The Long and Short
GE spin-off should close the value gap to peers
Dan Bruzzo, CFA | October 14, 2022
This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors.
About a year ago, General Electric (GE: Baa1/BBB+*-/BBB) announced its intention to split the remaining company in a series of transactions over subsequent years. The news came as GE launched a massive tender offer on the debt with the proceeds from the sale of GECAS. The company’s forthcoming spin-off of the healthcare unit is now officially scheduled for January 2023. As the multi-year restructuring of GE comes close to reality, the value gap in GE debt obligations relative to its highly rated industrials peers is beginning to close. Investors holding the name are still well-positioned to benefit from the subsequent tender offer and exchange to follow, but this phase marks the conclusion of what has been an attractive relative value story for the past two-plus years. Most of the anticipated debt reduction from the proposed tender appears to be priced in at current valuation of legacy GE relative to peers.
Graph 1. GE index-eligible debt issues versus high-rated industrial peers
On Tuesday of this week, GE filed a Form 10 with the SEC – a registration statement detailing the separation of the GE healthcare business (GEHC), which is scheduled for early January 2023. Last year, management had stated their intention to spin-off healthcare in January of 2023, and then subsequently separate the energy businesses in January of 2024, leaving their core aviation business as the legacy General Electric credit. Additional details will be made available at an investor day in early December but here are some of the important details of the transaction and debt tender that have been released so far.
GE will retain a 19.9% stake in GE healthcare, while the remaining 80.1% will be distributed to shareholders via tax-free spin-off. GEHC will be organized into four business units: Imaging (approximately 54% of 2021 revenue), Ultrasound (18%), Patient Care Solutions (17%), and Pharmaceutical Diagnostics (12%).
The projections in the GEHC financial supplement that was filed Tuesday are highly indicative of a solid investment grade standalone credit profile, as management previously stated all spun-off entities would maintain. The new entity will incur debt of $10.2 billion via the new public bond launch and through term loans. GEHC will also take on approximately $5.2 billion in net pension liabilities, which is a sizable piece versus the $11.3 billion in pension obligations that stood on the GE balance sheet at year-end 2021.
The healthcare company will also set up $3.5 billion in committed credit facilities, which it does not intend to access at the time of the spin-off and will therefore provide a nice liquidity buffer for the new entity. The cash balance is expected to be $1.8 billion, implying a net debt balance of $8.4 billion. That compares with standalone annual revenue for the healthcare unit of approximately $17.6 billion in the prior year, annual gross profit of $7.2 billion, and free cash flow of $2.8 billion (though FCF is down considerably in the current year-to-date).
As originally anticipated, GEHC will use the proceeds from its inaugural debt raise to pay a cash dividend to legacy GE, which will in turn be utilized for another tender offer of existing debt obligations. We estimate the tender could be in the area of $8 billion. While this tender of GE debt was widely expected to be launched in conjunction with the GEHC debt deal, management also indicated for the first time that a portion of debt may also be issued directly into legacy GE, and then exchanged for the existing debt. This detail had not previously been revealed to our knowledge.
When the details of the tender and exchange are disclosed near the first week of January, we expect the legacy GECC notes (issued under the GE Capital International Funding Co. entity) to figure prominently in the waterfall of priority for the USD-denominated portion of the tender. Those include the GE 4.418% ’35 notes ($6.9 billion remain outstanding of the $11.4 billion issued in GE’s big recapitalization effort of 2016) and the GE 3.373% ’25 notes ($300.9 million outstanding of the $1.95 billion issued). The remainder of the tender/exchange will likely include other notes previously targeted by GE in past tender offers, particularly those with higher coupons and debt issues approaching maturity. GE has approximately $3 billion also has $3 billion in public debt maturities coming due in 2023.
For legacy GE, there will be separation costs that were not disclosed at this time. When the spin-off of the two businesses was first proposed last year, management anticipated that there would likely be one-time costs of around $2 billion, plus tax costs of under $500 million.
Until otherwise restated, management’s credit goal of the restructuring was to attain single-A ratings at legacy GE in the long-term. S&P placed GE on review for downgrade back when the original plans were announced to reflect the uncertainty of the restructuring. This week, the rating agency reiterated the watch negative, stating that they are looking for leverage to be reduced “comfortably” below 3x (from its current level of around mid 3x) when the tender is launched to avoid a downgrade and have the current rating affirmed. Moody’s negative outlook on the credit pre-dates the GECAS separation and reflects concerns about operational weakness at the aviation unit dating back to the heights of the pandemic.