Sunday, February 18, 2018

The importance of GE's credit rating

The cover story in Barrons this week is on GE's dim prospects. I confess to being a very minor source for that story. I don't own GE - but there is a price below the current price where I would buy it.

That said, I think there is one last shoe to drop, and it is a doozy. And it wasn't covered in Andrew Bary's excellent article. That is that GE's credit rating - and hence its business - is under threat.

GE's best business (by far) is jet engines where it competes with Rolls Royce (in wide-bodied engines) and a Pratt & Whitney consortium in narrow bodied engines. 

There is a new generation of engines (and planes) now - and the aviation business is booming. Boeing's stock price reflects that.

But GE is no longer the unequivocal engine leader. In wide-bodied (ie planes with two aisles) the current leader is the Airbus A350 powered by a Rolls Royce engine. It is the most fuel efficient long-haul plane on the market (measured in fuel cost per passenger-mile) and the engine is provided exclusively by GE's competitor. GE is playing catch-up - but will probably succeed with the Boeing 777x which (on paper anyway) will take the mantle as the world's most efficient plane.

In narrow-bodied the GE may still be the leader but Pratt & Whitney has caught up a great deal. Picking the competing engines apart is difficult (although at the moment the Pratt & Whitney competition has problems with a knife-edge seal). [I know serious aviation nerds who think the P&W engine is a better product with better prospects - although I think that is a minority view.]


The jet-engine business is threatened by GE's current worries. You see jet engines (especially wide-bodied jet engines) are sold with very long-term maintenance contracts. If I order a 777x now it will be a couple of years before the first delivery, maybe 10 years before my delivery and expect to be flying the plane for another 20-25 years after that. I may be ordering 10 planes in which case my last delivery may be 15 years away and I expect to fly that plane for a further 25 years. 

Whoever buys this plane needs to be confident that GE will be around and solvent in 40 years to actually do the maintenance. The GE aviation business is more credit sensitive than almost any business I can think of.

And that is a problem because as Andrew Bary notes GE's debt is already trading as if the credit rating is BBB+, and if you are entering very long maintenance agreements BBB+ is simply not good enough.

If Ahmed bin Saeed Al Maktoum or Akbar Al Baker gets jittery re GE's credit rating then it will threaten GE's ability to sell engines or even Boeing's ability to sell planes (on which GE is the monopoly engine provider). 

Who are these guys you have never heard of? Well Ahmed bin Saeed is the CEO of Emirates airline and Akbar Al Baker is the CEO of Qatar airlines. These are the biggest buyers of long-haul jets in the world. They are GE's most important customers.


GE is, I think, a rationally run business - meaning management run it to management's incentives. In the old days that was to buy stock and keep the price high (options) but now it is clearly just for business survival.

And business survival requires that GE maintain its credit rating. 

That is why there will be an equity raise.


There are plenty who argue that GE should be broken up. I am not averse to the possibility but it is much harder than it looks. GE has lots of obligations including over 100 billion in debt and 30 billion in pension shortfalls. It also has guaranteed a few (painful) insurance obligations.

If you break up GE those obligations have to go somewhere. And debt holders or the Pension Benefit Guarantee Corporation is not going to accept them being placed against GE's troubled businesses (such as power systems). And Ahmed bin Saeed isn't going to accept them being placed against the aviation business.

So in a break-up a lot of capital needs to be raised. Probably in excess of 50 billion. 

Bluntly I do not think a break-up is realistic. You could get away with under half the raise if you don't break it up. And maybe you could just sell some businesses to strengthen the balance sheet and get away without a raise.


Rolls Royce went through this. There was a period where Rolls was problematic - and if you looked at the balance sheet you would have immediately rated it A+. But even then A+ was barely enough - even the threat of a downgrade and Rolls would have had to raise capital to protect their business.

Rolls never raised equity - but it was touch-and-go. 

GE is far more problematic than Rolls at the nadir - simply because there are far more obligations on GE's balance sheet.

I reckon an equity raise is likely. I don't know why they didn't cut the dividend in its entirety (except maybe that wasn't enough). It may be that 20 billion in asset sales is enough - but I have my doubts. I think they will need more to keep the customers satisfied. 

Ahmed bin Saeed Al Maktoum, this one is up to you.


POST SCRIPT: I have been asked several times how GE got into this trouble. Here is my very quick summary.

a). GE was left hyped up and overly dependent on finance income and accounting tricks under Welch (who I think is the main culprit here),

b). Immelt did not defuse all the unexploded Welch bombs anything like fast enough. GE would have gone bust on the Welch trajectory, and Immelt got it off the Welch trajectory, but not far enough off the Welch trajectory, and

c). Both Welch and Immelt behaved as if their body odour was perfume. They believed their own hype and bought back stock and stock and more stock. Total shares repurchased were over 100 billion dollars. Just 30 billion of that money now would solve the credit rating problems.

d). Power systems which was once perhaps the golden business fell on hard times. Solar is now cheaper than coal or gas. Renewables are cheap. This is a problem if you are the biggest capital equipment sellers to the old tech. This was exacerbated by spending 10 billion on Alstom just as it all fell apart. Immelt doubled down on dying technology.

The 20 year accounts are here.

Friday, February 9, 2018

Nasdaq and the New York Stock Exchange (and possibly Herbalife) team up to help organised crime

Charlie Gasparino suggested in a tweet and a story that Herbalife, the Nasdaq and the New York Stock Exchange have teamed up to produce an anti-short-seller Bill. The Bill forces disclosure standards on short sellers.

I have no conclusive evidence either way as to whether Herbalife is involved behind the scenes or not. However the Bill is real and Charlie is usually a fairly thorough reporter and I have no reason to disbelieve him. And Herbalife has not denied the story.

The Bill is a threat to my physical safety. 

I want to assure readers that I am not exaggerating in the slightest. 

Bronte has a business model on the short side of maintaining a large database of people we regard as crooked and finding stocks associated with them and shorting those stocks. Often we do not know the full extent of the crook's business - we are just running on pattern recognition.

One such stock was China Agritech. We were short it originally because there was a minor crook associated with it. We worked out plenty including some ridiculous disclosures such as "proprietary nano-honeycomb embedding and microelement deep complexing technologies" in their organic fertiliser. Shorting a company associated with low-level scammers that literally claims to sell high-tech shit is just my style. 

Unbeknownst to me at the time however the Chief Financial Officer of China Agritech - Mr Yau Sing (Gareth) Tang- had a history. Mr Tang and Mr Jimmy Hueng were the directors of a Hong Kong Company called Win's Prosperity Group which collapsed. The story is told by Professor T. Wing Lo in the British Journal of Criminology. The direct quote (about a Hong Kong stock scam) is:
This case began with the renaming of a listed construction company, OLS Group, as China Prosperity Holdings (CPH) on 29 April 1999. Coincidentally, both the Chinese and English words for ‘Prosperity’ were the same as in Jimmy’s company, Win’s Prosperity Group. Jimmy Heung and a Mr Tang were the only directors of Win’s Prosperity Group. Tang was also the Executive Director of CPH, but Jimmy, as a triad figure, is not allowed to hold directorship of any listed company.
Jimmy Heung - now deceased but then Gareth Tang's regular business partner - was easy to find. His father was the founder of the Sun Yee On Triad. It was widely reported he was the Triad boss at the time China Agritech was fleecing American shareholders.

Anyway I publicly ridiculed China Agritech on this blog. Obviously I did not know of Triad involvement when I did this as I am not stupid or reckless. But not knowing Triads are involved does not obviate their involvement.

I stopped talking about China Agritech when I received threats of violence by phone from China from people who made very clear that the threats were credible. I reported these threats at the time to the Federal and local police which made it apparent to me that the Australian system wasn't well equipped to handle cross-border threats from China.

And more importantly I vowed to become far more restrictive about what I would say about short positions and what I would disclose about short positions in the future

Whatever - China Agritech was listed on the NASDAQ. It wasn't a small pink-sheet company and it had institutional shareholders. 

China Agritech is dead and buried now - and so is the Triad figure who was responsible for this fraud - so I feel safe enough talking now. I do not feel safe talking about this stuff generally. Indeed I would never willingly disclose such a short. Unless forced to by this Bill.

What this Bill will do is allow Triads and other organised crime gangs to list stocks on American stock exchanges and not worry about market participants anonymously exposing the natures of their crimes. The short-sellers will have to disclose themselves, not only to the SEC, but also to the those that will do them harm.

I say - without fear of exaggeration - that this is the Organised Crime Stock Fraud Protection Bill.

I can understand why crooked companies might support this Bill. And it gives me pause that Charlie reports a company that I own supports this Bill. But I have no understanding (other than a cynical grab for listing fees) as to why the NYSE and NASDAQ are happy for Sun Yee On Triad companies to list on their exchanges and why they support a Bill to protect them.


Why should shareholders have to disclose positions anyway?

Running a funds management company you only really have one output. Positions in stock market. That is your intellectual property. 

There is no other business I know where the business is forced to disclose the entirety of their intellectual property.

That said - I can think of a decent reason to force disclosure of long positions. If I own a share I own a vote. If you own a share you also own a vote. If own 30 percent of a company in most cases I can effectively control it. My votes impinge on the power of your votes. 

Because my ownership of shares can change the value of your ownership of shares most countries force disclosure when ownership stakes become large enough to matter (typically, but arbitrarily at five percent). This seems a reasonable compromise between keeping the buyer's intellectual property private and allowing the rights/control issues around a company to be visible to market participants.

However when I short a share I have no rights whatsoever - just an obligation to buy back the stock sometime. My short position doesn't impinge on your long position except in as much as there are deferred buyers in the stock. The above argument for forcing disclosure simply does not apply.

Indeed other than symmetry for symmetry's sake I can't think of a single argument for forcing short disclosure and I can think of strong arguments opposing it.

I would like the NYSE and the NASDAQ to lay out a cogent argument (other than mere symmetry) why disclosure should be forced and why this does not protect organised crime.

If Herbalife is truly behind this Bill (as Charlie Gasparino reports) then I would also like an explanation of why they support the Bill.

John Hempton

Post script: Charlie Gasparino has since contacted me and assures me that Herbalife has confirmed the story. 

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