Here are some key insights to keep in mind as we follow the news of GE’s plan to shed GE Capital.

By Geoff Colvin
April 10, 2015

General Electric GE said Friday it plans to sell most of its GE Capital unit to create a “simpler, more valuable company” focused on its core industrial operations.

It’s a landmark decision for the company, which grew from a manufacturer of electrical gear, light bulbs, and appliances into a global conglomerate through a process of strategic acquisitions, innovations, and reorganizations.

Here are three insights to keep in mind as we follow the news of GE’s massive restructuring.

1. Investors don’t like conglomerates. That’s the simple rationale for GE’s move, and it’s a good one. Diversification of risk was supposed to be one of the main attractions of conglomerates, but most of the world learned decades ago that investors don’t like it. They’d rather diversify by assembling their own portfolio of different businesses than have a corporate manager assemble one for them. Thus the well-known “conglomerate discount.” GE was one of the few major companies that plowed ahead as a widely diverse conglomerate (a term they hate at headquarters). CEO Jeff Immelt has been de-conglomerating GE for years, without exactly calling it that — no more NBC, plastics, or appliances. What he’s doing now is his biggest, most dramatic move in his long-running de-conglomerating program. And guess what: The stock jumped on the news. Not a surprise.

2. Corporate success is ultimately a matter of earning a return on capital that exceeds the cost of capital — it’s an obvious fact that is rarely examined. Highly significant, though seldom noted, is that Immelt has added boatloads of capital to GE during his tenure. In the financial crisis, GE lost its treasured triple-A credit rating, thus raising the cost of that mountain of capital. Not good. By getting rid of most of GE Capital, he also offloads tons of capital. That could be a good thing, but only if he can earn high returns on the remaining capital-intensive industrial businesses. An important downside of the move: It causes GE’s capital costs to rise even more, because it prompted Moody’s to downgrade the company’s debt rating.

3. Beware the allure of share buybacks. GE announced a buyback of up to $50 billion with the restructuring, which sounds like something investors should love. But remember: for companies as for individuals, buying shares is a good idea only at the right price. In the past GE has spent billions buying back shares when the stock was trading at prices much higher than the current one — and then was forced to sell shares at far lower prices during the financial crisis. Buying high, selling low — that’s not the road to prosperity. Let’s hope this buyback works out better, but one never knows.

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