April 11, 2015

GE’s Decision to Divest GE Capital

On Friday, April 10, 2015, GE announced that it would be divesting most of the assets of GE Capital.  The investment community reacted extremely positively, since GE’s stock price increased by 11% in one day.

I made a similar decision for Pitney Bowes, thanks to the strong recommendation of my Chief Financial Officer Bruce Nolop in early 2003.  It took me three years to complete the sale of Pitney Bowes’ Capital Services business to Cerberus Capital, but we completed the sale in July 2006, well in advance of the financial crisis.

At the time I made this decision, we had several warning signs that this was not a good business to retain, but, except for occasional extraordinary gains and losses, it produced high profits, high cash flows, and an acceptable return on invested capital.  It was exceptionally well managed from top to bottom, and I enjoyed with every member of the team.  I regretted having a number of very dedicated employees leave the company.

Nevertheless, this was one of the best decisions I made during my 11-year tenure as CEO, and I particularly thank Bruce Nolop for supporting me strongly the entire time.  It was not an easy process, and the difficulty we experienced during the exit process was symptomatic of why the business was not one in which Pitney Bowes or any other industrial company should have been competing.

In the three-year period from when I concluded we needed to sell the business to when we completed the sale, we were subjected to an “audit” of transactions which, based on well-intentioned, but misdirected, accounting rules, were in our financial statements as far back as five years before the year in which we expected to exit the business.  Our auditors, Price Waterhouse Coopers, dug into the documentation of long-term leases and other financing transactions that we had done as far back as the 1980’s.  For many of these transactions, their work papers had been routinely destroyed after 10 years and our documentation was incomplete.

The end result of this process was that almost every month during this year we would be told that a particular transaction had to be “reclassified” in terms of the timing of income and expense recognition.  It did not change the amount of income we recognized or challenge the total accuracy of how much revenue and income we reported, but it adjusted the timing of both revenue and income, usually to a future year.   PWC’s actions played unnecessary havoc with our financial reporting, and needlessly made us look like we had done sloppy accounting in the 1980’s and early 1990’s.

Many of the PWC findings reflected more of a desire to be conservative and compliant than to make sure that the financial statements were clear and consistent over time.  I empathize more with them today than I did then, because what they were doing reflected a regulatory bias toward having accountants exercise what the Public Company Accounting Oversight Board calls “professional skepticism.”  They were also operating under a fear of criminal prosecution, as were all the other public accounting firms, because of the government’s prosecution of Arthur Anderson.

All that being said, what the horrible exit process taught me is that financial services businesses are heavily shaped by tax and accounting financial engineering.  There are legitimate and socially beneficial purposes for financing businesses like Pitney Bowes Capital Services and GE Capital.  I was proud of the transactions we did to enable postal services to acquire capital equipment, or real estate developers to build a skyscraper like the BellSouth building in downtown Nashville, or transit systems like New South Wales Rail in Australia to buy railcars.  We added great value to businesses and governments, as has GE Capital.

However, the temptation of business people to squeeze extra revenue and income out of a financial services business to meet demanding shareholder earnings guidance led most financial services businesses, including Pitney Bowes, to take excessive risks from time to time.  These temptations were made even more attractive by tax incentives like the investment tax credits available during the 1980’s, which were like the proverbial apple in the Garden of Eden: they were irresistible temptations to sin.

In the 1980’s, most financial services companies and financial services divisions of non-financial companies like Pitney Bowes and Walt Disney hurriedly did long-term leases of assets like domestic commercial aircraft that burdened company leaders years after those who benefited from the earnings those leases generated left their respective companies. Those 1980’s era leases led to huge one-time losses for many companies, including Pitney Bowes, in 2002, when both US Airways and United Airlines filed for bankruptcy and the other major US domestic carriers threatened bankruptcy filings.

I wanted to sell these domestic aircraft leases when I became the President of Pitney Bowes Financial Services in 1993, but found out that those transactions were like Hotel California in the Eagles’ song: you could not leave them.  The penalties for selling or exiting them before the end of their average 24-year terms were punitive.

I give Jeff Immelt a lot of credit for making the decision to exit this business, even though he probably should have done it years earlier.  Even though the logic for Pitney Bowes’ exit from the business was more compelling than it was for GE Capital, there were members of my leadership team who were unenthusiastic about exiting our Capital Service business.  After all, we sacrificed revenue, income, cash flow, and financial flexibility by exiting our business.  The tangible, short term negatives of exiting were clear and quantifiable; the risks of staying in the business, although arguably much larger, were not. Whether we could take the cash and redeploy it to produce comparable revenue and income was uncertain.  As obvious as the merits of the decision seem, it is not easy to do.

Many leadership teams are reluctant to divest a major business without buying one of comparable size.  The prestige of many leaders depends on how their company stacks up in the Fortune 500 rankings, which are based on revenues, not aggregate stock market value or profits.  Compensation consultants compare compensation base on companies of comparable revenues, not on companies of comparable shareholder value or profitability, since revenue comparisons are easier to do.

Besides having the exit reduce the financial risks to Pitney Bowes is that it forced the company to focus on producing value based on products and services its core customers needed.  Although Pitney Bowes went through a very challenging period after mail volumes collapsed in 2008 and 2009, it is building a strong foundation under Marc Lautenbach’s leadership in digital commerce.

GE is a great company that will benefit from this decision, just as Pitney Bowes gained much more long-term strength and viability from the decision I made over a decade ago.  We know many present and former GE employees, and wish them well as they change the direction of a company and move into an uncharted future.