(Bloomberg) – John Flannery hardly needs any more headaches.
But at a time when General Electric Co. is facing what amounts to an existential crisis, a $31 billion deficit in its pension plan may complicate any turnaround that involves a breakup of the 126-year-old icon of American capitalism.
Divvying up the obligations won’t be easy. After all, GE owes benefits to at least 619,000 people. And retirees aren’t the only ones at risk. Ideally, breaking up a conglomerate as sprawling as GE would unlock value for shareholders, who have seen their stock fall 40 percent since the CEO took the reins from Jeffrey Immelt in August. Stronger divisions wouldn’t be dragged down by weaker ones, and each business would stand on its own financially.
Yet GE’s pension deficit has gotten so big, a misstep could risk leaving the separate units with commitments they ultimately can’t afford to pay.
“It can be difficult and tricky, especially when you’re substantially underfunded like GE,” said Georgeann Peters, a partner at BakerHostetler. “If it were a well-funded plan, no one would have too many qualms about it. Being materially underfunded and being such a material potential liability, I think it will be a major factor in any restructuring.”
In an emailed statement to Bloomberg, GE said that “in the evaluation of any alternative, we always consider the synergies and dis-synergies, and we only pursue things that generate meaningful value for our shareholders.”
Flannery, who has cut costs and pledged to sell assets, renewed talk of a breakup among analysts after GE disclosed a $6.2 billion charge tied to an old portfolio of long-term-care insurance. The setback, which has drawn scrutiny from regulators, was the latest for a company that’s struggled with flagging demand and suffered one of its biggest annual losses in recent memory.
At the time, the CEO said all options were on the table and emphasized an earlier plan to focus GE on jet engines, power-generation equipment and health-care machines. Flannery said he would update investors in the spring.
Although Flannery made scant mention of the underfunded plan during last month’s conference call, GE said in November it planned to borrow $6 billion to help plug its pension hole, the biggest among major U.S. companies. Like many others across corporate America, GE’s pension returns have been pressured by low interest rates that prevailed in the aftermath of the financial crisis.
To make matters worse, the liabilities swelled under Immelt as GE spent more than $45 billion in recent years on buybacks to win over Wall Street.
Of course, in its current form, GE can kick the can down the road because it has decades before some liabilities come due. What ultimately happens to the company’s structure is anyone’s guess. But most lawyers and actuaries agree that if Flannery does pursue a breakup, it might not be as simple as separating the pensions and dividing obligations across its business lines, particularly as GE has undergone a number of internal reorganizations over the years.
For instance, GE’s health-care division employed 54,000 workers at the end of 2016. While that’s almost as many as its power unit, the health group generated a third less revenue. The renewable energy division had just 2,000 more employees than the transportation unit, but almost double the sales. Then there’s the almost 300,000 retirees who currently receive defined pension benefits, as well as the 227,000 ex-GE employees with vested plans. And of course, not every current employee has a pension.
“That’s the challenge and hurdle to all of this -- the leverage and liabilities they have on this balance sheet make it hard to separate businesses that are pretty bifurcated fundamentally,” said Steve Tusa, an analyst with JPMorgan Chase & Co. The size of GE’s pension deficit is “material, it’s meaningful.”
General Motors Co. serves as a cautionary tale. Back in 1999, the automaker spun off Delphi Corp., its auto-parts arm, along with its pension. When Delphi went bankrupt in 2005, GM was forced to take back some liabilities. But it, too, went bust during the financial crisis, leaving the underfunded plans for 70,000 Delphi workers and retirees in the hands of the Pension Benefit Guaranty Corp., a government agency responsible for backstopping troubled plans.
Because of the size of Delphi’s pension deficit, which exceeded $6 billion, and a legal limit on how much the PBGC could cover, some retirees were left with less than what they were promised.
That’s not to suggest GE retirees share the same fate. The PBGC, which has legal authority to terminate private pension plans and recoup assets, has historically focused on companies closer to insolvency. While Moody’s Investors Service downgraded GE one level to A2, the company’s credit rating is still five levels above junk. GE also has cash reserves of $82 billion, which it could use to plug the pension shortfall if it wanted to.
“If a company is spinning off a financially sound unit with a proportionate share of the pension liabilities, it makes it a lot easier,” said Donald Carleen, a lawyer at Fried Frank. “If an over-weighted portion of the pension liabilities will end up with a business unit that is weaker financially, the PBGC will want to take a closer look.”
More often, the agency works to ensure pension benefits are protected when a company decides to restructure, says Sanford Rich, the PBGC’s former chief of negotiations and restructuring, a job Karen Morris took over in 2016.
Under its early warning program, the agency can usually get companies to the negotiating table by dangling its power to terminate any underfunded plans. (Some have dubbed it the “nuclear option,” which the PBGC has never used.)
Both Alcoa, which spun off its aluminum-parts business in 2016, and Sears Holdings Corp., the embattled retailer, forged deals with the PBGC to shore up their pension plans. A PBGC spokesman said the agency hasn’t contacted GE about its situation.
“They want to make sure the pension liabilities are housed in an entity that can afford them,” said Laura Rosenberg, senior vice president of Fiduciary Counselors Inc., who previously worked at the PBGC.
For GE, any agreement with the agency could leave Flannery with less wiggle room as he tries to revive the industrial behemoth’s fortunes, not to mention less money to put toward shareholder rewards.
“Their plan is big enough that this is certainly a major issue for them,” said John Lowell, a partner and actuary at October Three Consulting. “It’s legally more difficult to do it if they’re underfunded.”