Will GE be the proverbial “black swan?” – It had come to my attention that General Electric was locked out of the commercial paper market three weeks ago after Moody’s downgraded GE’s short term credit rating to a ratings level (P-2) that prevents prime money market funds from investing in commercial paper. Commercial paper (CP) is an important source of short term, low-cost, liquid funding for large companies. At one point, GE was one of the largest users of CP funding. As recently as Q2 this year, 14.3% of GE’s debt consisted of CP. Now GE will have to resort to using its bank revolving credit to fund its short term liquidity needs, which is considerably more expensive than using CP.
Moody’s rationale for the downgrade was that, “the adverse impact on GE’s cash flows from the deteriorating performance of the Power business will be considerable and could last some time.” Keep in mind that the ratings agencies, especially Moody’s, are typically reluctant to downgrade highly regarded companies and almost always understate or underestimate the severity of problems faced by a company whose fundamentals are rapidly deteriorating.
As an example, Moody’s had Enron rated as investment grade until just a few days before Enron filed bankruptcy. At the beginning of November 2001, Moody’s had Enron rated at Baa1. This is three notices above a non-investment grade rating (Ba1 for Moody’s and BB+ for S&P). Currently Moody’s and S&P have GE’s long term debt rated Baa1/BBB+. In the bond market, however, GE bonds are trading almost at junk bond yields.
Once a company that relies on cheap short-term funding is locked out of the commercial paper market, it more often than not precedes the rapid financial demise of that company. Because GE is GE, it may not be rapid, but I would bet GE is on the ropes financially and could go down eventually. GE’s CEO was on CNBC two weeks ago on a Monday proclaiming that the Company’s number one priority is to bring “leverage levels down” using asset sales. One asset GE is said to be considering selling is its aviation unit, which is considered its crown jewel. This is the classic signal that a company is struggling to stay solvent – i.e. burning furniture to keep the lights on and heat the house. It’s not a bad bet that GE might file chapter 11 – or even Chapter 7 liquidation – in the next 18-24 months (maybe sooner).
I wanted to discuss this situation because I opined on Twitter recently that a sell-off in GE’s stock below $5 could trigger an avalanche of selling in the stock market. Just as significant, an event in which a company like GE is shut off from commercial paper funding is the type of “pebble” that is tossed onto an unstable financial system and starts a credit market crisis. The downgrade of GE’s short term funding rating is a reflection of rising and widespread systemic instability and the general financial deterioration of corporate America. I predict that we’ll start to hear more about GE’s collapsing operational and financial condition and we’ll start to see a lot more companies head down the same path as GE.
Note: The above commentary is an excerpt from the November 18th Short Seller’s Journal. Since then, GE’s stock price has dropped another 5.5%. I had recommended shorting GE at $30 in the January 29, 2017 issue of SSJ. GE’s tangible net worth (book value minus goodwill + intangibles) is negative $31.3 billion.
GE also has a $28.7 billion+ underfunded pension obligation. It is by far the largest underfunded pension in corporate America. I say “$28.7 billion+” because I’m certain that if an independent auditor plowed through the pension fund assets and liabilities, it would discover that the assets are overstated and the liabilities (future beneficiary payouts) are understated.
In other words, GE’s balance sheet is the equivalent of financial Fukushima. The previous CEO borrowed $6 billion to cover pension payments through 2020. This is like throwing napalm on a gasoline fire.