General Electric's (GE) shares have dropped off from their latest 2-month high this week after analysts made negative comments about the company's revised deal terms relating to the 2018 Wabtec (NYSE:WAB) transaction. The revised merger terms between General Electric's former transportation business and Wabtec are not a big deal, though, and should not distract investors from the real story. The big story is General Electric's restructuring, and the opportunity for investors to potentially double their capital with an investment in GE.
John Flannery, previous Chief Executive Officer of General Electric, sold GE's rail business to Wabtec in 2018 in a $11.1 billion deal. The asset sale was an important milestone for General Electric as the company shifted its focus towards simplifying its business and paying down debt. The sale of General Electric's rail business was part of the previous CEO's push to divest $20 billion of assets in an effort to aid the deleveraging process.
At the end of last week, though, General Electric informed shareholders that the merger deal has been modified as follows [emphasis mine]:
Under the terms of the modified arrangements, which have been approved by Wabtec’s Board and by the Finance and Capital Allocation Committee of the GE Board, GE will complete the spin off of a portion of GE Transportation to GE shareholders and immediately thereafter merge GE Transportation into a wholly owned subsidiary of Wabtec. Upon closing, Wabtec shareholders will own approximately 50.8% of Wabtec on a fully diluted basis, compared to approximately 49.9% under the previous terms. GE shareholders will directly own approximately 24.3% of Wabtec on a fully diluted basis and GE will own common stock and non-voting convertible preferred stock which together represent approximately a 24.9% economic interest in Wabtec on a fully diluted basis, up from the 9.9% stake that GE would have owned under the originally announced transaction terms. GE will also receive approximately $2.9 billion in cash at closing, as announced in May. In aggregate, Wabtec will issue 3.3 million fewer shares than originally contemplated.
The revised deal terms (Wabtec shareholders will own a larger chunk of of GE's former business) have been met with negative analyst commentary. Some analysts are concerned that the deal isn't "beneficial" for GE shareholders, though the dilution here is only minor. While it is true that dilution is never "beneficial" for existing shareholders (in this case both General Electric and GE shareholders), I don't think this relatively minor deal adjustment really needs to register on investors' radars.
GE will sell down its interest in Wabtec subject to certain staggered lock-up provisions and size constraints designed to facilitate an orderly disposition of its shares. The GE interest is valued at $3.4 billion based on Wabtec’s current market stock price of $71.03. No sales can be made for 30 days post-closing, and GE must complete all sales before the third anniversary of the merger closing, subject to limited exceptions for market conditions.
General Electric still gets nearly $3 billion in cash at closing that the company will surely want to put towards debt repayments in order to facilitate its goal of a $25 billion net debt reduction by 2020. Subsequent stock sales will allow GE to fully monetize its investment and put even more cash towards debt repayments in the coming years. Investors, hence, should not feel irritated about the revised merger deals: While analysts make some noise about the deal, it is really insignificant for existing GE shareholders. Further, investors may want to keep their eyes on the price: A successful GE restructuring and a rebounding share price.
Investor Sentiment Remains Bearish
General Electric is no analyst or investor favorite right now, but that doesn't mean one cannot make any money on GE going forward. The company is in the midst of an ugly restructuring defined by layoffs, cost cuts, asset sales, and, unfortunately, a de-facto dividend suspension.
According to Marketbeat, a website that consolidates analyst research and their target prices, 2 analysts have a "Sell" rating on General Electric, 10 analysts suggest GE's shares are a "Hold", and 9 analysts recommend to buy General Electric. The consensus price target for GE currently sits at $13.22, indicating ~48 percent upside potential.
After a year of disappointing developments (widening SEC investigation, impairments, getting booted from the DJIA, dividend suspension) for General Electric, investor expectations are pretty low with respect to GE's upcoming fourth-quarter earnings release. While the fourth quarter will likely not yet show a significant improvement in GE's cash flow, the industrial company is doing the hard work that will eventually yield efficiency gains and improved capital returns.
General Electric's shares may have recovered from the December rout, but they are still in the bargain bin, in my opinion. GE is by far the most attractively valued industrial company in its peer group, with shares selling for less than 10x next year's estimated profits.
General Electric is in the midst of a major restructuring, and the revised merger deal terms with Wabtec are just noise that distracts from the real story. General Electric will release fourth-quarter earnings on Thursday, which will show investors what 2019 has in store for the industrial company. The revised merger deal terms with Wabtec are not nearly as big an issue for GE or its shareholders as some analysts think they are. GE is doing what it has to do to restructure its business: It sells assets in order to reorganize the company and raise cash for debt repayments. Investors should ignore the noise and focus on the turnaround instead. I think there is a reasonable chance for investors to double their capital over the next 2-3 years. Speculative Buy.