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Monday, August 07, 2006

GE: Even The Smart Money Makes Mistakes

Stocks: (GE)(SI)(CBS)

The Wall Street Journal recently noted that Warren Buffett has been investing some of the $43 billion on the company’s balance sheet. Over the last year, he has bought stocks like ConocoPhillips and General Electric, proving, at least in the case of GE, that even the Oracle Omaha can make mistakes. GE continues its habit of being unable to get out of its own way.

For investors, the only thing GE has going for it is it dividend which drives a yield of 3.1%. According to a recent analysis by The Motley Fool, the dividend is 53.7% of free cash flow. That means the level of the payout is safe, but it raises the issue of what GE plans to do with the rest of that money.

GE continues to puzzle even the most ingenious investors. The company continues to grow. Revenue for the June 30 quarter was $39.9 billion. GE recently told analysts that its margins in the second half would rise to 16.2%.

Compared to other conglomerates, GE still looks fairly expensive trading at over two times sales. Siemens trades at less than one time sales, and United Technology at less than 1.5 times.

While GE’s financial services business is the star of the company, its jet engine and medical devices businesses also do well. NBC Universal is out of favor because media companies like CBS are viewed as poorly positioned for the new media age. The company’s studio business relies on having more hits and than bombs, an unpredictable cycle that Wall St. does not like at GE, Time Warner, or anywhere else. A number of investment pundits have suggested that GE sell NBC Universal because it does not dovetail with any of GE’s other businesses.

While selling NBC might be a solution to one of GE’s problems, it would only address an area that is a small part of the company. The issues at GE are much more fundamental. From 1996 to 2000, the company was growing at well over 10% a year. From 2004 to 2005, revenue actually dropped.

GE may actually be much better off buying a large company that is not terribly well run than it would be starting to sell off relatively small division. Siemens comes to mind because it has businesses closely related to GE’s and it management is not considered world class. Siemens has a medical device business, a transportation systems business and a business services operation. All of these fit nicely into GE’s matrix of operating companies.

If GE could get the multiple on the Siemens’ units closer to the way that similar units are valued at GE, it would be worth over $100 billion in additional market cap for a combined entity, putting a value of $180 billion on the Siemens’ assets instead of the current $72 million market cap that the market gives them now.

The market believes that GE’s management is better than Siemens, and there is a way to get a great deal of value out of that.

Douglas A. McInyre can be reached at He does not own securities in any of the companies that he writes about.

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