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Dow Jones drops GE: The whys and hows

  Although it was known that GE as a company hadn't been performing well, it was still a shock when the over 120-year old company was dropped from the Dow Jones list. Naturally, it wasn't an overnight occurrence, but rather a chain of events, some unavoidable, others unfortunate.  

Dr Suresh Srinivasan

The Dow Jones Industrial Average (Dow) is a group of 30 company shares that is intended to represent the overall performance of large US companies, in the US stock market. Ideally, the Dow is intended represent stocks across all industry sectors such that the performance of the Dow reflects large capitalised stocks, as a whole. Dow is a price-weighted index, and not a market-cap-weighted index such as the S&P 500. This means that it places more emphasis on the share price of the stock. In effect, with Dow, member companies with a higher share price will have a larger influence on the index and its movement.
General Electric (GE) was part of Dow index for more than 120 years, and was the oldest member of the Dow. In June 2018, GE was replaced by Walgreens Boots Alliance, and GE was kicked out. This is a historic development, where the curtains fall on a stellar legacy.
GE enjoyed an extremely unique position in corporate America and the world. Considered a hotbed for grooming leadership, GE’s managers eventually took over most of the American corporates; that was the reputation GE enjoyed in creating world class leaders. In fact, there have been several case studies written at universities like Harvard focusing on GE and its managers’ leadership capabilities.

The beginnings
In 1889, scientist Thomas Edison, along with all his patents and inventions like the electric bulb, and with J.P. Morgan bringing the financial power and expertise, together executed a series of acquisitions that eventually set up the company Edison General Electric Company. This again went through a series of acquisitions, and in 1896, GE was one of the original 12 companies listed on the newly formed Dow Jones Industrial Average Index.

Recent history
Unfortunately, GE’s per-formance in recent years has been deteriorating, and the company was no longer being considered to be a good representation of the large capitalised stock market. This is one of the reasons why GE was removed from the Dow index. At the time of removal, GE wasn’t the worst performer within Dow in terms of market capitalisation, but was actually the 8th from the bottom.
However, GE had the lowest stock price among all the Dow members. The highest share price in the Dow was Boeing’s, at more than 20 times that of GE. This too was another reason for removing GE from the Dow ranks, as there is a defined extent to which the disparity between the highest and lowest share price is tolerated; obviously, in case of GE, the line had been crossed.
Eventually, when removed, GE’s share price was close to $13, and its influence on Dow was less than 0.5%. However, Walgreen Boots, which replaced GE in Dow, had a share price of close to $70, and its share price movements were quite stable, in contrast to GE’s share price that was showing a deteriorating trend.

The unexpected start of the decline
The natural question to be asked is how such a historic company with such a long legacy could have arrived at such a state of affairs.
Jeff Immelt took over GE after Jack Welch as the CEO of the company in 2001, four days before the 9/11 attacks. The GE Immelt inherited from Welch was a highly diversified company in a conglomerate form, including financial services as a large business. All these businesses were, in a combination, performing well as a conglomerate. However, things started to change quite dramatically and swiftly after 9/11.
The terrorist attack on New York’s twin towers sent the global economy into a virtual spin. The GE businesses were one of the worst hit — the airplanes, one of them powered by GE engines, crashed into the World Trade Center towers, which were insured by GE Capital. Air travel demand contracted violently, crippling GE’s business as the world’s largest lessor of aircrafts. All other industrial businesses took a steep dive and did not recover for the next 24 to 36 months. The performance of many big corporates declined, and GE bore the brunt on account of being a very highly diversified company.

Risk mitigation didn’t help
Immelt tried hard to unwind the excessive diversification of the company from the Jack Welch days. He divested the plastics business, home appliances and financial capital businesses. Not only were these considered good and bold moves, but they also brought the company into the more focused industrial identify that Thomas Edison would have been proud of. Such divestures which Immelt spearheaded were bold and highly challenging, but expectedly got the wrath of shareholders, employees and the markets as a whole, all of whom did not appreciate the downsizing of the company.
Immelt also carried out a number of technology acquisitions to support GE’s industrial capabilities, including the Alstom acquisition. However, some of his smaller acquisitions were criticised for being paid an exorbitant price. Particularly, his acquisition of explosive detection company Ion Track, subprime mortgage firm WMC, his many oil and gas acquisitions including Baker Hughes, were severely criticised for very high payouts, which the shareholders were unhappy about.
These large scale divestments, high priced acquisitions and poor performance resulting from poor cash flows exerted severe liquidity issues. However, Immelt must be admired for executing deals worth $100 billion of buying and divesting businesses, which very few other CEO, if any, would have ever done in his career.

The coming of the inevitable
It is well known that the risk in every such high stakes deal is significant, and even though the number of deals and the direction they took the company were celebrated, a few deals didn’t turn out to be healthy, and elicited the dissatisfaction of the shareholders. The not-so-great performance of the company in difficult market conditions did help Immelt either.
The markets were also unhappy with the fact that under Immelt, a succession plan was not transparent. Given that he had been leading the company for over 16 years, the markets wanted to know who was being groomed to take over from Jeff Immelt.
GE’s bonds, which were rated triple-A, the gold standard, when Immelt became chief, were now rated five tiers lower at A2, and being traded at prices more consistent with a Baa rating, just one notch above junk bonds. Finally Immelt had to leave, and it was very unfortunate that the shareholders, investors and the market celebrated on the day of his departure announcement, with even GE stock prices going up on that day.

The current reality
However, the downfall had already begun, and with the new leadership of John Flannery, the company continued to lose. Flannery is suggesting that GE might be more valuable in pieces, and has recommended that the company be broken down and run piecemeal, which could possibly unlock value better than as an integrated unit.
Although it is a sad moment for GE enthusiasts, these events provide enormous learning for corporates and management students. Your success in the past is by no means an indicator or barometer for your future well-being. Companies have to strongly reinvent themselves for decade after decade, and cope successfully with changing market conditions, address new customer requirements and embrace evolving technologies ahead of the competition.

Dr Suresh Srinivasan is a Chartered Accountant, has an MBA (Bradford UK) and a Doctorate in Strategy. He is the Director of the 2-year PGDM at Great Lakes Institute of Management, as well as a Professor (Strategy & Accounting). He is also a management consultant.