ILMN - General Electric Proves Once Again It's A Deep Value Play With Latest Spin-Off News

Summary

• The management team at General Electric filed some valuable information regarding the upcoming spinoff of its healthcare operations.
• This new entity, GE HealthCare, is worth a significant amount of money, likely more than General Electric as a whole right now.
• This presents tremendous upside potential for investors moving forward.

In November of 2021, the management team at General Electric ( GE ) announced that they had decided to spin off two major parts of the conglomerate into separate publicly traded companies. This maneuver will turn the massive industrial business into three separate entities, serving as the cherry on top of the several other transactions the company engaged in over the past few years as it sought to reinvent itself. A great deal of uncertainty has surrounded this strategy, particularly when it comes to what these standalone companies will look like. As we near the end of 2022, management has finally started to make some much-needed filings aimed at clearing the air on these matters. And what data we have today thanks to the first significant filing is enough evidence to reveal just how undervalued General Electric as a whole is. Clearly, the company deserves the ‘strong buy’ rating I previously assigned it.

General Electric - A great enterprise

When the management team at General Electric decided to spin off its operations into three separate publicly traded firms, one of these companies was designated to be the health care operations of the firm. As of this moment, we know this entity as GE HealthCare, which will trade under the ticker symbol GEHC once the separation is made official in early 2023. We do not yet know how many shares investors in General Electric will receive, nor do we know what share price to anticipate. All we do know is that 80.1% of the stock outstanding in the enterprise will be distributed to common shareholders in the conglomerate, while the remaining 19.9% will be held by General Electric itself. This particular structure will allow the conglomerate to sell off its stake in the firm at whatever the market rate is, effectively allowing it to raise additional cash to pay debt down further and/or to have proceeds in order to reinvest in its core operations.

Thanks to the filing made by management on October 11th, we now have some much-needed clarity when it comes to what this standalone healthcare business will look like. For starters, the enterprise will be split up into four key segments. The first of these is being referred to by General Electric as its Imaging business. Through this unit, the company will provide a massive portfolio of scanning devices, clinical applications, service capabilities, and digital solutions for the imaging space. The firm has approximately 400,000 medical imaging systems installed globally, with areas of concentration including oncology, cardiology, neurology, nuclear medicine, orthopedics, women's health, pediatrics, surgery, and more. The company will supplement its imaging solutions with over 200 digital applications and software solutions, including artificial intelligence and advanced data science capabilities. Certain services it provides include those related to repairs, upgrades, and lifecycle management. The company also offers data integration services, equipment financing, education and training, and much more. This is the largest of the company's segments, accounting for 53.6% of the revenue generated by GE HealthCare and 39.1% of its profits. This is a rather large market opportunity for the company, amounting to $44 billion globally.

The next largest segment to pay attention to is the Ultrasound unit. Through this segment, the company provides ultrasound medical devices and solutions. Just like the Imaging business, Ultrasound has an installed base of around 400,000 devices. Its portfolio of offerings help to facilitate screening, diagnosis work, treatment, and monitoring of certain diseases. It also serves customers in a variety of fields, such as women’s health, cardiovascular, point of care, radiology, and more. The company's offerings also include online customer communities with over 75,000 users registered to access their platform. On top of this, the company has been tremendously innovative, even going so far as to develop the first 3D obstetric imaging device and the first handheld ultrasound. This particular unit accounted for 18% of the revenue generated by GE HealthCare and 27.9% of its profits during the 2021 fiscal year.

Coming in third, accounting for 16.6% of the company's revenue and 11.2% of its profits is the Patient Care Solutions unit. This particular unit provides medical devices, consumable products, digital solutions, and various services that aim to complement a care team's clinical expertise by taking clinical data that it collects, processing it, and using it for the purpose of visualization and clinical decision support. Particular use cases include patient monitoring, anesthesia delivery, maternal infant care, diagnostic cardiology, and more. And finally, we have the Pharmaceutical Diagnostics business. This unit acts as a leading supplier of diagnostic agents to the global radiology and nuclear medicine industry. The purpose here is to help clinicians assess patients in order to enable precise diagnosis and provide better therapy selection. Overall, their products are used in over 100 million patient procedures across the globe every year. The diagnostic agents that the company produces or complementary to its imaging and ultrasound devices, including other related technologies. This particular unit was responsible for 11.5% of the company's revenue and for 21.8% of its profits last year.

Over the past three years, GE HealthCare has posted consistent revenue growth, with sales climbing by 5.7% from $16.63 billion to $17.59 billion. When it comes to profitability, the picture has been a bit volatile. Net income grew from $1.52 billion in 2019 to $13.85 billion in 2020. But this was due to discontinued operations. In 2021, profits came in at $2.25 billion. This volatility makes other profitability metrics more useful when evaluating the company's health. For instance, operating cash flow rose from $1.84 billion in 2019 to $2.62 billion in 2020. During the 2021 fiscal year, it fell to $1.61 billion. But if we adjust for changes in working capital, then we would see a consistent uptrend, with the metric climbing from $2.25 billion in 2019 to $2.89 billion last year. A similar trend can be seen when looking at EBITDA. That metric ultimately rose from $3.15 billion to $3.80 billion over the same three-year window.

When evaluating results for the first half of the 2022 fiscal year compared to the same time last year, the picture is a bit more complicated. For instance, operating cash flow did improve, climbing from $8.69 billion in the first half of 2021 to $8.23 billion the same time this year. This growth was driven by a 7% rise in the Ultrasound business and a roughly 2% increase associated with the Imaging segment. The other two segments of the company actually declined year over year. But what makes the picture more complicated is the fact that stated results don't necessarily conform with pro forma results. For instance, in the second quarter of 2022, GE HealthCare generated net profits of $874 million. But on a pro forma basis, this would be reduced to $663 million. Overall though, there was a decline in profits and cash flows experienced this year relative to last year, driven largely by increased costs year over year.

One big question that investors are likely to want an answer to is what the enterprise might be worth once it's a standalone business. Based on data from the 2021 fiscal year and using balance sheet data from the first half of 2022, this should not be all that difficult a question to answer. As part of my analysis, I decided to look at five different players that are similar in nature to GE HealthCare. These firms can be seen in the table below. On a price-to-earnings basis, these companies ranged from a low of 34.3 to a high of 75.3. Using the price to operating cash flow approach, the range was between 28.4 and 105.4. And when it comes to the EV to EBITDA approach, the range was between 24.5 and 50.1.

In performing this analysis, I decided to remove the most expensive of the five companies from the list. Doing this, we end up with an average price-to-earnings multiple of 41.2, an average price to operating cash flow multiple of 33.5, and an average EV to EBITDA multiple of 28.8. If we were to assume that the standalone GE HealthCare were to trade at that average, we would see a market capitalization of $92.6 billion from a price-to-earnings perspective. The price to operating cash flow approach would yield a value of nearly $96.7 billion, and the EV to EBITDA approach would give us a value of roughly $101 billion.

To put this in perspective, the entire market capitalization of General Electric as a whole is $71.3 billion. So what this analysis suggests is that the rest of the enterprise, including the highly lucrative Aviation unit, has a negative value on a market capitalization basis. To be even more conservative, I then took the trading multiples of the cheapest of the prospects I compared the enterprise two. In this case, the market value would be between $77.1 billion and $84.6 billion. Once again, investors are receiving the health care operation, plus they will receive the rest of the enterprise for free. As another precaution, I then decided to look at the company from the perspective of its enterprise value divided by its operating cash flow. For the five companies I compared it to, the range was between 30.9 and 109.8. Taking the average of the four lowest, and multiplying that by the 2021 EBITDA generated by GE HealthCare, I would end up with a multiple of 28.8. And using the trading multiple of the lowest of the five comparable firms, I would get a multiple here of 24.5. So even in this scenario, shares of GE HealthCare look appropriately priced at levels that indicate the company as a standalone enterprise is worth far more than General Electric as a whole.

Takeaway

No matter how you stack it, the picture for General Electric looks fantastic. I do acknowledge that current economic conditions might weigh on the company. Having said that, the standalone healthcare business looks to be worth a tremendous amount of money at this point in time. Because of this, I do expect that, once the spin-off is completed, the value of both firms will be more accurately reflected. And ultimately, this suggests to me that General Electric is worthy of a ‘strong buy’ designation.

For further details see: