Wednesday, June 4, 2008

Will General Electric get its advanced materials back?

Jeff Immelt gets some bad press these days. But I am not convinced he is all that bad. In the financials area (the area which I know well) he is brilliant.

He sold FGIC (a competitor to Ambac). It has since imploded and S&P rate it as junk.

He sold/spun out his mortgage insurer. Also a good deal.

He sold the crappy business of insuring people against the need to go into nursing homes. (It went with the mortgage insurer - and it is the best player in a very bad space.)

He has got rid of his business taking long term litigation risk. That will probably be OK.

He has however made some head-scratching purchases - particularly in medical. Jeff Matthews points out a shocker.

In the last results - much pilloried - the finance business did poorly (but way better than it would have had Immelt not pruned it so hard). The businesses that sell things outside America where the competitor is European (jet engines, rail, turbines etc) all shot the lights out. And medical was awful. Maybe Jeff Matthews is onto something.

But for the moment I just want to pick on what looks to have been a very good sale - the GE Advanced Materials business sold to Apollo (Private Equity). The buyers paid $3.8 billion in a mixture of cash, securities and left GE with a 10% interest. GE received just over 3 billion in cash - and (to the best of my knowledge) still holds $400 million in pay-in-kind securities. The business was renamed Momentive and has a new website - but also uses the GE Silicone Website.

The sale was part of the GE Plastics exit. And in this case I suspect Immelt got a very good price indeed. Momentive blames its problems on rising input costs - but those apply to the competitors too. Moreover the competitors are more European - and hence have a huge currency swing against them. This should have been a winner for private equity but they just paid too much.

That renouned business paper the (Albany) Times Union reports that they are now paying the PIKs in kind rather than cash.

Score that to Immelt.

At some stage though we are going to learn whether the sale of Advanced Materials was strategic or opportunistic. The biggest creditor when this defaults will be GE. With little difficulty GE will own the business again - if they want it.

Disclosure: long a small amount of GE. My biggest worry with GE is that the business that Immelt should know best (medical) is the problem child. I don't understand how his calls in finance could be so good - and then he does the acquisition that Jeff Matthews refers to. Jeff knows the medical as well as I know the finance.

Follow up: Momentive have filed a 10K. It is pretty ugly - with over $3 billion in debt - a few PIKs whcih can only be paid in cash after 2010 and a lot of finance leases (which look like debt as well). Leverage is over 10 times.

GE retains a $400 million debt instrument - but I seriously doubt it will get paid. It is not of the same class as the PIKs - instead it is a 2017 zero coupon.

Now we get to test whether GEs accounting is up to much. If they valued that zero at zero then they have no charge. If they valued it at something near par they better take a rather large haircut.

Watching with interest.

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