General Electric shares lost more than 11% of their value on 15 August 2019.The previous day’s close was $9.03. During hectic trading, with more than 400m shares changing hands (more than four times the previous day’s volume), GE touched a low of $7.65 (a drop of more than 15%) before closing at $8.01, registering its biggest one-day loss since 2008.
GE CEO Larry Culp responded by investing. He’s already been buying shares. He picked up 332,000 shares at an average of $9.04 on 12 August, taking his stake to more than 940,000 shares. Culp evidently saw the share price slump in the wake of Markopolos’ allegations as another buying opportunity. He purchased 252,200 shares for an average of $7.93 on 15 August.
Looking at some of the specific claims made by Harry Markopolos we outline below GE’s statement (italics) and Markopolos’ allegations:
GE Insurance: We believe that our current reserves are well-supported for our portfolio characteristics, and we undertake rigorous reserve adequacy testing every year. The future implementation of the GAAP insurance accounting standard does not align GAAP and statutory reserves as Mr. Markopolos alleges, but rather will be dependent on a number of variables that will not affect statutory accounting, which drives our funding requirements.
Markopolos alleges GE is ‘hiding massive loss ratios, the highest ever seen in the LTC insurance industry’. He adds: “According to industry data, approximately 86% of GE’s LTC claims are ahead of them and the accompanying losses are growing at an exponential and un-survivable rate. Of the $29 Billion in new LTC reserves that GE needs, $18.5 Billion requires cash immediately while the remaining $10.5 Billion is a non-cash GAAP charge which accounting rules require to be taken no later than 1QTR 2021. These impending losses will destroy GE’s balance sheet, debt ratios and likely also violate debt covenants.”
BHGE accounting: As a majority shareholder of BHGE, we are required to report BHGE on a consolidated basis under US GAAP, contrary to what Mr. Markopolos alleges. Further, consolidation of BHGE by GE includes additional disclosure of BHGE’s results made through BHGE segment results reporting in the notes to GE’s consolidated financial statements. BHGE is also a stand-alone SEC registrant with its own separate SEC filings under Form 10-Q and 10-K as a separate company. In the most recent 10Q, GE disclosed the loss upon deconsolidation of BHGE from a sale of our interest (taking us below our current majority position) would be approximately $7.4bn as of July 26, 2019.
Markopolos notes that GE sold 101.2m shares in BHGE in November 2018 which left it with 50.4% ownership and a $2.2bn pre-tax loss on the sale. He says: GE improperly continued to account for its shares in BHGE as a Non-Controlling Interest in 2018, despite the fact that the substance of GE’s BHGE’s holdings was now strictly an investment, a clear violation of FASB Accounting Standards Codification 810-10-25-38A “Recognition – Variable Interest Entities” and FASB SFAC No. 8, BC3.26’s “Substance over Form” Concept. However, if GE had treated it as an Investment, as accounting rules require, it would have incurred a $9.1 billion loss. Maintaining a 50.4% interest (non-controlling interest threshold) in BHGE is a sham transaction with no business purpose done solely so that GE can create the false impression that GE has a reason to keep $9.1 billion in losses off of its books in 2018.”
GE’s liquidity: Contrary to Mr. Markopolos’ allegations, GE continues to maintain a strong liquidity position, committed credit lines, and several executable options to monetize assets. The Company ended the second quarter with $16.9bn of Industrial Cash excluding BHGE, $12.5bn of liquidity at GE Capital and access to $35bn of credit facilities. As it relates to GE’s leverage targets, as the Company has previously stated during 2Q earnings, it expects to make significant progress towards these goals by the end of 2020.
Markopolos claims: “GE’s 2018 year-ending working capital was minus $14.3B with BHGE and minus $20.3B without! Knowing this was critical information for investors, lenders, vendors, retirees, and regulators it was a willful
“Do a word search on ‘working capital’ and you will see GE spreads out its discussion of working capital over numerous pages of their 10-K and only discusses changes in working capital, but never gives you a true picture of how dire their financial position is.
“There are three key risks to GE’s survival. First, a stiff recession after ten years of domestic economic growth, will see that the next chapter in GE’s history is Chapter 11. Second, in 2021 there isn’t going to be any positive cash flow, which is the fairy tale that GE’s new management team is pitching because an accounting rule change for insurance liabilities and significant under-reserving is going to cause GE to take $29 Billion in additional reserve hits for its Long-Term Care (LTC) liabilities. Third, assuming GE can avoid a recession and somehow borrow enough to fund its LTC liabilities, it will next face repaying its $107 Billion in debt and also covering its $27 Billion in pension liabilities. How is GE, a company that has almost no cash and which earned a total of only $14.9 Billion over the last seven years, going to out-earn over $160 Billion in liabilities with the operating business units it hasn’t already sold to stay afloat?
“Our final three questions are for KPMG, GE’s auditors for the past 110 years dating back to 1909: 1) What did you know? 2) When did you know it? and 3) Where’s your ‘Going Concern Opinion?’”