October 2, 2008
By Michael Markowski

General Electric’s (NYSE:GE) announcement yesterday that Warren Buffet had invested $3 billion in it by purchasing Perpetual Preferred shares sent GE shares surging in the mid afternoon -- this after the shares had hit new 52-week lows earlier in the morning. The announcement that GE was raising a total of $15 billion, which included a common stock offering of $12 billion stunned me. For my entire life I had held this image that GE was the bluest of the blue chips. This was a company that had routinely announced stock buy backs and now it was selling 5% of the company with its shares trading at their 10 year lows because it needed capital.

Even though GE’s shares traded up on the announcement and closed 13% higher than their lows for the day the announcement was anything but good news. Here is why:

• In the three year period ended December 31, 2007, GE had bought back or had purchased $25 billion of its own shares. GE in the six months ended June 30, 2008, purchased $1.5 billion of its own shares. In the quarter just ended June 30th the purchases totaled $680 million. Most of these shares were purchased at prices, which averaged between $30 and $35 per share according to GE’s trading range for most of the three-year period. Bedrock corporations such as GE rarely make the mistake of using their own capital to purchase their own shares to only watch the price of the shares fall significantly below the purchase price. What compounds the mistake even more is that in one minute GE is purchasing its own shares. In the next minute its selling the very same shares back to the public at a significant discount because it is in need of capital. GE’s behavior is unbecoming for any corporation much less a blue chip one. It smacks of desperation at worst and at best it questions the ability of GE’s management and Board of Directors to protect its shareholders.

• To make matters worse GE borrowed the funds that it used to buy back its shares. Its long term debt has climbed steadily from $212 Billion in its year ended December of 2005 to $351 billion in its six months ended June 30, 2008. Its now obvious that GE’s management and Board of Directors were imprudent when they borrowed monies to purchase the company’s own shares for its treasury. They should have been figuring out ways to reduce its debt instead of increasing it to buy back GE’s own shares. Its Board of Directors and its CEO should be removed immediately.

• The announcement led me to do an analysis of GE’s Balance Sheet. There had to be a reason as to why the revered company is so desperate to raise equity capital with its share price at a 10 year low. After analyzing GE’s Balance Sheet I determined the root of its desperation. GE has $72.5 Billion in current assets and $260 Billion in current liabilities. Its current ratio of .27, is anemic. The ratio means that GE’s current assets cover only 27% of its current liabilities. This is well below the 2 to 1 ratio of current assets to current liabilities, which is considered to be the measure of a healthy balance sheet. GE’s big problem is that it had $205 Billion is short term debt that contributed to its current liabilities in June of 2008 and it appears that this debt has been revolving since at least December of 2005. My guess is that GE has been paying interest on the short term debt instead of attempting to raise long term debt that would get it off of the current liabilities portion of its Balance Sheet. Finally, GE’s capital raises from the sale of preferred and common shares will increase its net tangible book value from $5 billion to $20 Billion. This amount of course would only be a pittance when compared to its total liabilities of $680 Billion.

GE in this new era of de-leveraging is extremely vulnerable because (1) its getting increasingly difficult to find lenders who have big appetites to lend and (2) its earnings growth is dependent on its ability to get more credit. For example, for the 10 year period beginning in 1998 and ending in 2007, GE’s liabilities increased by 114% and its earnings increased by 138%. In calculating the difference in growth rates its not hard to come to the conclusion that GE’s net annual earnings would not have kept up with inflation if it had not had the ability to borrow more and more money.

I am perplexed as to why Buffet, the Oracle of Omaha, decided to invest in GE. Buffet has scolded individual investors who use margin accounts or leverage to purchase stocks. Yet here he is making an investment into GE, which is a company that is doing just that; borrowing monies to purchase its own shares.

The bottom line is that I expect that GE shares will embark on a feeble rally after the US Congress passes legislation of some sort on the Financial crisis bailout. After that I expect that GE’s share price will consistently erode to new lows as it tries to cope in a new world where growing earnings without borrowing monies is much more difficult.