Sector

IndustrialsManufacturingAviation

Background

Josh Aguilar is a senior equity analyst at Morningstar. We cover GE's business strategy, how it lost the right to be an industrial conglomerate, and the role GE Capital played in its rise.

Cover

Date

September 14, 2022

Episode Number

74

General Electric Business Breakdown

Background / Overview

General Electric (GE), founded in 1896 with roots tied to Thomas Edison, has a storied history as a conglomerate that once dominated American industry. Known for innovations like the incandescent light bulb, X-ray machine, electric locomotive, and commercial jet engine, GE was a technological and industrial powerhouse. At its peak in 2000, it was the world’s most valuable company, with a market capitalization nearing $600 billion. However, today’s GE is a shadow of its former self, having divested numerous businesses and refocused on three core segments: Aviation, Healthcare, and Energy (branded as Vernova). This transformation reflects a strategic retreat from a sprawling conglomerate structure to a more focused industrial entity, driven by years of mismanagement, poor capital allocation, and external pressures like the 2008 financial crisis.

GE’s historical business model was built on a diversified portfolio spanning industrials, media (NBC), financial services (GE Capital), appliances, lighting, and more. Under Jack Welch (CEO from 1981 to 2001), GE was celebrated for its managerial excellence and consistent earnings growth, earning Welch the title of “Manager of the Century” by Fortune. However, the reliance on GE Capital, which at its peak accounted for nearly 60% of earnings, masked underlying weaknesses in its industrial operations. The conglomerate structure, once a strength, became a liability as misaligned capital allocation and cultural hubris led to significant value destruction under Jeff Immelt (CEO from 2001 to 2017). Current CEO Larry Culp, since 2018, has spearheaded a restructuring to streamline operations, reduce debt, and spin off Healthcare (2023) and Energy (2024), leaving Aviation as the core of the remaining GE.

Ownership / Fundraising / Recent Valuation

GE is publicly traded, with no single dominant shareholder or private equity sponsor. Its market cap has significantly declined from $600 billion in 2000 to a fraction of that today, with the podcast noting that Honeywell’s market value now exceeds GE’s by nearly 16%. Specific enterprise value (EV) multiples or recent transaction details are not provided, but the company has been divesting assets to reduce leverage and refocus. For example, GE sold its BioPharma business to Danaher for over $20 billion, and the NBC sale in 2011 was valued at under $40 billion, significantly lower than comparable deals like AT&T’s $110 billion acquisition of Time Warner. The podcast highlights GE’s current valuation as potentially undervalued, driven by “deal limbo” fears and skepticism about its turnaround, but no precise EV or multiples are given.

Key Products / Services / Value Proposition

GE’s current operations focus on three segments, each with distinct products and value propositions:

1. Aviation:
• Description: Manufactures commercial and military jet engines, including the market-leading LEAP engine (joint venture with Safran) for narrowbody aircraft like Boeing’s 737 MAX and Airbus A320neo, and the GE9X for widebody aircraft. Services include high-margin parts and maintenance contracts.
• Value Proposition: Operates in an oligopolistic market with high barriers to entry due to scale, reliability, and regulatory requirements. The “razor-and-blade” model sells engines at a loss (list price ~$14 million, often discounted 50-70%) to generate multi-decade, high-margin aftermarket revenue via parts and “power-by-the-hour” service agreements.
• Volume/Revenue: Majority of aviation revenue comes from commercial aerospace, expected to grow double digits in the near term due to pent-up demand. Aftermarket services (parts and contracts) are a significant revenue driver.
• EBITDA: Mid-single-digit organic growth with ~20% operating margins through the cycle, with higher near-term margins due to operating leverage.
2. Healthcare:
• Description: Produces medical imaging equipment (MRIs, X-rays, ultrasounds) and is investing in digital capabilities like AI and machine learning for workflow automation and improved patient outcomes.
• Value Proposition: Serves hospitals and outpatient centers in an oligopolistic market, competing with Siemens Healthineers and Philips. Benefits from secular trends like aging populations, chronic conditions, and physician shortages. Strong free cash flow (FCF) conversion (~100% of earnings).
• Volume/Revenue: Lower mid-single-digit growth, with high-teens operating margins.
• EBITDA: Stable, high-margin business with potential for dividend payments (35-60% of earnings typical for healthcare firms).
3. Energy (Vernova):
• Description: Encompasses Power (gas and nuclear turbines, servicing), Renewables (wind turbines, primarily offshore), and Digital Grid. Focuses on the energy transition but faces challenges in renewables profitability.
• Value Proposition: Power benefits from the energy transition as a bridge technology (gas turbines address renewable intermittency). Renewables target high-growth areas like offshore wind but face competitive and margin pressures. Operates in a less oligopolistic market for renewables, with regional competition from Chinese players like Goldwind.
• Volume/Revenue: Power expected to achieve mid-single-digit operating margins; Renewables may grow high single digits but not break even until mid-decade.
• EBITDA: Renewables currently unprofitable (negative mid-teens operating margins), with Power more stable but less profitable than Aviation or Healthcare.

Segments and Revenue Model

GE’s revenue model varies by segment but centers on a mix of equipment sales and high-margin aftermarket services:

• Aviation: Sells engines at a loss to secure long-term service contracts. Revenue is split ~50/50 between time-and-materials services and “power-by-the-hour” agreements, where GE maximizes engine uptime for steady cash flows. Key drivers include global passenger traffic (revenue passenger kilometers, RPKs) and middle-income growth in developing markets.
• Healthcare: Sells high-value equipment (e.g., MRIs) with recurring revenue from maintenance and software upgrades. Digital offerings (AI, automation) enhance margins by improving hospital efficiency. Driven by aging populations, chronic conditions, and surgical procedure growth.
• Energy (Vernova): Power generates revenue from turbine sales and servicing, with stable demand from gas as a transition fuel. Renewables rely on turbine sales, with limited service revenue compared to Aviation. Profitability is pressured by competition and production tax credit (PTC) cycles in the U.S.

Splits and Mix

• Segment Mix (Revenue):
• Aviation: Largest and most profitable, majority of commercial aerospace revenue.
• Healthcare: Stable, mid-sized contributor, set to spin off in 2023.
• Energy (Vernova): Power is stable but less profitable; Renewables is high-growth but unprofitable, set to spin off in 2024.
• Geographic Mix: Not detailed, but Aviation and Healthcare serve global markets, while Renewables face regional competition (e.g., Chinese players in Asia). U.S. PTC cycles heavily influence Renewables revenue.
• Customer Mix: Aviation serves airlines (e.g., American Airlines) and airframers (Boeing, Airbus). Healthcare targets hospitals and outpatient centers. Energy serves utilities and industrial clients.
• End-Market Mix: Aviation tied to air travel demand; Healthcare to healthcare spending; Energy to energy transition and utility investment.
• EBITDA Contribution: Aviation and Healthcare drive profitability (20% and high-teens margins, respectively). Energy’s Renewables segment drags overall margins due to negative mid-teens margins.

Historical mix shifts show GE moving away from diversified conglomerate revenue (e.g., media, finance) to focused industrials. Future spins will further concentrate revenue in Aviation post-2024.

KPIs

• Revenue Growth: Aviation expected to grow double digits near-term (pent-up demand); Healthcare low-mid single digits; Renewables high single digits but unprofitable.
• Operating Margins: Aviation ~20%, Healthcare high teens, Power mid-single digits, Renewables negative mid-teens.
• FCF Conversion: Healthcare ~100%, Aviation and Power lower due to capital intensity, Renewables negative.
• Backlog Burn Rates: Aviation (long-cycle, multi-year orders), Healthcare (mid-cycle, ~1-year orders), Energy (mixed, with Renewables tied to PTC cycles).
• Trends: Aviation shows acceleration from travel recovery; Healthcare stable; Renewables decelerating profitability due to competition and PTC dynamics.

Headline Financials

• Revenue Trajectory: Revenue has declined significantly from $130 billion in 2000 to $74 billion recently, reflecting divestitures and a smaller operational footprint. Aviation and Healthcare are growth drivers, while Renewables face profitability challenges.
• EBITDA and Margins: Historical data lacks specific EBITDA figures, but 2000 saw strong earnings growth across segments. Today, Aviation and Healthcare maintain healthy margins, while Renewables’ losses drag overall profitability.
• FCF: FCF has plummeted from $13 billion to $2 billion, driven by lower operating cash flow, higher leverage, and capital-intensive businesses like Renewables.

Value Chain Position

GE operates midstream in its value chains, manufacturing high-value equipment and providing aftermarket services:

• Aviation: Midstream, producing engines and components, with aftermarket services (parts, maintenance) capturing significant value. Suppliers provide raw materials and components; customers (airlines, airframers) integrate engines into aircraft.
• Healthcare: Midstream, manufacturing imaging equipment and software, with services enhancing hospital efficiency. Suppliers provide electronics and materials; customers (hospitals) use equipment for patient care.
• Energy: Midstream, producing turbines and grid solutions. Power services existing installations, while Renewables focus on new installations with limited aftermarket revenue. Suppliers provide steel and components; customers (utilities) integrate into power generation.

GTM Strategy: Aviation and Healthcare leverage oligopolistic market positions to secure long-term contracts. Renewables rely on project-based sales, influenced by government incentives like PTCs. GE’s competitive advantage lies in scale, installed base, and service expertise, though Renewables face pricing pressure.

Customers and Suppliers

• Customers: Airlines and airframers (Aviation), hospitals and outpatient centers (Healthcare), utilities and industrial clients (Energy).
• Suppliers: Not detailed, but likely include raw material providers (steel, electronics) and component manufacturers. Renewables face logistical challenges with large components (blades, towers), favoring regional suppliers.
• Dependency: Customers rely on GE for mission-critical equipment and services, particularly in Aviation (FAA oversight) and Healthcare (patient outcomes). Supplier power is moderate, with GE’s scale enabling bulk purchasing.

Pricing

• Aviation: Engines sold at a loss (50-70% below $14 million list price) to secure high-margin service contracts. Service pricing is stable, with ~50% via “power-by-the-hour” agreements, ensuring predictable revenue.
• Healthcare: Equipment pricing reflects oligopolistic market dynamics, with high margins on digital and service offerings. Contracts are typically multi-year, tied to equipment lifecycles.
• Energy: Power pricing is stable, supported by service contracts. Renewables face pricing pressure from Chinese competitors and PTC-driven project timing, leading to negative margins.
• Drivers: Pricing power stems from differentiation (Aviation, Healthcare) and mission-criticality. Renewables’ commodity-like market limits pricing power.

Bottoms-Up Drivers

Revenue Model & Drivers

• Aviation:
• Model: Razor-and-blade, with equipment sales driving multi-decade service revenue. ~50% of service revenue from “power-by-the-hour” contracts.
• Price: Engine discounts (50-70%) reduce upfront revenue but ensure service profitability. Service pricing is resilient due to FAA requirements and oligopoly.
• Volume: Driven by global air travel (RPKs), middle-income growth, and narrowbody demand. Double-digit growth expected near-term.
• Mix: Commercial aerospace dominates, with military engines smaller. Aftermarket services are high-margin.
• Healthcare:
• Model: Equipment sales with recurring service and digital revenue. AI and automation enhance margins.
• Price: High due to oligopolistic market and mission-critical equipment.
• Volume: Driven by aging populations, chronic conditions, and hospital investments. Low-mid single-digit growth.
• Mix: Imaging equipment leads, with digital offerings growing.
• Energy (Vernova):
• Model: Power: Turbine sales and services. Renewables: Turbine sales with limited services.
• Price: Power stable; Renewables pressured by competition and PTC cycles.
• Volume: Power stable; Renewables high single-digit growth but unprofitable.
• Mix: Power more profitable; Renewables drag margins.

Organic vs. Inorganic: Recent growth is organic, with divestitures reducing inorganic contributions. Bolt-on M&A expected in Healthcare.

Cost Structure & Drivers

• Variable Costs:
• Aviation: Engine production (materials, labor) and service delivery. Economies of scale from high volumes.
• Healthcare: Equipment manufacturing and software development. Moderate variable costs due to high margins.
• Energy: Turbine production (steel, components). Renewables face high variable costs due to large components and logistics.
• Drivers: Raw material inflation, labor costs, and supply chain efficiency. Renewables’ costs are elevated due to unprofitable contracts.
• Fixed Costs:
• Aviation: R&D (e.g., sustainable engines), manufacturing facilities, and regulatory compliance. High fixed costs drive operating leverage.
• Healthcare: R&D for AI and digital, plus manufacturing plants. Moderate fixed costs.
• Energy: R&D for renewables, turbine production facilities. High fixed costs in Renewables contribute to negative margins.
• Drivers: Operating leverage is strong in Aviation and Healthcare, weaker in Renewables due to losses.
• EBITDA Margin:
• Aviation: ~20%, driven by service revenue and operating leverage.
• Healthcare: High teens, supported by equipment and digital margins.
• Power: Mid-single digits, stable but lower than Aviation/Healthcare.
• Renewables: Negative mid-teens, due to high fixed/variable costs and pricing pressure.
• Cost Trends: Fixed costs (R&D, facilities) are significant across segments, but Aviation and Healthcare benefit from scale. Renewables require cost-cutting to reach breakeven.

FCF Drivers

• Net Income: Driven by Aviation and Healthcare margins, offset by Renewables losses.
• CapEx: ~$2.5 billion in 2000, not detailed recently but likely significant in Aviation (R&D for sustainable engines) and Renewables (offshore wind). Healthcare has lower capital intensity.
• NWC: Not detailed, but Aviation’s long-cycle contracts and Renewables’ project-based sales likely tie up working capital. Healthcare’s shorter cycles improve cash conversion.
• Cash Conversion: Healthcare (~100%) is the strongest converter. Aviation and Power are capital-intensive, reducing FCF. Renewables’ negative margins suppress FCF.
• FCF Trend: Declined from $13 billion (2000) to $2 billion, reflecting lower revenue, higher leverage, and Renewables’ losses.

Capital Deployment

• Organic Investment: Heavy focus on R&D (Aviation: sustainable engines; Healthcare: AI; Renewables: offshore wind).
• M&A: Bolt-on acquisitions in Healthcare (e.g., BK Medical). Historical M&A (e.g., Alstom for $10 billion, impaired by $22 billion) was value-destructive.
• Share Repurchases: $3 billion authorization, viewed favorably given perceived undervaluation.
• Dividends: Reduced from $5.4 billion (2000) to $535 million (2021). Healthcare expected to pay 35-60% of earnings post-spin; Aviation and Energy lower (15-50%).
• Strategy: Shift from aggressive M&A and buybacks under Immelt to organic growth and deleveraging under Culp.

Market, Competitive Landscape, Strategy

Market Size and Growth

• Aviation: Global commercial aerospace market driven by air travel (RPKs), growing with GDP per capita and middle-income expansion. Double-digit growth near-term due to post-COVID demand.
• Healthcare: Medical imaging and digital health market, growing low-mid single digits, driven by aging populations, chronic conditions, and hospital investments.
• Energy: Power market stable, tied to gas as a transition fuel. Renewables (wind) growing high single digits, driven by energy transition and PTCs, but competitive.
• Industry Growth Stack: Air travel tied to population growth and economic development; Healthcare to demographic trends; Renewables to policy incentives and decarbonization.

Market Structure

• Aviation: Oligopoly with GE/Safran, Pratt & Whitney, and Rolls-Royce. High barriers (scale, regulation) limit entrants. Minimum efficient scale (MES) is large, favoring incumbents.
• Healthcare: Oligopoly with Siemens Healthineers, Philips, and smaller players (Canon, Toshiba). High MES due to R&D and manufacturing costs.
• Energy: Power is oligopolistic (Siemens Energy, Mitsubishi); Renewables less so, with regional players (Vestas, Chinese firms). Lower MES in Renewables allows more competitors, pressuring margins.
• Traits: Aviation and Healthcare benefit from regulation and mission-criticality. Renewables face policy-driven cycles (PTCs) and pricing competition.

Competitive Positioning

• Aviation: Market leader in narrowbody engines (LEAP), with strong aftermarket moat. Positioned as reliable, high-scale provider.
• Healthcare: Strong player in imaging, gaining in digital/AI. Positioned for efficiency and patient outcomes.
• Energy: Power is competitive but stable; Renewables lag due to pricing and competition from Chinese firms.
• Risks: Renewables face disintermediation from low-cost competitors. Aviation and Healthcare are insulated by scale and regulation.

Market Share & Relative Growth

• Aviation: Significant share in narrowbody engines, growing faster than market due to travel recovery.
• Healthcare: Stable share, growing in line with market.
• Energy: Power holds steady share; Renewables losing ground to Chinese competitors.
• Trends: Aviation outpacing market; Renewables underperforming due to profitability challenges.

Competitive Forces (Hamilton’s 7 Powers)

1. Economies of Scale: Strong in Aviation and Healthcare, where large-scale production and R&D create cost advantages. Weaker in Renewables due to regional competition.
2. Network Effects: Limited, as GE’s businesses rely on physical products, not platforms.
3. Branding: Historically strong (Edison legacy), but diminished by mismanagement. Aviation retains reputation for reliability.
4. Counter-Positioning: Aviation’s “razor-and-blade” model is unique, locking in customers. Healthcare’s digital pivot differentiates it. Renewables lack counter-positioning.
5. Cornered Resource: Aviation’s LEAP engine and Healthcare’s imaging technology are proprietary, but Renewables rely on commoditized tech.
6. Process Power: Aviation’s service expertise and Healthcare’s AI integration create advantages. Renewables lack process-driven edge.
7. Switching Costs: High in Aviation (FAA oversight, long-term contracts) and Healthcare (equipment integration). Low in Renewables, enabling customer churn.

Porter’s Five Forces:

• New Entrants: Low threat in Aviation/Healthcare (high barriers); moderate in Renewables (lower MES).
• Substitutes: Low in Aviation (no viable engine alternatives); moderate in Healthcare (competing technologies); high in Renewables (solar, other renewables).
• Supplier Power: Moderate, as GE’s scale enables bulk purchasing, but Renewables face logistical costs.
• Buyer Power: Moderate in Aviation (airlines negotiate discounts); low in Healthcare (mission-critical equipment); high in Renewables (price-sensitive utilities).
• Rivalry: Low in Aviation/Healthcare (oligopolies); high in Renewables (fragmented, price-driven).

Strategic Logic

• CapEx Bets: Offensive in Aviation (sustainable engines) and Healthcare (AI); defensive in Renewables (cost-cutting to breakeven).
• Economies of Scale: Aviation and Healthcare achieve MES, enabling cost leadership. Renewables exceed MES, facing diseconomies (logistics, competition).
• Vertical Integration: Limited, as GE focuses on midstream manufacturing and services.
• Horizontal Integration: Bolt-on M&A in Healthcare to capture digital startups. Historical M&A (e.g., Alstom) was value-destructive.
• New Geos/Products: Renewables target global energy transition markets, but face Chinese competition. Aviation and Healthcare expand existing offerings.

Valuation

GE’s valuation is depressed due to “deal limbo” fears, past mismanagement, and Renewables’ losses. The market does not fully credit the sum-of-the-parts (SOTP) value of Aviation, Healthcare, and Energy post-spins. Aviation’s high margins and growth potential suggest a premium multiple, while Healthcare’s stability supports a mid-teens P/E. Renewables’ negative margins drag overall valuation. The podcast notes a $3 billion share repurchase authorization, signaling management’s belief in undervaluation. No specific P/E or EV/EBITDA multiples are provided, but the market’s focus on historical failures and spin-off risks suppresses the stock price.

Key Dynamics and Unique Aspects

GE’s business model is unique in its historical reliance on a conglomerate structure, which allowed cross-subsidization but led to inefficiencies. Key dynamics include:

1. Aviation’s Razor-and-Blade Model: Selling engines at a loss to capture multi-decade, high-margin service revenue is a powerful moat, reinforced by FAA oversight and oligopolistic market structure. The “power-by-the-hour” model ensures predictable cash flows, distinguishing it from commoditized industrials.
2. Healthcare’s Secular Tailwinds: Aging populations and digital integration (AI, automation) position Healthcare for stable growth and high FCF conversion, unlike capital-intensive industrials.
3. Renewables’ Competitive Pressure: Unlike Aviation and Healthcare, Renewables operate in a fragmented market with low switching costs and pricing pressure from Chinese competitors, limiting profitability.
4. Historical GE Capital Dependence: At its peak, GE Capital’s 60% earnings contribution masked industrial weaknesses, enabling short-term earnings management but leading to a 2008 liquidity crisis due to leverage and lack of deposits.
5. Cultural Hubris: Immelt’s aversion to bear cases and aggressive M&A (e.g., Alstom’s $22 billion impairment) reflect a culture that prioritized growth over risk management, a stark contrast to Culp’s lean, decentralized approach.
6. Deconglomeratization Trend: GE’s breakup reflects a broader market shift toward focused businesses, as conglomerates struggle to allocate capital efficiently across disparate segments.

Unique Interview Insights:

• GE Capital’s Role: The podcast emphasizes GE Capital’s outsized role in propping up earnings, a dynamic missed by investors during Welch’s era. This reliance on leverage, not managerial brilliance, drove GE’s peak valuation.
• Immelt’s Missteps: Immelt’s 16-year tenure is critiqued for poor capital allocation (e.g., $14 billion in ill-timed oil investments, $1.5 billion WMC penalty), contrasting with Welch’s short-termism. His Alstom acquisition, heralding a “golden age of gas,” ignored market trends, leading to massive impairment.
• Culp’s Lean Focus: Culp’s decentralized, lean management contrasts with GE’s historical centralized model, aligning each segment’s P&L with its own capital needs.
• Renewables’ Regional Divide: The geographic advantage in Renewables (logistical barriers to shipping turbines) is eroding as Chinese competitors gain ground, a risk underappreciated by management.

Conclusion

GE’s transformation from a sprawling conglomerate to a focused industrial player highlights the pitfalls of over-diversification and poor capital allocation. Aviation and Healthcare are well-positioned in oligopolistic markets with strong moats, while Renewables struggle with competition and profitability. The shift to a decentralized, lean model under Culp, coupled with planned spin-offs, aims to unlock value, but market skepticism and Renewables’ losses temper optimism. The podcast underscores the importance of aligning capital allocation with market realities and avoiding hubris, lessons critical for understanding GE’s rise, fall, and ongoing restructuring.

Transcript