Lights Out: Pride, Delusion, and the Fall of General Electric

by Thomas Gryta

“My second day as chairman, a plane I lease, flying with engines I built, crashed into a building that I insure, and it was covered with a network I own,” he said just weeks afterward.

To some, the turbo-charged deal-making looked like a series of desperate moves. In mid-October, the Economist remarked that “it was not wholly clear whether Jeffrey Immelt, the firm’s boss, was climbing out of a hole, or digging himself deeper in.”

The conglomerate was performance-driven and had a thick top-down management structure.

Managers were expected to hit those targets at the end of every quarter, and anyone who came up short scrambled to cover their required contribution to feeding Wall Street’s expectations. Since the Welch years, GE had rarely missed a quarter’s projections, and that wasn’t an accident.

The investigators found that if GE decided to sell an asset to boost quarterly profits and couldn’t find a quick buyer, it sometimes called up someone close to home to buy the asset. Years earlier, in 2002 and 2003, GE had sold a number of diesel locomotives to banks, knowing that the banks would resell them months later.

Company flacks liked to remind newspaper reporters and others who challenged his decisions that Immelt had studied applied mathematics at Dartmouth. He’d gone on to the nation’s preeminent business school—not exactly a friendly place if you don’t like math. But Immelt also sometimes joked that his math skills were so poor that he couldn’t help his daughter with her homework.

The group originated more than $65 billion in mortgages from 2005 to 2007, making it one of the top producers of subprime mortgages in the United States.

“I’d be shocked beyond belief and I’d get a gun out and shoot him if he doesn’t make what he promised now,” he said. “Just deliver the earnings. Tell them you’re going to grow 12 percent and deliver 12 percent.”

“I’d be shocked beyond belief and I’d get a gun out and shoot him if he doesn’t make what he promised now,” he said. “Just deliver the earnings. Tell them you’re going to grow 12 percent and deliver 12 percent.” welch

Tusa explained himself. Speaking of GE in a note he distributed to his clients, he wrote: “It would appear as though accountability for hitting targets is the top priority, and some managers might be chasing earnings.” He added: “We also think the high bar for success in such a competitive environment could create a scenario in which bad news is not tolerated, making necessary communication with senior level managers a challenge until it’s too late to fix.”

He had flagged the difficulties that GE was having in the commercial paper market to regulators, but he hadn’t communicated those concerns to investors or the public.

The most notable impact of Lehman’s failure was the major losses taken by a money market fund, the Reserve Primary Fund, with $65 billion in assets, when its shares fell below $1, breaking yet another source of a once-dependable investment.

Buffett bought $3 billion in GE preferred shares, collecting $300 million in annual dividends, and he also received the right to buy $3 billion in GE common stock for $22.25 a share for five years.

Besides the $3 billion vote of confidence from Warren Buffett, GE said that it would also sell $12 billion in stock in a public offering. This announcement was made only six days after Immelt’s latest assertion that GE wouldn’t need to make such a move.

So far in 2008, the company had spent more than $3 billion buying its own stock. And in 2007, GE had spent $15 billion on its shares. Over the entire period, GE paid an average price of about $37.50 for half a million shares worth more than $18 billion.

The message was that the problems in the financial markets were very serious, but not for GE.

After repeatedly asserting that it didn’t need help, GE would use the government guarantee to sell almost $131 billion in debt through a staggering 4,328 different issuances.

On Immelt’s first day in 2001, the shares were around $38. When he was dining in Beverly Hills in September 2008, the stock was at $25. Shares opened 2009 at around $15 and closed the month of January at $12.

In the 1990s, “anyone could have run GE and done well,” he quipped. “Not only could anyone have run GE in the 1990s, his dog could have run GE, a German Shepherd could have run GE.”

GE’s stock kept falling for a while, but then it stabilized and turned around. It would close, at its lowest point in the crisis, at $6.66, but then rebound above $10 within weeks.

The campaigns of both politicians and companies, Schmidt told GE, were not “won by the candidate or company with the best character, or product, but by the one with the simplest and most clearly told story.”

Alstom, the French conglomerate that competed with GE in the power turbine business and also made passenger trains, had quietly sold €350 million in new shares to private investors, just months after buying back its own stock and reporting earnings that had shown no sign that the company would need to raise money.

Alstom had four times as many workers for every dollar of revenue it brought in.

Instead of charging a small team with developing the best product and then letting the operation grow with the product’s evolution, GE set up a huge organization that wasn’t quite needed yet.

Ge Digital predix

Taking control of an entity like PSM would enable GE to sell services not just to buyers of its own turbines but to those who had bought turbines from competitors like Siemens. To the bankers working the Alstom deal, this was one of the potential blockbusters buried beneath the headline.

GE had built the first natural gas turbine to run a power plant in the United States in 1949. The first unit, which pumped out even more electricity than the planners had hoped for, wouldn’t be decommissioned until 1980. The first gas turbine ever was run a decade earlier in Switzerland by a company that, through a series of acquisitions, ended up being acquired by Alstom in 2000. Now it too was part of GE.

He began the shutdown of research centers in Shanghai, Munich, and Rio de Janeiro, shifting some of their engineering work into individual business units. The once-sprawling and endlessly growing research operations would now be concentrated in just two global research sites, located in Niskayuna, New York, and Bangalore, India.

The approach to deciding whether to buy back stock advised by Warren Buffett and his longtime business partner Charlie Munger has two simple prongs: a company must have plenty of capital to run its operations, and the shares it repurchases must be selling “at a material discount to the company’s intrinsic business value, conservatively calculated.”

Jeff Immelt will not be remembered for wisely deciding how to spend GE’s cash. Buybacks were a regular fixture under Immelt, who spent more than $108 billion on them after 2004, when the SEC required companies to disclose their practices. At the end of 2018, GE’s entire market value was $67 billion. In Immelt’s last eighteen months as CEO, he spent almost $26 billion in cash on repurchases even as the stock fought to stay near $30 during that period. Just fifteen months later, it had dropped below $10.

Flannery wanted to focus on three core divisions—Power, Aviation, and Healthcare—and exit most of the rest of GE’s operations.

Immelt would later privately admit that he would never have spent cash from the Capital exit on stock repurchases if he’d known such a liability existed.

GE had constructed its insurance portfolio through deals that provided generous cash flow as younger policyholders paid their premiums. With that lucrative upfront cash from relatively young policyholders now causing an exponentially larger hole in the balance sheet, and with the cost of covering nursing homes and long-term care proving to be higher than expected, the worst was yet to come for GE.

GE has denied allegations of fraud. As of early 2018, GE was reinsuring about 300,000 long-term care policies, about 4 percent of all such policies in the industry.

Like many longtime GE executives, his love for the organization ran deep, and he struggled with the prospect of being the one who would have to dismantle it.

GE’s board of directors was unquestionably weakened from having the CEO as the chairman of the board. Many companies still cling to this structure, but it openly violates basic corporate governance principles. The CEO shouldn’t also be in charge of the committee that employs him. Some GE directors would challenge Immelt, but that usually was fruitless and could land them in the penalty box, or sometimes off the board entirely.

In naming Culp to the board, Flannery was fully aware of the possible future that appointment might bring about. Before Culp joined the board in April, an adviser had warned Flannery that Culp would be the man to replace him atop GE if things soured. He didn’t care, Flannery said. He just needed the best people to help him right the listing ship.