Here’s what the GE HealthCare spin-off means for investors
General Electric (EG 1.82%) is about to change forever. The first major part of the conglomerate breakup will come in early 2023 with the GE HealthCare spin-off. This will be a critical event for GE for several reasons, so let’s take a look at them and try to decipher what this means for investors.
GE’s disruptive plan
Following the company’s separation of GE HealthCare, management plans to combine the GE Renewable Energy and GE Power segments into a single company. In early 2024, this too will be spun off as GE Vernova. The remaining business will focus on aerospace and will be renamed – wait – GE Aerospace. GE Aerospace will retain a 19.9% stake in the healthcare spin-off. He could liquidate some of that stake later to reduce debt or (as management put it in the investor update detailing the breakup plan) “to optimize each company’s capitalization.”
This is a critical point as management intends to ensure that these three GE companies emerge from the split with higher quality debt – and debt-to-earnings metrics play an important role in these debt ratings. Unfortunately, a potential problem here is that GE Vernova’s future business has revenue issues. 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 profits this year. Simply put, management will need to ensure that it exits GE Vernova with an acceptable level of debt, which may require a contribution from GE HealthCare. Additionally, GE shareholders will want the best price from the spin-off.
Strong market position
GE HealthCare is already an $18 billion revenue business that management expects will grow at a mid-single-digit percentage rate over time and generate profit margins in the 10-20% range. Its core imaging business (X-ray machines, MRI scanners, etc.), generated $10 billion in revenue in 2021 in a $23 billion market. Next came ultrasound, which generated $3 billion in sales in a $7 billion market, followed by “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). Among its main competitors are Siemens Healthineers and Phillipsbut as the numbers above reflect, GE has particularly strong positions in the imaging and ultrasound markets.
A demanding year 2022
It hasn’t been an easy year for GE and its rivals. It started with the spikes in the delta and omicron variants, which negatively impacted medical equipment deployments in hospitals. Then all three companies were hit by China’s “zero COVID” lockdowns, which exacerbated already existing supply chain challenges around the world. This last problem persisted. So, for example, Siemens Healthineers reported supply chain delays as the cause of lower molecular imaging and ultrasound revenue in its most recent quarter. Meanwhile, Philips said 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 he wanted.
GE HealthCare was not spared. In its second-quarter earnings report, released in July, management told investors they expected “about $3 billion” in segment earnings for the year, “slightly lower than previous guidance.” In its Investor Day presentation in March, management told investors to expect segment profit in the range of $3.1 billion to $3.3 billion.
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 estimated 2023 EBIT. Plugging GE HealthCare’s estimated 2022 earnings of $3 billion into Siemens Healthineers’ multiple for that year gives the future independent company an enterprise value (calculated as market capitalization plus net debt) of $59.1 billion.
However, shares are not valued solely on current corporate earnings, and GE HealthCare management expects its margins to rise significantly in the second half of 2022 as supply chain issues ease. . To hit that $3 billion full-year target would require about $1.8 billion in profit on about $9.7 billion in second-half sales, implying an 18.5% margin for that year. period.
When the fallout occurs, the crucial question will be what will the 2023 revenues be? Assuming another year of revenue growth in the single-digit percent range and some margin expansion (as previously forecast by GE management), GE HealthCare could generate $19.5 billion in revenue next year. with a 19% margin, giving him $3.7 billion in winnings. Based on Siemens Healthineers 2023 EV/EBIT ratio, this would give GE HealthCare an enterprise value of $65 billion.
What it all means
There is a big difference between an enterprise value of $59 billion and $65 billion. GE HealthCare’s position in this range could be heavily dependent on its margin performance in the second half of 2022. Simply put, GE must meet its healthcare guidelines for the rest of the year. Plus, he needs to do this to allow GE HealthCare to take on more debt (remember EV is market cap plus net debt, and GE wants to ensure a successful spinoff) to lighten the load on GE Vernova in 2024 .
Lee Samaha has no position in the stocks mentioned. The Motley Fool has no position in the stocks mentioned. The Motley Fool has a disclosure policy.