Gross Point Blank: GE's Got a Paper Problem
Justin Lahart
03/20/02 - 04:32 PM EST
Updated from 3:20 p.m. EST
When
General Electric (GE) filed its annual report earlier this month, it boasted that the section on financials contained "30% more content." But for all that, the guy who runs the world's biggest bond fund said Wednesday that GE's disclosure falls well short of the mark.
In a wide-ranging critique published on his firm's Web site, Bill Gross, who oversees $250 billion in assets for
Pimco, said that he wouldn't hold GE's commercial paper "for the foreseeable future" and suggested he wouldn't be taking on big positions in the company's longer-term debt. Gross particularly took aim at GE's massive commercial-paper issuance, which he said isn't sufficiently backed by bank credit lines. But he also said GE management, including Jack Welch, has failed in recent years to provide investors with needed disclosure.
As the market chattered about the company's denial of reports that it would buy CIT from
Tyco (TYC), GE shares fell 2.76% Wednesday. The spread on GE Capital's 10-year debt widened slightly, to 85 basis points over the comparable Treasury, implying a bit more risk.
Funding
Echoing comments made recently by credit analysis boutique Gimme Credit and rating agency Moody's Investors Services, Gross noted that bank lines for GE's finance arm, GE Capital, back up less than a third of its commercial paper. Given its unblemished rating, it appears extremely unlikely that GE Capital would lose access to the commercial paper market for short-term funding. But if that ever did happen, the company could find itself in a pickle, Gross said.
In a release Monday, Moody's noted that with $127 billion in short-term debt maturing within a year, GE Capital is the largest issuer of commercial paper in the world. "Partial backup coverage exposes a large borrower like General Electric Capital to funding risk," said Moody's. Companies including
Qwest, a much lower-grade credit, have recently drawn down bank lines upon being shut out of a risk-averse commercial paper market.
"Normally companies which borrow in the CP market are required to have bank lines at least equal to their commercial paper, but GE Capital has been able to accumulate $50 billion of unbacked CP because of the lack of market discipline," wrote Gross.
"Our plan has been to rebalance our portfolio with a little less reliance on commercial paper," responds GE Capital spokeswoman Marissa Moretti. "We're also increasing our bank line coverage and should have this in place by the second quarter."
As for whether GE Capital would arrange bank lines to back all of its paper, Moretti says, "we don't have a specific target in terms of our backup coverage for commercial paper, but our goal is to increase it."
Jack in the Box
Gross wrote that if that "discipline" returns, GE investors could find themselves in the hands of an angry market. And that's partly because the company hasn't been fully forthcoming with details of just how it's become such an earnings machine, Gross wrote.
"Nor do I think have Jack Welch and his successor Jeffrey Immelt been totally forthcoming in the explanation for why GE has been able to grow earnings at nearly 15% per year for the last several decades," Gross wrote. "The fact is that GE is a conglomerate financed by a money machine -- its subsidiary GE Capital -- but unlike
Berkshire Hathaway, its foundation is vulnerable because its survival depends upon the confidence of outside investors."
GE, Gross continued, "grows earnings not so much by the brilliance of management or the diversity of their operations ... but through the acquisition of companies (more than 100 companies in each of the last five years) using high-powered, high P/E multiple GE stock or cheap near Treasury Bill yielding commercial paper." In that regard, Gross's criticism of GE echoes the market's early-year dismissal of Tyco, which set plans to split into four parts amid investor criticism of its opaque finances and its little-understood acquisition record.
Gross feels that GE Capital's recent $11 billion bond offering was motivated not so much by an interest in raising money while rates were low (what the company said) as by a recognition that its days of easy financing in the commercial paper market are over. The offering "was an intelligent recognition of that, but they have tens of billions of unbacked commercial paper that remain," he wrote. "Without the benefit of this leverage afforded them by the Street, their operations to me resemble more closely the failed conglomerates of yesterday such as Gulf + Western and LTV."
Was a Bullfrog
Gross carts around a lot of influence in the bond market. Though somewhat mercurial (today's missive begins with quote from
Jeremiah), he called the peak in bond yields back in early 2000 and the end of the bull market in Treasuries this fall. Pimco's $51 billion
(PTTAX)Total Return fund, which Gross directly manages, has outperformed its peers each year for the past decade. But even if Gross didn't have a penchant of getting it right, his GE comments matter simply because he controls so much money.
"It always matters what Pimco does," says Mary Ann Hurley, bond trader at D.A. Davidson in Seattle. "They move the market when they want to move the market. It waves a flag."
But Hurley emphasized that Gross' remarks likely wouldn't deter would-be buyers of GE's debt. Some investors, in fact, consider it inexpensive.
"I like GE because GE is trading cheap," says Stephen Mahoney, portfolio manager for Glenmede Trust in Philadelphia, who owns GE Capital bonds. "There's a lot of downside already priced into the bonds."
