Can GE Survive Its Cooked Books?

NEW YORK, NY – SEPTEMBER 19: Jack Welch is joined onstage by 24 different philanthropist and influential enterprise individuals featured on the Forbes listing of 100 Greatest Business Minds throughout the Forbes Media Centennial Celebration at Pier 60 on September 19, 2017 in New York City. (Photo by Daniel Zuchnik/WireImage)Getty

Jack Welch offers himself an F for selecting his successor, Jeff Immelt. And GE’s accountants weren’t doing their jobs when Immelt was CEO.

Those are two issues I realized from an extended December 14 Wall Street Journal article about GE (whose shares are in my portfolio).

Part of me is greedy at the concept that holding GE inventory at this value is a lottery ticket on the prospect that CEO Larry Culp can revive the corporate’s income development.

The extra sensible facet is considering that JPMorgan analyst Steve Tusa was unsuitable on December 13 to improve his score on GE from promote to impartial as a result of he thinks a lot of the dangerous information about GE was mirrored in its inventory value.

This makes me ponder whether GE can survive its cooked books — and the place GE’s auditor, KPMG — whose contract with GE is up for bid and will finish in 2020, in response to Bloomberg — was when all this was occurring.

A KPMG spokesman mentioned in an announcement December 14, “We’ve been privileged to work with GE for many years and are proud of our work and our teams. It is good governance, and a responsible activity, for strong audit committees to review and assess their external auditor relationships. We welcome the future opportunity to work with all the stakeholders to demonstrate the value KPMG can continue to deliver.”

Before stepping into that, let’s have a look down reminiscence lane. 17 years in the past, you will recall, Enron went bankrupt — creating $74 billion in losses, costing hundreds of Enron staff their jobs, and resulting in the demise of accounting large Arthur Andersen.

If — as Mitt Romney famously mentioned in 2011, “Corporations are people too, my friend.” — Enron was a hypocrite and a liar.

As I wrote in my 2003 e-book Value Leadership, Enron executives behaved in direct opposition to the corporate’s values — together with what it wrote about Respect: ”We deal with others as we want to be handled ourselves. We don’t tolerate abusive or disrespectful therapy. Ruthlessness, callousness and vanity do not belong right here.‘’

And in fact Enron cooked its books — which acquired short-seller Jim Chanos interested in why Enron’s revenues have been rising and its money movement was not. As it turned out, Enron was hiding its debt in off-balance-sheet entities and Arthur Andersen signed off on it.

What does this need to do with GE? It began with Jack Welch — who was well-known for a constant string of double digit earnings per share will increase — that beat expectations by a penny.

GE Capital helped Welch try this. As the Journal wrote, GE Capital was

A helpful, deep bucket of economic spackle with which to clean over the cracks in quarterly earnings reviews and maintain Wall Street comfortable. Sometimes that meant peddling half a parking zone on the ultimate day of 1 / 4, or promoting an element curiosity in an influence plant solely to buy it again after the quarter closed.

Immelt was completely different than Welch in that he thought management was about being optimistic and making individuals really feel good. But he additionally had an ego that made him need to create a legacy for his tenure at GE.

So Immelt overpaid for a money movement sucking maker of trains, rail tools, energy generators and mills, France’s Alstom. After that deal closed in November 2015, demand for the generators flagged.

Missing the money movement from GE Capital — $310 billion of whose property had been offered — GE Power executives took a web page from Welch’s technique. They made it seem that GE Power was assembly its income and revenue targets by manipulating its monetary reviews to return out higher than GE Power’s financial actuality.

And in so doing, they introduced Enron to my thoughts. According to the Journal, “GE executives assured one another they were making accounting maneuvers [that] were legal, if aggressive. But [these maneuvers] also meant that the profits were mostly on paper. Rarely was a new dollar of profit flowing in the door.”

Indeed these maneuvers — which included giving GE Power prospects reductions on service contracts in trade for paying earlier — contributed to a $1 billion money movement shortfall from GE’s Industrial companies that got here to gentle in April 2017.

This shortfall “raised red flags about aggressive accounting and whether the company could make its goals,” in response to the Journal.

This was not the one accounting downside going through GE. In 2004, GE spun off most of its insurance coverage holdings into Genworth Financial — promoting a lot of the rest to Swiss Reinsurance two years later.

But not all of that company most cancers was surgically eliminated. Instead, GE held onto long-term-care insurance coverage that covers nursing house and assisted residing bills.

The downside was that GE’s 300,000 insurance policies — four% of these offered within the U.S. — have been cash losers.

This downside fell to Immelt’s successor, John Flannery. In a November 2017 presentation on his technique for fixing GE, the shortfall between premiums acquired and losses paid have been revealed to be worse than anticipated.

Two months earlier, GE’s CFO Jamie Miller had estimated the shortfall at $three billion. But in Flannery’s presentation the determine was greater than $6 billion. What’s extra, insurance coverage regulators demanded that GE give you $15 billion in reserves in opposition to future prices, famous the Journal.

In September 2018, Flannery sealed his doom with a presentation to administrators wherein he introduced GE would miss its cash-flow targets and must take a cost of greater than $20 billion to write down off Alstom and different earlier acquisitions.

To paraphrase Michael Corleone from Godfather II, if something on this life is for certain — if historical past has taught us something, it is CEO who cuts corners on accounting will kill the corporate.

Enron’s CEO did. I hope that Welch and Immelt didn’t plant the identical seeds of destruction.

GE’s board must conduct an exhaustive unbiased audit to unravel its accounting issues.

With KPMG — which has audited GE since 1909 and earned virtually $143 million in audit charges in 2017, in response to the Journal — slated to proceed as GE’s auditor till at the least 2019, how can that occur?

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