As end-of-an-era stories go, this one was irresistible. General Electric, once the mightiest corporate conglomerate in the world and a benchmark of American industrial genius, fell out of the Dow Jones Industrial Average (DJIA) this week. Its replacement: a pharmacy chain.
The moment sent GE's obituarists into an ecstasy of eulogies for motherhood, apple pie and the American way. GE was already a company in long-term decline: its market value has shrunk from $500 billion two decades ago to about $120 billion today.
Last year it announced the sale of its lighting division, perhaps its most historic unit. Thomas Edison, the scientist who invented the light bulb, is regarded as GE's founding genius.
Even Warren Buffett had given up on this icon of American capitalism: he sold the last of his GE stake in 2017, after making a reported $1 billion profit on his original investment.
So GE’s expulsion from the Dow was interpreted as the last chapter of an epic American story. Or as more evidence of the decline of the conglomerate – the sprawling, multi-industry, neither-one-thing-nor-the-other type of company which investors used to love, but don’t seem to any more.
Or as the latest attempt by Dow Jones, the company that compiles the DJIA, an utterly misleading index of stock market activity, to make itself a little less irrelevant.
Like the best stories of decline and fall, GE’s is a combination of all three. Yet lost in the noise is the fact it is still standing. It is a shadow of what it was 20 years ago.
It is smaller, and is trying to become more focused by shrinking back to its manufacturing strengths in power turbines, aircraft engines and energy technology. That is no bad thing. GE’s problem is not that it is an industrial conglomerate. It is that it was once, in very recent history, tantamount to a hedge fund.
GE's problem is not that it is an industrial conglomerate. It is that it was recently tantamount to a hedge fund
It can be forgotten in accounts of the global financial crisis, which erupted a decade ago, that GE was one of its largest casualties. At the time, the company’s largest division was GE Capital. This unit once accounted for half of all profits and was the reason for GE’s soaring share price.
It was the brainchild of Jack Welch, the celebrity chief executive who ran GE from 1981 to 2001.
GE Capital was a leveraged-finance credit institution, and it put GE in the lending business. This was fine in the years of the credit bubble, and not so fine when the bubble burst.
By then Welch had departed to devote his time to peddling cliches about "leadership". His successor, Jeffrey Immelt, faced the job of rescuing the industrial arms of GE, and dealing with the legacy costs of GE Capital.
To do that, Immelt had to tear up Welch's legacy. Now John Flannery, who became chief executive last year, is having to do the same with Immelt's legacy.
This week, GE announced the spinning out into separate listed companies of GE Healthcare, Baker Hughes, an oilfield-services group, and other bits of the conglomerate that, combined, account for roughly one-third of GE’s annual revenue and profits.
Tearing up the legacy of one’s predecessor is a waste of a chief executive’s time. But sometimes it has to be done. Flannery is taking GE back to the things it is good at – making huge pieces of industrial kit. The “new” GE will have three divisions: GE Aviation, GE Power and GE Renewable Energy. It is still a conglomerate, but one with complementary strengths.
Tearing up the legacy of one's predecessor is a waste of a chief executive's time. But sometimes it has to be done
Yet this enormous turnaround effort is not the reason GE lost its place in the Dow. That happened for technical reasons. The unreliability of the Dow as a market benchmark has been highlighted before in this column.
Now GE has become a victim of the index’s main flaw – that it is share price-weighted rather than market value-weighted.
The higher a company’s share price, the greater its weight in the Dow. That did for GE, which has seen its share price tumble to under $15 this year. According to S&P Dow Jones Indices, GE had a weighting in the index of less than half of a percentage point. The shares of Walgreens Boots Alliance, GE’s replacement, trade at $60. So it will “contribute more meaningfully to the index,” S&PDJ said.
GE remains one of the biggest US companies. And while its industrial business looks analogue in the digital age, somebody has to make the engines that fly planes: you cannot just Google one (not yet, anyway).
Moreover, the conglomerate remains a valid corporate structure, and not just in the US. It thrives in Germany (Siemens), Turkey and in many Asian economies.
Whether GE’s turnaround succeeds will not be clear for several years. Yet investors appear ready to buy into it. Since being liberated from the Dow on Tuesday, GE’s shares have risen 8.5 per cent, while those of Walgreens are down 11 per cent. GE might be out, but it is not down.