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Plan to Shrink GE Capital a Needed Shot in the Arm for GE

Shareholders will be rewarded with higher quality earnings going forward as GE takes the next step in transforming the company, writes Morningstar’s Barbara Noverini.

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By announcing the $26 billion sale of its real estate portfolio this morning to Blackstone,  General Electric (GE) revealed an aggressive new plan to shrink GE Capital even further by 2018, marking an important milestone in the company's portfolio transformation. In addition to shedding nearly all of GE Real Estate, management indicated that the commercial lending and leasing segment, GE Capital's largest business, is next in line for divestment, along with any remaining consumer lending platforms. GE Capital ended 2014 with over $360 billion of invested capital on its books (referred to as ending net investment, or ENI) just shy of GE's original $350 billion target. Successful execution of this next phase will decrease ENI to about $90 billion over the next two to three years, leaving just the specialty finance verticals that complement GE's aviation, energy, and health care segments. We view this development as the shot in the arm that GE shares have sorely needed. Combining the  Synchrony (SYF) split-off with the estimated proceeds from this next round of divestments, GE shareholders can expect nearly $90 billion in capital returned.

Long viewed by the market as the primary source of risk in General Electric’s portfolio, we believe management can now fully focus on GE's stalwart industrials portfolio, which we believe is poised to benefit in the near-term from increased investment in R&D that has revitalized the company’s industrial products portfolio. With 90% of General Electric's earnings expected to originate from its wide-moat industrial businesses by 2018, we believe shareholders will be rewarded with higher quality earnings going forward. We plan to incorporate this new information into our discounted-cash flow model, including about $6 billion in cash costs related to the business exits, and a higher consolidated tax rate going forward. However, we expect that any impact to our current fair value estimate of $30 per share will be neutral to positive.

Barbara Noverini does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.