GE's Card Spinoff Is a Great Deal for Investors

NEW YORK ( TheStreet) -- General Electric ( GE) will see a decline in earnings from the spinoff of its consumer finance business, but analysts expect the company to be more highly valued by investors as it refocuses on its industrial businesses.

GE on Friday announced it would spin off its North American consumer finance arm through a carefully crafted transaction that will be tax-free to GE shareholders and include an initial public offering of up to 20% of the equity in the new company. Following the IPO, which the company expects to complete "later in 2014," the company plans to completely exit the consumer finance business by making a tax-free distribution of the remaining 80% to GE shareholders during 2015.

The company also said it might decide to complete the disposal of the consumer finance arm by "selling or otherwise distributing or disposing of all or a portion of its remaining interest in the Retail Finance shares."

What does this mean for investors?

For one thing, it is a major piece of Jeff Immelt's long-term strategy to trim GE Capital's contribution to General Electric's earnings to roughly 30%. During the third quarter, GE Capital's contribution to the parent company's operating income was 49%. For the first three quarters of 2013, the finance unit's contribution to the parent's operating earnings was 46%. GE Capital had $515 billion in total assets as of Sept. 30, declining from $562 in September 2013. The unit's "ending net investment" (ENI), excluding non-interest bearing liabilities, cash and equivalents, was $385 billion as of Sept. 30, down from $425 billion a year earlier.

GE Capital will shed another $50 billion or so through the spinoff of the consumer finance unit, bringing the unit within Immelt's long-term ENI target range of $300 billion to $350 billion.

The long-term initiative to trim GE Capital, while improving the unit's liquidity, is aimed at allowing GE to continue providing middle market commercial financing and continue to lend to its industrial customers, while avoiding the type of crisis the company faced in 2008. At the height of the U.S. credit crisis, liquidity in the commercial paper market dried up, forcing GE to rely on the Federal Deposit Insurance Corp.'s Temporary Liquidity Guarantee Program (TLGF) and the Federal Reserve Bank of New York's Term Asset Backed Securities Loan Facility (TALF).

Illustrating the great strengthening of its balance sheet, GE reported that its ratio of debt to equity was lowered to as of Sept. 30 from 9.6 at at the end of 2008.

In addition to lowering the risk of needing another government liquidity backstop in the event of another financial crisis, GE hopes to unlock value for investors through the consumer finance spinoff.

GE's stock closed at $27.20 Friday. The stock traded for 15.3 times the consensus 2014 earnings estimate of $1.78, among analysts polled by Thomson Reuters.

Deutsche Bank analyst John Inch on Monday reduced his 2014 EPS estimate for General Electric to $1.72 from $1.85, to factor in the IPO for the consumer finance business, while introducing a 2015 EPS estimate of $1.87. He reiterated his "buy" rating for the shares, while raising his price target to $32 from $28.

Even with the significant increase in his price target, Inch wrote in a note to clients that his price target, based on an expanded multiple of 17 times Deutsche Bank's 2015 EPS estimate, "would be lower than our multi-industry coverage universe average valuation by roughly 1 turn."

"This appears reasonable considering GE's favorable attributes including elevated organic growth prospects based on backlog expansion, high cost-cutting runway/opportunity and accelerating return of capital to shareholders," he wrote.

According to Inch, GE's multi-year cost-cutting efforts is in the "early innings," when compared to other industrial giants, including Honeywell ( HON) and Dover Corp. ( DOV), implying further upside over coming years.

William Blair analyst Nicholas Heymann on Monday reiterated his "market perform" rating for GE, with a price target of $27, but was also quite positive in his comments in a note to investors about the planned consumer finance spinoff. Heymann noted that GE had already returned $12 billion in excess capital to investors through dividends and share buybacks, "out of a targeted $20 billion-$30 billion." He also provided another eye-popping number, writing that the following the consumer finance unit's IPO, "the subsequent tax-free share exchange could return $16 billion-plus tax-free to GE shareholders."

GE on Friday said it expected to grow its earnings-per-share in 2014 and 2015, as the company expects that "gains will equal restructuring."

What might the spin-off mean to competitors?

GE is the largest private label credit card lender, with a portfolio of about $36 billion as of Sept. 30.

"Given the size and private label focus of GE's current operations, we feel that the implications are fairly limited to certain names in our coverage universe, namely Capital One ( COF) and on a smaller scale Alliance Data ( ADS)," KBW analyst Sanjay Sakhrani wrote in client note on Friday.

The other private label lenders could find themselves in a better competitive position against the spun-off GE consumer finance company, because its "bank funding advantage could be moderated as the business would not likely have the same access to funding as it currently has," according to Sakhrani.

The business being spun off had a very strong 4% return on assets during 2012, with a profit of $2.2 billion on about $53 billion in total assets, according to KBW. That's a pretty impressive ROA, but the new company may be operating on a more even playing field than it currently enjoys. It will be very interesting to see how aggressive the new company's management will be in its efforts to gain new business following the spinoff.

GE's shares were up 0.6% in late morning trading Monday, to $27.37.

GE Chart GE data by YCharts

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-- Written by Philip van Doorn in Jupiter, Fla.

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Philip W. van Doorn is a member of TheStreet's banking and finance team, commenting on industry and regulatory trends. He previously served as the senior analyst for TheStreet.com Ratings, responsible for assigning financial strength ratings to banks and savings and loan institutions. Mr. van Doorn previously served as a loan operations officer at Riverside National Bank in Fort Pierce, Fla., and as a credit analyst at the Federal Home Loan Bank of New York, where he monitored banks in New York, New Jersey and Puerto Rico. Mr. van Doorn has additional experience in the mutual fund and computer software industries. He holds a bachelor of science in business administration from Long Island University.

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