GE's Rollover Risk Supports Short Trade

by: Rakesh Saxena October 24, 2008 | about stocks: C / GE    

Rakesh Saxena

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In an analyst conference call on October 10, General Electric’s (GE) Chief Financial Officer, Keith Sherin, denied any plans to tap the Federal Reserve Bank’s commercial paper facility, unless the market situation became particularly adverse. Yesterday, GE announced that it has registered to be part of the funding program due to be launched this Monday. Essentially, issuers like GE and Citigroup (C) are now relying on the government to stay alive; it’s as simple as that.

The GE announcement stated that it is authorized to access the Fed commercial paper window since its commercial paper continues to be highly rated by Standard & Poor’s and Moody’s. The fact is that GE was due for a downgrade today if the Fed did not come up with the cash; the ratings are supporting access to cash (estimated to be in region of $50-60 billion) which, in turn, is justifying the rating itself. Besides GE, there is good reason to believe that this defer-the-problem, rating-cash-rating cycle will be evident throughout the Fed’s $1.7 trillion 90-day commercial paper spectrum.

Without a doubt, borrowing short and lending (or investing) long has been an acceptable corporate strategy, and a significant contributor to corporate profits, for well over three decades. And US dollar - third currency interest rate differentials have been producing regular profits for corporations like GE and Citigroup.

But, for far too long, corporate and bank balance sheets have shown a diminished recognition of rollover risk, i.e. the risk of participants in a commercial paper programme withdrawing their commitments to purchase freshly issued paper upon the expiration of an earlier series. More specifically, in an era of continuous expansions in corporate business models, financial statements have failed to adequately disclose whether assets themselves are inherently proving up debt service capability, or whether debt obligations are being met, in part or whole, from new share issues and from new debt.

Rollover risk is not a risk which has received much attention from risk pricing and risk insurance specialists. Firstly, yields on commercial paper are generally presumed to reflect the distinction between quality and non-quality credits. And, secondly, buyers of commercial paper have looked to the rating agencies for guidance.

For the record, rating agencies, by their own tacit admissions of late, failed to focus on the perils of leverage and the merits of superior capital adequacy ratios.

On the surface, the Fed’s activity in the commercial paper market is deemed to be a temporary phenomenon. How temporary, only time will tell. In reality, on closer scrutiny, this assistance package amounts to nothing less than a blatant subsidy provision for elite American corporations whose business models (and balance sheets) are unable to respond to the challenging global economy, and to the prospects of an extended domestic recession. Socialism should not be a bad word anymore.

Investors in GE can expect additional dilution in 2009. That, in the face of serious questions regarding the quality of GE’s huge emerging market commitments in view of the recent turmoil, sets the basis for a perfect short trade, perhaps through puts, even at Thursday’s closing levels. Remember that Warren Buffett has a 10 percent dividend to fall back on, and his option to buy stock at $22.25 is valid for a full five years with anti-dilution protections. So don’t just go and buy because Warren bought.

Disclosure: Short GE, no position in C

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This article has 11 comments:

  •  
    Oct 24 08:20 AM
    Wow! This is entirely self-serving for the shorty. And, perhaps, he will make money. GE is trading like a bank, albeit a good one like BAC. If you plot them, over the last year they have traded very similarly. However, financials are about 50% of GE. The other half is an industrial machine. The other half has, so far, not done badly. Certainly, not badly enough to be done nearly 50%. So, I think this devaluation of GE is over-done. I think Ge should be down about half of a bank, or 20 to 25%. I, consequently, think the bad news is already in the price.

    Of course, this morning, futures are way down. So, maybe the market is telling me something different.
    Reply | Link to Comment
  •  
    Oct 24 08:40 AM
    Hi epeon, my thoughts exactly. This AM welcome to the unwind of the hedge fund. We watch gold and oil, both down and on the announcement by OPEC. Only reason is redemptions, redemptions, redemptions. Keep in mind that money will eventually go somewhere. My guess equities. Lots of good companies at book. Buy carefully but now is the time.
    Reply | Link to Comment
  •  
    Oct 24 09:06 AM
    So the companys are getting back up to lend money to businesses that could go under at any time. Do you blame them ?
    If businesses and commerical paper is going bad I would not loan without governmnet backing either .
    Maybe businesses should not have borrowed so much money or taken so much out of their company as profit to aviod higher taxes in the years to come.
    Reply | Link to Comment
  •  
    Oct 24 09:24 AM
    Rakesh you are absolutey right, the only thing that will save companies like GE and Citigroup is whether the government choses to to save them with public money.
    GE has been brutal in the way they have lent money to the down and outs here in Australia and I presume everywhere else and it is all coming home to roost.
    Gee even Butffet missed that fact, not just all the pumpers and apologists for companies like this.
    Reply | Link to Comment
  •  
    Oct 24 10:15 AM
    Wow, you might want to look at some actual numbers. Stock trading at 8x and paying a 7% dividend yield, plus half of it is industrial business. On top of that, you give no evidence of what the dollar amount or percentage impact would be from supposed rollover exposure. I wouldn't touch this as a short - valuation seems reasonable, paying a fat divididend yield (that a short has to pay out to the borrowee), and so far confirmed ratings. You might want to consider that the Feds asked GE to buy into the facility so that it gave the facility more credibility. PLUS, if I were GE, I would access all the sources of capital I could, regardless of how much I needed it. Why play a company like GE that could get flight to quality bids as this thing unwinds and it hits its earnings, when there are still plenty of banks that will be taken over by the government (to wit, JPM, C and FITB, among others).
    Reply | Link to Comment
  •  
    Oct 24 10:22 AM
    No suprise, when Congress allows "naked shorts" and retracts the "up-tick rule" the stock in firms like GE will yo-yo on a daily basis. This market needs to replace the rules that slow the swings so the investors can evaluate the stocks and start buying based on fundementals.
    Reply | Link to Comment
  •  
    Oct 24 10:38 AM
    Hi, this is Russell Wilkerson from GE. We have continued to fund our short term debt needs in the commercial paper market without disruption. We are a Triple-A-rated company and your statement that "GE was due for a downgrade today if the Fed did not come up with the cash" is wrong. GE doesn’t “borrow short and lend long.” GE's strategy for many years has been to match-fund our assets in terms of duration, currency and rate.

    Our decision to access the CPFF is good for our customers and good for the market. Here is a link to information on our decision to access the CPFF facility. www.gereports.com
    Reply | Link to Comment
  •  
    Oct 24 11:55 AM
    Go ahead and short! I will enjoy the profit when you are scrambling to cover.
    Reply | Link to Comment
  •  
    Oct 24 10:26 PM
    Nice takedown Russell

    I still like it despite it's done the worst of any stock I own
    Good luck with the short, I look forward to the squeeze.
    Reply | Link to Comment
  •  
    Oct 25 01:04 PM
    Thanks Russell. I will go through the financial statements again, particularly on the "maturity mismatch" issue, and change my position if need be. -Rakesh
    Reply | Link to Comment
  •  
    Nov 02 08:36 AM
    Rakesh has given good reasons to short GE [see article] and the overall macro background and share price behavior seems to favour shorting. Does not mean betting the farm on shorting, but as a trade with stop loss it is quite logical.
    Reply | Link to Comment
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