Are you kidding me? It wasn't the U.S. Securities and Exchange Commission. It wasn't the New York Times. It wasn't the Washington Post. It was those famous "gumshoes" in Kansas who discovered the fraud. And so, what was formerly the largest company in America –
What else is hidden in those billions of dollars of financial assets the company holds?
And what are they really worth? Investors are going to want to know. And sooner or later, the government will have to come off the bench and start to do its job. GE can't hide the truth forever. Kansas won't save investors.
What should you learn from this?
First, avoid companies with weak assets that can't earn reasonable returns on their assets. Second, beware of companies that have weak balance sheets, but management teams that continue to leverage the company by paying out more capital (in buybacks and dividends) than it can really afford. And finally, make sure you include unfunded pension liabilities in your calculations of long-term debts.
For example, look at American Airlines (AAL)...
Over the past five years, it has bought back $9 billion in stock and paid another $1 billion in dividends. Meanwhile, total debt at the company grew by even more – $16 billion. And what about profits? Well, free cash flow was negative $6 billion. And there's a huge pension liability. American Airlines isn't being run to produce wealth over the long-term. It's being managed to cash out the insiders and end up back in bankruptcy.
Or consider Ford Motor (F)...
The carmaker has $150 billion in debt and a $16 billion pension liability.
It earned 7% (in cash) on its assets last year, at the end of the biggest boom in car sales ever. Much of this demand, however, was financed by subprime auto lending, which will go away as interest rates rise.
Telecom AT&T (T) earns less than 10% a year in cash on its asset base, holds more than $160 billion in debt, and has an outstanding pension liability of more than $30 billion.
Bottom line: Never own a company when its managers run the company's balance sheet in a way that you'd never organize your own company. And never rely on the mainstream media to tell you the truth about America's biggest companies.
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In the mailbag... a few things I've written over the years have generated as much animosity as my position on GE. Just like when I predicted General Motors' (GM) collapse back in 2006/2007, a lot of people believed something was wrong or even "anti-American" about offering warnings to the public about malfeasance in corporate America.
Let me be crystal clear about something: I love our country, but I'm frequently dismayed and horrified at the people who control it. The things GE's senior management have done to our country – to our investors, our capital markets, and their employees – are criminal. And there's absolutely nothing wrong with doing everything I can to protect my subscribers (and anyone else who will listen).
Did GE go bankrupt in 2012? No, it didn't. And if you think that means my warnings and my predictions were wrong, that's fine. Technically, you're correct – it didn't happen in 2012.
In any case, there's no question that GE is going to have to raise more equity capital under duress, just as I said it would. That outcome has
In regard to my track record, GE will always count against me because our timing was off. But what's far more important to me is that, for the last 20 years, GE has been wasting capital and causing investors losses – huge losses, the biggest losses in the history of America's capital markets. I described exactly why those losses were inevitable, as early as 2002. I kept thousands of investors, maybe hundreds of thousands of investors, away from the company. I'm proud of that work. And I'm grateful that you, through your subscription, allow me to do this kind of work.
Finally, if you avoided GE because of our work, I hope you'll let me know about it... Send us an e-mail at feedback@stansberryresearch.com. Plenty of people over the years have sent me a lot of
September 13, 2013: "Dear Porter, do you still anticipate a bankruptcy and failure of General Electric?
"Did you see the very bullish cover article in Barron's magazine last week that described what is happening at GE? Lots of good things. Going to be an industrial powerhouse, at least that is their intention, according to Jeff Immelt... Huge backlog, peeling off certain financial assets, lowering costs, adding selling of services (less capital intensive), not just industrial equipment, etc. Stock cheaper than its peers.
"Perhaps you have had a change of mind. If so, that is good. One needs
Porter comment: Robert – What was happening at GE is exactly what I told you was happening: A lot of fraudulent financial engineering and a tremendous amount of debt that couldn't be financed for long. Hope you avoided the stock.
September 30, 2013: "Porter, you are very proud of your successful forecasts, including the collapse of GM. You remind your readers of it constantly. Here's one story you just never mention
Porter comment: In regard to GE, I couldn't have guessed the degree to which the Fed would be able to manipulate interest rates lower, and thus lower GE's cost of capital to below 1%. That was something I never thought would happen.
But... really... it's just postponed the inevitable. Whether it goes bankrupt or not, falling by 75% and then having to issue more equity makes the firm a complete wipeout for anyone who has owned it since 2000. Hope you weren't one of those folks.
December 23, 2013: "I have been a subscriber for several years and you and your team have made me a much better investor. I appreciate the education that you share with your subscribers. I wish you and yours a happy holiday season and encourage you to make the memories with your family while you can.
"I will make one observation about your work/opinions. Your diligence and willingness to take on the Government and the Street
Porter comment: Yes... you're right. We were way ahead of the curve on GE. But if you'd bought the stock 20 years ago, you'd be down, including dividends.
Sometimes being way ahead of the curve is the right place to be.
Regards,
Porter Stansberry
Baltimore, Maryland
January 19, 2018