Conglomerates, Post Enron
Enron’s collapse is causing a fundamental change in the attitudes of investors, lenders and credit rating agencies toward conglomerates and companies carrying heavy debt.
Conglomerate Tyco International’s decision this week to split into four companies was forced in part by investor unwillingness in the wake of Enron’s bankruptcy to support Tyco’s complex accounting and corporate structure.
In Enron’s wake, the market is looking with a skeptical eye at General Electric, AOL Time Warner, Honeywell and other companies built, as Tyco was, largely by numerous acquisitions.
Investors and analysts are suddenly suspicious of the fact that conglomerate and multi-industry companies consolidate profits and losses and debts of many divisions in a single income statement and balance sheet. Enron hid losses and debts; therefore all complex financial statements are suspect, goes today’s thinking.
Tyco Chairman L. Dennis Kozlowski acknowledged the Enron effect Tuesday when he said “a lot of people are suffering because of Enron.” Kozlowski built Tyco by hundreds of acquisitions in the last decade into a company that took in $36billion in revenue last year from burglar and fire alarms, surgical dressings and financial services.
What is happening is a fundamental change in the investment market environment, according to analyst Nicholas Heymann of Prudential Securities, who follows both GE and Tyco.
The industrial concept that worked to build Tyco was that the firm could tap debt markets to acquire small specialized companies, such as Kendall Healthcare and ADT security systems.
Tyco then reaped value by consolidating those companies and giving them greater force in their own industries as well as a corporate office that theoretically could finance their operations at lower cost.
“However, things have now changed fundamentally,” Heymann wrote Wednesday in a report on Tyco. Because Tyco stock has fallen--it closed Wednesday at $45.10 a share, down $2.45 for the day and 28% below its 52-week high--it cannot make more acquisitions without diluting current shareholders.
And with debt markets concerned about high debt levels, Kozlowski is splitting the firm into four companies and selling 15% to 20% of each company in public offerings to raise cash that can pay debt.
GE also is under pressure because its stock, off almost 30% in the last 52 weeks, remains at levels the company sold at in 1999. GE closed Wednesday at $37.55, down 65 cents.
Some industry experts and analysts have long called for GE to spin off some of its divisions to give shareholders a direct stake in successful businesses such as medical services.
But now the tone among analysts has changed to a skepticism over GE’s reported earnings and its corporate structure, which spans eight industries, from aircraft engines to light bulbs to banking, insurance and other financial services.
GE Chief Executive Jeffrey Immelt defended the GE structure Wednesday. He told questioners in Boston at an impromptu news conference that GE isn’t likely to follow Tyco’s example and split the company.
“We just feel like our business model offers investors superior returns and gives us a chance to go forward,” Immelt said, according to wire service reports.
The GE “model” is that the firm’s trained managers can run any of its businesses and generate strong profit returns. GE last year returned 25% on shareholders’ equity and 24% on total capital. The firm has little long-term debt.
Immelt even said confidently that GE would take a look at Tyco’s operations with an eye to possible acquisitions for its own divisions. Last week, Immelt told security analysts GE would have to make acquisitions if it was to meet targets for 17% earnings growth in 2002.
However, there is a real question whether even GE can make acquisitions. Last year, U.S. investment markets were not enthusiastic about GE’s proposed acquisition of Honeywell, which fell through because of opposition from the European Union. GE’s stock price today does not encourage acquisitions.
In fact, GE’s record of constantly rising earnings is being questioned because 40% to 45% of the firm’s $14 billion in net income came from GE Capital, the giant financial services divisions that last year had about $70 billion in revenue.
In the post-Enron environment, skeptical analysts question just how much financial results can be tailored conveniently to cover up poor performance in the industrial divisions. Immelt is conscious of such criticism. He has said in recent interviews that he would like to reduce the company’s dependence on GE Capital.
But Wednesday, with the post-Enron environment putting pressure on GE, Immelt was combative. Enron’s collapse “has nothing to do with GE,” Immelt said. His company has 500 people who audit its books. “We have hundreds of meetings with analysts and investors. We think we are transparent,” Immelt said.
Clearly the market’s attitude toward GE and other conglomerates has changed. What remains to be seen is how long the new skepticism will last and what its effects will be on some of the most prominent diversified companies in American industry.
