DECISION TIME for Immelt and Buffett
June 4 2007 by Bill Rothschild
Going Big” has been a popular theme of corporations worldwide.
The underlying premise is that size and diversity is a way to hedge your bets and assure that you have the ability to avoid unpredictable downturns. Two great companies, General Electric and Berkshire Hathaway, have successfully adopted this theme.
In 2006, GE generated $163 billion in revenues, 12.65 percent net profit margin, had a strong cash position, and a global workforce of 319,000. Berkshire posted 2006 revenues of $98.5 billion and a very respectable net profit margin of 11.4 percent, while accumulating large cash flows and employing 217,000. (See chart, page 43.) Each company had its own unique style and approach to making these impressive numbers.
Simplicity vs. Complexity
Berkshire Hathaway (BH) has a very clear, simple portfolio of companies. Warren Buffett, though one of the richest men in the world, leads in a natural, unpretentious way. There are no large corporate staff organizations, and the management measurements are uncomplicated.
General Electric, on the other hand, has established and promoted highly sophisticated, complex systems and procedures to manage an increasingly complex portfolio and global strategy.
Warren Buffett seeks acquisitions that are financially sound, have no debt, strong management and can stand alone. He makes it clear “if there is a lot of technology, we won’t understand it.” He is not interested in turnarounds or companies requiring major surgery or restructuring. He wants companies with a strong management team that will continue to manage the companies. The result is that Buffett has made many acquisitions of companies with well-known brands that are mature, easy to understand and low technology industries.
Under Jeff Immelt, General Electric has done the opposite. Immelt targeted high technology, solutions-oriented, global markets and industries. He grouped the traditional GE businesses into a huge conglomerate of infrastructure and industry-oriented- focused businesses and grew health care, and continued to invest in broadcasting, while using the company’s powerful financial services arm as a means of getting orders for the solutions and systems businesses.
General Electric is willing to make acquisitions that require the infusion of new management and may require extensive surgery and restructuring, provided they strengthen their targeted markets and enhance their ability to provide a fuller offering and solutions.
“Trust Me” vs. “Obsessive”
General Electric has gained a reputation as an innovator in management systems and practices. Its succession planning system is complex, time-consuming and expensive. In some ways, it has become an obsession. Reginald H. Jones, Jack Welch’s predecessor as chairman and CEO, even reorganized the company to select his successor. Immelt spends a month a year performing the process.
Buffett is on the other extreme. He is 75 and “he is Berkshire Hathaway.” He makes it clear that he has a successor in mind. He doesn’t plan to leave and asserts “trust me” that everything is under control.
The GE system has proven that it can develop and select strong leaders at all levels who can adapt to change, while Berkshire’s system is untested, since Buffett has never selected his successor. Rich Man vs. Ordinary Man Since its inception, GE has had the “widows and orphan” stock price strategy. They prefer to have a large number of investors. In order to make its shares more affordable, GE traditionally splits its stock when it hits 100 and provides a dividend. Buffett has taken the opposite approach and never splits the stock, preferring that it only be affordable to the most affluent investors. Berkshire Hathaway has two very expensive stocks: “A” shares that currently sell in the $109,000 range and “B” shares that sell in the $3,600 range. Both are too rich for the ordinary investor.
Looking Forward at BH
Buffett has been on the job for 40 years, is one of the richest men in the world, and is clearly a “legend,” which is the key issue facing his successors. Obviously, none of the candidates can equal him. He asserts that he has three candidates and his job is easy. But it is clear that his successors will not be placed on the same pedestal as Buffett, and if expectations are not met, the investors will not be as kind in their response.
As you can see from the chart on page 44, many of BH’s acquisitions are less than six years old. Buffett admits that most of the acquired companies are now led by very rich people, who could decide to leave at any time. At some point, all companies have significant strategic, operational and financial problems, so they may need help and even new management.
The folksy, no-staff approach of BH will not be adequate to cope with these problems, and it is very likely the company will need to increase its systems and staff. Further, it will have to develop its own people. In short, BH will have to follow some of the practices that are common in most large companies and will not survive in its current form.
If the subsidiaries are not meeting their objectives and are not able to implement their strategies, however, then they could be spun off. This is not a problem now since the company is not a union, but a confederation of independent states. If the company follows this approach, then it will become just like all of the previous conglomerates and most likely follow their course of self-destruction.
The GE Situation
Immelt took over the company from another “legend.” Jack Welch reigned over GE for 20 years. He set high hurdles, became a CEO celebrity (and is still trying to remain one), and brought the stock to over $60 a share. When Jack left, everyone wondered whether anyone could fill his big shoes.
Immelt clearly recognized that he had to make changes and took a very different course than his predecessor. Welch had focused on relatively mature businesses and grew his financial services businesses. The result was that Immelt inherited a mature portfolio and concluded: “Another decade of 4 percent growth and GE will cease to be a great company.” The Welch portfolio was more like the Buffett portfolio and was not technology- intensive.
“GE has used its financial strengths to build a fast-growth portfolio. Now, we are using our breadth and depth to create unique GE solutions in technology, services, commercial excellence and globalization,” Immelt has said. “Technology produces highmargin products, wins competitive battles and creates new markets.”
Immelt clearly articulated his goal of growing the company 8 percent per year. To do this, GE has made major investments in emerging markets, like China, India and the Middle East. It has opened research and development labs in China, India and Europe and upgraded the traditional lab in Schenectady, N.Y.
In short, the company became more complex and increased its risk profile with the combination of complex systems and solutions in emerging and risky parts of the world.
Now Immelt is frustrated. In the 2006 annual report, he describes his frustration about the poor performance of GE stock over his tenure, details his strategies and policies, and proclaims the company has a strong track record of “reliable quality growth.” The theme of the report has moved from “go big” to “invest and deliver.” He strongly believes he is doing everything right and that the investment community should buy in and drive the stock higher.
So why hasn’t GE even kept up with the Dow growth? I am not a stock expert, but I will give you three reasons. First, the company has become so complex and is so constantly changing its portfolio that the investors are confused. Second, Immelt has a 20-year game plan and most investors are looking for immediate gains and have no long-term vision. Third, Immelt and his team appear so convinced that they are right they may not be willing to change.
Suppose the Immelt game plan doesn’t move the stock or, even worse, doesn’t meet the goals he has set and the expectations he has created? Let’s step back and review some of the options that exist.
ï¿½ Make It Simpler. Make the company less complex. This can be achieved by focusing more on products and services than solutions, as well as reducing the risk by participating in lower risk global areas. This strategy is not exciting, but it could build more investor confidence and increase the stock price.
ï¿½ Continue to Prune the Portfolio. Continue the traditional GE portfolio management approach perfected by Welch. In this case, the company asserts that nothing is sacred and all businesses are potential divestiture or harvest candidates. Immelt has already done this. He divested the insurance and reinsurance businesses and was even willing to take losses. He sold the advanced materials business (man-made diamonds, silicones) to a private equity firm.
In January of this year, Immelt announced that the company’s plastics business is now on the block. It could yield $12 billion from a Saudi firm-a major financial windfall for the company, similar to the Welch RCA deal.
I think that broadcasting and even additional parts of the traditional GE lines, like major appliances and lighting, could be divested. These moves would permit the company to focus on its major solutions, technology business, while maintaining its strong financial services operations. This portfolio approach may build more confidence among investors, since they recognize that the primary goal of the company is to continue to increase the bottom line.
What if neither works? In this case, I think we need to adopt the new company motto “Imagination at Work” and look for a more creative approach that may initiate the next stage of the company.
Let’s imagine that:
ï¿½ GE gives the investor an opportunity to invest in selective sectors of the company and not just in the total company portfolio. In this scenario, GE decides to offer stock in its key areas/sectors. For instance, it creates separate stock offerings in GE Healthcare, GE Infrastructure, GE Money, GE NBC/Universal, GE Commercial Financing and other key components of the company. These would replicate the current building blocks of the company. So investors could invest in either the total company or selective parts of the company. This is not unrealistic since many companies have done this and have been successful in doing so. Of course, this will require more evaluation.
ï¿½ GE is major stockholder of new companies. The GE Corporation would continue. The company would only sell a part of the new companies and retain majority control over the businesses. I would recommend that GE retain 75 percent of the companies and sell the other 25 percent on the open market.
ï¿½ GE would focus on maintaining GE traditional success factors. Under this new scenario, the GE corporate staff would be significantly reduced and focused on a few key areas. For instance, the company would continue to work on succession plans for the key management positions in the company and especially the next CEO. The corporate staff would monitor external changes and help the subsidiaries anticipate and respond to change, as well as change the portfolio as required. It would continue to have companywide training at all levels, take stands on political issues as needed and continue the strong financial, strategic and manpower networks that have contributed to its past success.
The anticipated results could be very positive to all of the key stakeholders. The stock should rise overall, the investor will have more options and the company will continue to retain its AAA rating and have a strong and deep bench.
In my latest book, The Secret to GE’s Success, I describe the company as remarkable, since it has had the ability to succeed and prosper for over 127 years. I use the word “Latin” to capture the five reasons for this success. These include leadership, adaptability, talent, influence and networks. Though all are important, I think one of the most important is the company’s ability to adapt and admit mistakes.
Immelt and his team have adapted and created a solid, though complex, game plan. (See chart, above.) The real question is whether it will work and whether the investment community will reward the company if it does.
The verdict will be in within the next few years. I continue to believe GE is a remarkable company and hope that if and when the company must adapt, it will do so as effectively as it has in the past.
Bill Rothschild is CEO of Rothschild Strategies Unlimited and the author of The Secret to GE’s Success.