General Electric (GE) - Get Report is perhaps the greatest company on the planet. It is a leader in all of its businesses. It has terrific management, tremendous cash flow and a rock-solid balance sheet. However, it ain't cheap at 25 times 2002 earnings. The company still has a Jack Welch multiple.
I love Jack Welch. I've read the books. I've owned the stock. He may be the greatest CEO of our time (apologies to Bill Gates) -- but he is checking out. I don't know anything about the new guy, Jeffrey Immelt, other than that he beat out two pretty terrific managers, new
CEO Robert Nardelli and new
CEO James McNerney for the job. I bet the new guy will be great. But I also bet that he will be no Jack Welch.
I believe that investors can do better by creating the GE family of businesses at a considerably lower multiple. Build your own GE with
The Worry Factors
But before we make our GE salad, let's touch on a few concerns I have about GE:
- The post-icon CEO hangover. Consider some examples from other companies: Since Roberto Goizueta died in October 1997 while at the helm of
Coca-Cola, the stock has provided a negative 18% return compared with a positive 32% for the
S&P 500. Since Alfred Zeien retired from
Gillette in April 1999, the stock has provided a negative 42% return compared with a negative 7% for the S&P 500. Who wants to follow the Beatles on
The Ed Sullivan Show?
Managed earnings risk. I'm not the first person to call GE's bluff on this issue, but how can a company that generates more than $120 billion in annual sales in such a wide variety of economically sensitive businesses generate quarterly earnings growth that looks like the bunny ski slope when you connect the dots? Skeptics and critics of managed earnings should check out
Emerson Electric's July 11 press release: "After careful consideration, our management team made a proactive decision to not continue Emerson's record 43 consecutive years of increased earnings per share." I used to think that earnings were generated by businesses rather than decided on by management teams. The
Securities and Exchange Commission is very focused on cookie-jar reserves associated with acquisitions, and it's a short hop from that issue to that of managed earnings. After reporting excellent earnings in a weak economy, might the earnings cupboard be bare?
An overly aggressive pension fund return assumption (not necessarily unique to GE). GE is projecting that its pension fund will generate a 9.5% annualized return. Given that the long bond is trading at 5.6%, this assumption seems aggressive. What will happen to earnings if the pension fund underperforms this target? Easy, earnings will go down. In fact, earnings over the past several years have been enhanced by the bull-market returns generated by the pension fund.
The Main Ingredients
So, let's make a salad. Goldman Sachs and Citigroup are probably the best financial services companies in the world. I respectfully suggest that they are superior businesses to GE Capital. (As full disclosure, I spent eight years at Goldman.) Both Goldman and Citigroup are trading at 14 times 2002 earnings.
For the GE industrial piece, how about Honeywell and Boeing? Honeywell, the target of GE's affections, is now being run by 67-year-old GE alumnus Lawrence Bossidy. The stock is trading at 14 times 2002 earnings, and Bossidy is there to make something happen. Boeing is cheap at 12 times 2002 earnings.
For the GE media piece, Viacom is trading at 13 times 2002 earnings before interest, taxes, depreciation and amortization. I love being in business with Sumner Redstone (read
his book... it's actually quite good, despite bad reviews) and Mel Karmazin.
In summary, GE is the best company in the world, but it may not be the best stock in the world.
Jim Cramer's Hurtin' Thirty was the perfect eulogy for an era. It's time to bury the garbage that was foisted upon us by the former Masters of the Universe, otherwise known as the Sand Hill Road crowd and the investment bankers who did their bidding. I will not name names. The world is too small. I might want something from these guys when the next cycle comes around. But, I have to disagree with Cramer on a few of his choices for the Hurtin' Thirty. I hate disagreeing with Cramer because he's so smart.
I'm a fan of intelligent speculation. Not hoping and praying, but rather, placing bets that offer leveraged returns. I believe that a few of the companies on the Hurtin' Thirty list offer great option value. They should be viewed as a sort of Long-Term AnticiPation (LEAPs) option rather than stocks. As with options, investors should be prepared to lose the entirety of their capital. However, there is an opportunity for significant capital appreciation if we get a few of these right. This strategy is not an alternative to buying
. This strategy is an alternative to going to Vegas. No free drinks, but the odds of winning are considerably higher.
, which Cramer knocked in
Part 5 of his series. The CLEC (competitive local exchange carrier) opportunity is a real one. The Bells control 92% of local voice and data traffic, and this number is going down. The companies in the CLEC sector have been justifiably crushed for terrible capital structure management. The weak economy, too much competition, and the monopolistic tendencies of the Bells have negatively affected operating results.
While the economy shows no signs of getting better, the competitive landscape is improving as numerous emerging carriers go out of business. Additionally, FCC Chairman Michael Powell seems sensitive to the plight of the CLECs. McLeod has reasonably good management, and Forstmann Little (who sits above the common stock holder in the capital structure with preferred stock) has stood by the company. The stock is a dollar. It is never going back to $25. Over the next two years, the stock is going to either zero or $8. It is not a stock. It is an option.
. The words "content delivery" and "Internet infrastructure" make me cringe. But they have some of the smartest guys on the planet working for them, and $260 million in cash. As Cramer pointed out,
the name means "smart" in Hawaiian. These are not just smart guys. These are rocket scientists. I like betting on rocket scientists with cash. Who knows what might come out of their laboratory? However, they have $300 million of convertible debt outstanding. This represents stunningly stupid capital structure management. Not exactly Morgan Stanley's finest moment. Oops. I named a name.
The bonds are trading in the 40s with a 24%-plus yield. I like the bonds. When
Cable and Wireless
bought Digital Island, the convertible bonds tripled while the stockholders received no premium. Importantly, Akamai is cutting its burn rate ($73 million to $54 million quarter over quarter) and its capital expenditures ($24 million to $18 million quarter over quarter). Akamai's EBITDA losses are declining at a fast rate. Moreover, they claim to be fully funded. While more people lie about their fully funded status than lie about their golf game or investment performance, I believe these guys. Again, it's not a stock. It's an option.
Finally, I like
. Cramer seems able to generate only the
slightest level of disgust for this company. Actually, fatigue rather than disgust. As Cramer said, Internet security services is a neat little business. The company has $169 million of cash against a market capitalization of $275 million. It lost $14 million last quarter, and is adjusting its cost structure to reflect the hostile operating environment.
Head count has been reduced from 1,200 to 806. The company's revenue mix between software and services continues to improve. Entrust anticipates narrowing losses over the next two quarters and a return to profitability in the first quarter of 2002. Entrust's burn rate is minimal, and it expects to end the year with $150 million in cash. There could be significant upside if these guys execute. Again, it's not a stock. It's an option.
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Brett Messing is partner of Oscar Capital Management LLC, an investment adviser that is based in New York and Los Angeles, registered with the SEC and has approximately $1 billion in assets. At the time of publication, Oscar Capital and its clients owned Home Depot, Citigroup, Goldman Sachs, Honeywell, Boeing and Viacom. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Messing appreciates your feedback and invites you to
send it along.
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