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Since GE (GE)'s stake in Baker Hughes (BHGE) is less than 40%, it may not be able to consolidate 100% of BHGE's revenues and cash flow, as in the past. GE also consolidated 50.6% of BHGE's net income in its books after deducting 49.6% of its net income attributable to minority shareholders.
GE will most likely need to apply the equity method to process the BHGE investment. According to this method, GE can not recognize BHGE's revenue in its consolidated financial statements. It can only declare profits attributable to its share. Not being able to consolidate BHGE's revenues and cash flow could cause problems for GE.
Baker Hughes drove GE's revenue growth in 2018. Excluding Baker Hughes' revenue, GE would have seen a drop in revenue. While Baker Hughes recorded a revenue increase of $ 5.7 billion in 2018, General Electric (excluding BHGE) recorded a revenue reduction of $ 2.3 billion. In the first half of 2019, GE's consolidated sales decreased even though BHGE's revenues increased slightly. In short, GE's revenue growth without the consolidation of BHGE could be worse.
As GE records only BHGE's proportionate net income in its consolidated financial statements, the impact of the change in accounting method would be relatively minimal.
GE's cash flow without BHGE
The adoption of the equity method means that General Electric can no longer consolidate BHGE's cash flow into its books. This could be disastrous for GE, which is fighting Harry Markopolos' accusations that the cash flow should be inflated through BHGE consolidation.
To put this in context, General Electric reported $ 2.26 billion of cash flow from operations in 2018, of which $ 1.76 billion came from BHGE's accounts. Thus, without its BHGE consolidation, GE's cash flow would have been only $ 500 million, which Markopolos pointed out in its report.
The first half of 2019 makes things even more difficult. During the period, General Electric reported operating cash consumption of $ 842 million, but BHGE announced positive cash flow of $ 409 million over the same period. Without consolidating Baker Hughes' cash position using the equity method, GE would post a loss of $ 1.25 billion. This loss of free cash flow will be even more ugly if we separate BHGE.
Adjustment to fair value could result in losses in billions
When General Electric processes BHGE's equity method of consolidation, it will have to recognize the remaining interest in BHGE at fair value. So far, GE has declared BHGE's investment at its book value, its first amount recorded in 2017. Since then, the share price of BHGE has declined. Deconsolidation means that GE's current quarter losses could be substantial (assuming the transaction occurs before September 30th).
In addition to these losses, the fair value adjustment will also reduce General Electric's equity, which will result in higher debt to equity. This could cause problems for the company's credit rating. The $ 3 billion he will receive in return could give him a partial respite.
Another change to confuse the markets?
In its report, Markopolos asked General Electric to constantly modify its reporting and accounting methodology to make it impossible to compare the company's performance over several years and between peers. The transition of the consolidated company to an equity method may provide more ammunition. His allegation that GE would buy a company only to resell it later in order to report losses could also be deserved.
GE's problems at Boeing
Beyond his long-term care responsibilities and his problems with Baker Hughes, GE also faces the challenges associated with its GE9X engines that fit into Boeing's wide-body jets. Boeing has delayed the delivery of a variant of its 777X long-range model due to problems with General Electric engines. General Electric says the GE9X engine will be the most fuel efficient engine in its product line. Boeing also faces problems with its 737 MAX 8s.
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