General Electric (NYSE: GE) is about to change forever. The first significant part of the conglomerate's breakup will occur in early 2023 with the spinoff of GE HealthCare. That will be a critical event for GE for several reasons, so let's take a look at them and try to decipher what it means to investors.
GE's breakup plan
After the company spins off GE HealthCare, management plans to combine the GE Renewable Energy and GE Power segments into one business. In early 2024, that, too, will be spun off under the name GE Vernova. The remaining business will focus on aerospace and will be renamed -- wait for it -- GE Aerospace. GE Aerospace will retain a 19.9% stake in the healthcare spinoff. It could liquidate some of that stake later to reduce debt, or (as management said in the investor update detailing the breakup plan) "optimize capitalization of each business."
That's an essential point because management intends to ensure that all three of these GE companies come out of the split with investment-grade debt -- and debt-to-earnings metrics factor heavily into those debt ratings. Unfortunately, one potential problem here is that the future GE Vernova businesses have earnings challenges. For example, GE Renewable Energy is currently loss-making (it lost $853 million in the first half of 2022), while GE Power is on track to make between $1 billion and $1.2 billion in profit this year. Simply put, management will need to ensure it spins off GE Vernova with an acceptable level of debt, and that may require a contribution from the GE HealthCare stake. Moreover, GE shareholders will want the best price from the spinoff.
Strong market position
GE HealthCare is already an $18 billion revenue business that management believes will grow at a mid-single-digit percentage rate over time and deliver profit margins in a high-teens to 20% range. Its core imaging business (X-ray machines, MRI scanners, etc.), generated $10 billion in revenue in 2021 in a market worth $23 billion. Next comes ultrasound, which generated $3 billion in sales in a market worth $7 billion, then "life care solutions" ($3 billion in revenue in an $8 billion market), and finally pharmaceutical diagnostics ($2 billion in revenue in a $10 billion market). Its leading competitors include Siemens Healthineers and Philips, but as the numbers above reflect, GE has particularly strong positions in the imaging and ultrasound markets.
A challenging 2022
This has not been an easy year for GE and its rivals. It began with the delta and omicron variant spikes, which negatively impacted medical equipment deployments to hospitals. Then, all three companies were hit by China's "zero COVID" lockdowns, which exacerbated already-existing supply chain difficulties around the world. The latter issue has persisted. So, for example, Siemens Healthineers pointed to supply chain delays as the cause of its declining molecular imaging and ultrasound revenue in its most recently reported quarter. Meanwhile, Philips said that revenue from its ultrasound and diagnostic imaging businesses fell in the second quarter in part because it was unable to source all the electronic components it needed in the quantities it wanted.
GE HealthCare hasn't been spared. In its second-quarter earnings report, released in July, management told investors to expect "approximately $3 billion" in segment profit for the year -- "slightly below prior outlook." In its Investor Day presentation in March, management had told investors to expect a segment profit in the $3.1 billion to $3.3 billion range.
Valuation matters
Based on Siemens Healthineers' valuation, a rough estimate of GE HealthCare's future valuation gives it an enterprise value (EV) of between $59 billion and $65 billion. For example, Siemens Healthineers trades at an EV-to-EBIT (earnings before interest and tax) ratio of 19.7 based on 2022 estimates and a forward ratio of 17.6 based on 2023's estimated EBIT. Plugging GE HealthCare's estimated 2022 profit of $3 billion into the Siemens Healthineers multiple for this year gives the soon-to-be independent business an enterprise value (calculated as market cap plus net debt) of $59.1 billion.
However, stocks aren't priced just on companies' current earnings, and GE HealthCare's management expects its margins will expand significantly in the second half of 2022 as supply chain issues ease. To hit that full-year $3 billion target would require about $1.8 billion in profits on roughly $9.7 billion in sales in the second half -- implying a margin of 18.5% for that period.
When the spinoff happens, the critical question will be what will 2023 earnings be? Assuming another year of revenue growth in the mid-single-digit percentage range and some margin expansion (as predicted by GE management previously), GE HealthCare could take in $19.5 billion in revenue next year with a 19% margin, giving it $3.7 billion in earnings. Based on Siemens Healthineers' 2023 EV-to-EBIT ratio, that would give GE HealthCare an enterprise value of $65 billion.
What it all means
There's a big difference between an enterprise value of $59 billion and $65 billion. Where GE HealthCare falls within that range could be highly dependent on its margin performance in 2022's second half. Simply put, GE needs to meet its healthcare guidance for the remainder of the year. Furthermore, it needs to do so to enable GE HealthCare to take more debt with it (remember that EV is market cap plus net debt, and GE wants to ensure a successful spinoff) to lighten the load for GE Vernova in 2024.
10 stocks we like better than General Electric
When our award-winning analyst team has a stock tip, it can pay to listen. After all, the newsletter they have run for over a decade, Motley Fool Stock Advisor, has tripled the market.*
They just revealed what they believe are the ten best stocks for investors to buy right now... and General Electric wasn't one of them! That's right -- they think these 10 stocks are even better buys.
*Stock Advisor returns as of August 17, 2022
Lee Samaha has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
