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General Electric bounced back Friday after the CEO shored up confidence by purchasing a bulk of company shares, and analysts defended the industrial giant.
GE’s stock surged more than 9% on Friday following its biggest drop since April 2008 a day earlier. The shares had tanked 11% on Thursday.
The stock began its downward spiral Thursday morning after Harry Markopolos, best-known for pointing out irregularities with Bernie Madoff’s investment strategy years before the Ponzi scheme was exposed, published a report accusing GE of fraudulent financial statements.
Larry Culp, who took over the struggling industrial conglomerate last year, bought 252,200 shares for $7.93 each, according to a Thursday evening filing with the SEC. The CEO has roughly doubled his holding of GE shares this week.
In the 175-page report, Markopolos accused GE of $38 billion in accounting fraud — “bigger than Enron and WorldCom combined.” He outlined a “long history” of accounting fraud at GE, dating to as early as 1995, when it was run by Jack Welch.
“It’s going to make this company probably file for bankruptcy,” Markopolos told CNBC’s “Squawk on the Street ” on Thursday. “WorldCom and Enron lasted about four months. … We’ll see how GE does.”
A U.S. hedge fund, which Markopolos wouldn’t name, paid Markopolos to conduct the report. Markopolos told CNBC that he was getting a “decent percentage” of profits that the hedge fund would make from betting against GE.
Culp, who is a former CEO of Danaher, said the accusations were false, and driven by incentives to profit off of GE’s stock drop.
“GE will always take any allegation of financial misconduct seriously. But this is market manipulation – pure and simple,” he said in a statement. “Mr. Markopolos’s report contains false statements of fact and these claims could have been corrected if he had checked them with GE before publishing the report.”
Leslie Seidman, a GE board director and chair of its audit committee, also pushed back on the Markopolos report, which she said contained “numerous novel interpretations and downright mistakes about the actual accounting requirements.”
“In his own words, he stands to personally financially benefit from today’s significant market reaction to his report,” she said Thursday. “He is selectively front-running widely reported regulatory processes and rigorous investigations without the benefit of any access to GE’s books and records.”
Wall Street sides with GE
Equity analysts didn’t seem convinced that Markopolos had a bulletproof case, either.
Nick Heymann, co-group head of global industrial infrastructure at William Blair, said it was hard to believe that GE had fraudulently misrepresented its financial reporting — especially after engaging with several regulatory reviews of its accounting and financial disclosures for over two years.
“As such, we tend to find the effort to portray GE’s current financial condition assuming all three alleged cash or noncash charges totaling ~$38 billion should have been previously recognized is at best disingenuous and at worst highly inaccurate,” Heymann said in a note to clients Thursday.
Citi research analyst and managing director Andrew Kaplowitz also backed GE, telling clients that while analysts were “still digesting” it, the report had “sufficient shortcomings” and Citi continues to believe in Culp’s ability to improve the company over time. Kaplowitz pointed to Culp’s share purchases in the open market Thursday, which reflected “high conviction that the allegations do not represent incremental unknown challenges.”
“The 175 page report seems sensationalized and according to press reports the author appears to have a financial interest in a GE stock decline given a partnership with an undisclosed hedge fund,” Kaplowitz said in a note to clients Thursday. “Overall, we think that some of the allegations were already known and others ‘known unknowns,’ which lead us to retain our conviction in the potential for share price outperformance over time.”
Jim Corridore, equity analyst at CFRA Research, highlighted Markopolos and the anonymous hedge fund’s motives to profit from the stock’s decline.
“We have confidence in the increased openness in GE’s accounting under Larry Culp’s leadership after years of financial opaqueness under Jeff Immelt, when GE’s problems were created,” Corridore said. “We think GE is moving towards improving its balance sheet and think it has ample liquidity and access to capital markets to continue running its businesses and restructuring.”
The struggling industrial conglomerate abruptly removed its former Chairman and CEO John Flannery in 2018 after only a year on the job and installed Culp as his successor. Flannery had been appointed in August 2017, taking the reins from Jeff Immelt as GE’s stock steadily eroded.
To be sure, some on Wall Street still have questions after the report.
Jay Gelb, managing director and senior insurance equity research analyst at Barclays, said he was not currently in a position to say whether Markopolos’s GE shortfall reserve estimate was reasonable, “although it is certainly concerning.”
One area Markopolos’ report focuses on is GE’s long-term care insurance unit, for which the company had to boost reserves by $15 billion last year. By examining the filings of GE’s counterparties in this business, Markopolos alleges that GE is hiding massive losses that will only increase as policyholders grow older. He claims that GE has filed false statements to regulators of the unit. Separately, he goes on to find issues with GE’s accounting for its oil and gas business Baker Hughes.
Bank of America analyst Andrew Obin said the allegations appear to cover similar ground as ongoing investigations by the Securities and Exchange Commission, Department of Justice and existing shareholder lawsuits. While the firm’s valuation already assumes meaningful downside in GE’s long-term insurance business, given the current levels of U.S. interest rates, they now have a more “conservative assumption around the discount rate of insurance.”
Bank of America lowered its price target by $1 on Friday, citing ongoing market pressure on growth and margins in its power business, “execution issues” outside of power and bigger-than-expected capital requirements at GE Capital.
— CNBC’s Michael Bloom contributed reporting.