GE Capital: GE Capital marches on Europe

When a British investment house decided to unload an ill-fitting credit business, it drew up a list of preferred buyers including a UK clearer and a Dutch bank. Deliberately left out of the bidding was GE Capital Services (GECS), the finance arm of General Electric, the world’s largest company, which is keenly interested in vendor financing and had been trying to acquire the business, Pallas Group, for several years.

“We were not on the list because we have a reputation for buying cheap and tying our contract parties up in knots,” says Christopher Mackenzie, president of GE Capital Europe.

But the fact that a seller either doesn’t want to part with an asset or prefers to do a deal with someone else is not the kind of detail to prevent GECS from making an acquisition.

Mackenzie’s business development team had already researched UK vendor financing and knew that Pallas, with high-profile clients including British Telecom, Minolta, Toshiba Information Systems and Sun Microsystems, was the asset it wanted. Vendor financing – which enables manufacturers to offer credit to wholesalers – is one of GECS’ core activities and Mackenzie had been trying for some time to convince Pallas’s parent company, SG Warburg, that GECS was the natural owner of the business. Finally the message seemed to get through and Warburg, which only a few months later in mid-1995 would itself be taken over by Swiss Bank Corporation, put Pallas in play for a preferred group of sellers only.

Mackenzie knew that to prise Pallas away from the others at that stage would require some fairly strong action. So while rivals were still doing their due diligence, believing they had weeks before a firm offer would need to be placed, GECS sent in a binding commitment to purchase Pallas, subject to basic warranties on balance-sheet size, the previous year’s net income, level of provisioning and the portfolio yield. After recovering from their surprise, executives at Warburg agreed and the £71 million ($109 million) deal was all signed up within a week. The UK clearing bank interested in Pallas was left muttering about how relationships, like the one it thought it had with Warburg, didn’t seem to count any more. Mackenzie, a former investment banker who was hired from Schroders, admits: “I have never seen anyone do a deal in that way. Warburg was pretty surprised that we were able to move so quickly.”

The Pallas deal was clearly unusual and is best understood in the context of GECS’ two-year assault on Europe, during which it has purchased outright or acquired stakes in 34 financial businesses in 12 European countries. This acquisition trail has been characterized by dogged pursuit of target companies and rapid response to opportunities. Some targets, such as French finance company Sovac, purchased for $1.5 billion last December, were in GECS’s sights for over six years. Other deals, such as the taking of a 27.5% stake in Hungary’s state-owned Budapest Bank, were wrapped up in weeks to meet government deadlines. Since early 1994, GECS’s total European asset base has risen from $5 billion to $18.5 billion and net income increased from $64 million to $282 million.

This is only the beginning. GE Capital Europe’s vision for 2000 is a balance sheet of $50 billion with net income of $1 billion. With less than four shopping years to go, that means picking up $8 billion of assets a year.

Judging by its 1995 record, when $10 billion of European assets were acquired, there can be little doubt about the goal being achieved. The evidence is that GECS has lost none of its American-born reputation for tough negotiation and deal-making audacity. But what does perplex some observers is why GECS, which last year contributed 37% of General Electric’s $6.6 billion net income, has decided to bet on a European century when most of its rivals are busy investing across the Pacific.

General Electric is the world’s biggest company by market capitalization and its $70 billion revenues rank it in the top 40 of largest economies measured by GDP. In outlining future strategy, its chairman and chief executive Jack Welch has made much of opportunities in Asia. On the ground, however, and especially in the case of GECS, it is recession-ravaged western Europe, and parts of former Soviet-bloc eastern Europe, that are commanding attention. The interest in eastern Europe is considered surprising even by analysts who understand and support the company’s moves into western Europe.

Why Europe?

Although GECS chairman, president and chief executive officer Gary Wendt denies there is any grand European strategy, the roll call of acquisitions, together with a 30-strong business-development team spread across Europe, suggest the opposite. Key aspects of the business environment and markets in Europe clearly appeal to Wendt and his colleagues as they set about growing businesses including equipment management and leasing; insurance of credit, mortgage and municipal bonds as well as reinsurance; project and structured finance; an equity capital group; and consumer services such as car loans and credit cards. What are the attractions of Europe?

A dig into GECS’s business profile begins to provide the answers. First, GECS deals in mature-market products which require a robust legal structure to work effectively. Asset-based businesses such as leasing can only operate where the law clearly recognizes titled ownership of trucks and containers, allowing a lessor to recover them where necessary. The same clarity is needed for insurance since defining whether a person is sick or well, employed or unemployed, is crucial for success. Emerging markets such as those in Asia and South America often lack that rigour, but rule-conscious northern Europe is ideal.

Ted Tilley, chairman and chief executive of UK-based Consolidated Financial Insurance, which in its original form as Financial Insurance Group was one of GECS’s first European purchases, feels that a mature-market sales culture is also important. “Selling is an impolite, intrusive activity that people don’t enjoy,” he says. Employees in bank branches in some emerging markets, he says, would be shocked to discover their new role was to sell rather than to advise. In northern Europe’s financial sector, however, tough competition has turned many administrators and clerks into sales executives eagerly waiting for the sophisticated products of GECS to pass across their desks.

The shake-out in European finance is the second reason why Gary Wendt’s armies are marching across the continent. The twin forces of privatization and deregulation are throwing up new opportunities for GECS. In the utilities and roads sectors, GECS subsidiary Global Project and Structured Finance (GPSF) has identified a growing niche in providing finance for the private sponsors of activities that were once in the public sector. GPSF is looking closely at projects arising under Britain’s private finance initiative and last year took $25 million in convertible subordinated debt for the Lyon toll road in France. GPSF has recently been busier in emerging markets than in western Europe, but its involvement in the traumatic Dabhol power station in India, in which the government at one stage cancelled a signed deal, has alerted it to the dangers there.

“We are focusing on Europe and on developing relationships with the major players in the infrastructure sector,” says JosŽ Brena, managing director of GPSF. GPSF’s assets stand at $9 billion of which only 10% are outside the US, a proportion that is expected to grow to 25% over the next couple of years and could be more than half within a decade, predicts Brena. “International is our future, not our present,” he says.

The third factor bringing GECS to Europe is recession and the need for restructuring. Recession makes assets cheap and restructuring puts them up for sale. Fast-moving GECS likes to buy its way into a market rather than expand organically. In Asia there is much less asset-shuffling and so less on the market; in Europe there is an ever-growing stack as companies try to transform themselves by selling parts that do not fit their core business.

“There is an opportunity in Europe and GECS is going full force to take it up,” says a New York analyst who follows General Electric. “Lloyd’s of London is down, so GECS has bought two German reinsurers [Frankona and Aachen]. France is going under so GECS has moved in at attractive prices. They are not going to leave any stone unturned. Privatization in Europe and the breakdown of the buddy-buddy system, with the government being close to industry, has created a void. GECS is moving to fill it.”

The Europe effect is as evident in General Electric’s consolidated accounts as in breakdowns for GECS. In 1995 European operating profits for the group were $1.06 billion out of a total of $10.97 billion, up from $673 million out of $9.62 billion in 1994. But then links between General Electric’s manufacturing and finance arms are in many ways as strong today as when the latter started out providing loans to buyers of the company’s refrigerators in 1932. It’s not so much that General Electric and GECS are engaged in a hunt for direct business synergies, rather that General Electric’s experience in a geographical market is handed on to GECS and that a down-to-earth approach gained in manufacturing is applied to finance.

In Europe, for example, GECS probably wouldn’t have acquired a stake in Budapest Bank last December had not General Electric already shown that state-owned Hungarian assets could be viable investments through its involvement, since 1990, with lighting company Tungsram. All European assets GECS does acquire have to meet the General Electric target – a return on equity in excess of 20%, which often means making fundamental changes in their operations. Manufacturing techniques such as measuring fault rates (applied to bank statements, say, instead of to a lighting factory’s output) are applied to finance businesses to raise productivity.

“What [a manufacturing background] brings is a healthy disrespect for the jargon which people throw around in financial services to justify something they can’t explain. Our leaders won’t stand for that,” says Mackenzie.

The other great advantage GECS brings to Europe is its “non-bank bank” model. As European retail banks struggle with the effects of disintermediation (borrowers raising money directly in the capital makets) and excessive competition for deposits, GECS has already perfected a format that allows it to gain from this environment. It funds itself in the capital markets, using its triple A rating to do so at low cost; it concentrates on specialized product niches catering to sophisticated customers, and relies on non-bank distribution systems. Germany’s Service Bank, for example, in which an 80% stake was acquired for $47.8 million in March 1995, operates almost entirely out of Metro department stores. GECS generally doesn’t take interest rate, maturity or currency risks and works with matched funds making its profits on the strength of its services rather than the movement of markets.

It’s a formula loved by investors since it gives GECS stable earnings in an industry noted for income volatility. Small wonder, then, that some analysts, while welcoming the European push in general, have become worried over what they regard as departures from GECS’s conventional strategy. These relate to GECS forays into eastern Europe (with all its emerging market risks) and the interest it has shown in classic universal banks, such as Austria’s Creditanstalt. Where GECS has bought into a traditional bank in an eastern European country, such as the stake in Budapest Bank, analysts are becoming nervous. If such investments fail they will not derail the entire European expansion, say these observers, but they could remove some of the gloss.

“They seem to have a death wish to get into Hungary. There are better cashflows in mature Europe,” says a New York analyst. “I also worry when they start buying banks. They seem to be lowering their standards.”

Despite its confidence and planning, GECS has made mistakes in Europe before. It lost money providing unsecured mezzanine finance to two British firms, Magnet and Gateway. Similarly, its first European purchase of a UK retailer’s credit card business brought with it a portfolio of secondary home mortages that eventually lost the company millions of dollars. Wendt says this debacle taught GECS to stick to businesses it knows when venturing overseas. But Wendt is also known to be enthusiastic about eastern Europe – he spent last year’s summer vacation visiting Dresden, Krakow and Warsaw by bus.

Getting a foothold in eastern Europe was said to be a major reason why GECS showed interest in Creditanstalt, Austria’s second-largest bank, which the government is pledged to sell but which has been subject to much political wrangling. Credit card and leasing businesses were other parts of Creditanstalt that attracted GECS, and recent Austrian press reports are still linking GECS with the leasing. In the original talks, however, GECS was told it could not pick off parts of the bank and would have to take an overall stake, an option it considered expensive and unattractive. Although the Creditanstalt deal never materialized, GECS has bought the small Mercurbank from Bank Austria. This appears to fit better with its strategy. GECS has since sold back the deposit-taking to the original owner and is using this bank as a vehicle for its typical product line of leasing and consumer finance.

Although dismissing Mercurbank as “a non-entity and something terribly boring that no-one took much notice of”, a banker in Vienna says GECS would not have wanted to deal with Creditanstalt’s unions, huge staff and internal intrigues. “A niche operator is not going to burden himself with an elephant like Creditanstalt which is going to take years to get into shape,” he says.

Failure to acquire Creditanstalt has not kept GECS out of eastern Europe, however, and last July Tony Fekete was appointed director of business development central Europe, based in Budapest. Fekete is an east European specialist who formerly worked with Citibank in Hungary. Now he spends his time scouring the region for deals, flying weekly to London to meet the rest of the business-development team to discuss progress and tactics.

Last September GECS clinched its first east European deal when it bought Solidarmosc Chase DT Bank, a small consumer bank with a $20 million balance sheet, started in Gdansk by a Polish-American entrepreneur. “It gives us a business platform in Poland,” says Fekete.

The same thinking lies behind GECS’s purchase of a 27.5% stake in Budapest Bank late last year. This stake, together with one of 32.5% taken by the European Bank for Reconstruction and Development (EBRD), was worth $87 million to the Hungarian government. The deal has all the marks of a classic GECS acquisition – a fast, opportunistic move that delivered at an attractive price (see box, page 58) – except that Budapest Bank is not obviously geared towards GECS’s favoured niches. Its background is as a corporate lender and retail bank: originally it was burdened with non-performing assets, but was set in order by former Hungarian finance minister Lajos Bokros who served as its president before joining the government. In 1994 the bank reported pre-tax profits of Ft2.51 billion ($18 million) on assets of Ft193 billion.

A manageable challenge

Why was GECS so keen to get its hands on Budapest Bank? “We think it’s a manageable challenge to convert Budapest Bank from a wholesale-retail bank into a consumer finance and leasing company,” says Mackenzie. “We don’t anticipate that in three years’ time it will be a universal bank. It will be a mini-GE Capital. We’re confident it can be achieved because of the Tungsram model in the lighting business.” Mackenzie says the underdevelopment of Hungary’s capital markets meant GECS needed a classic bank for funding purposes.

Others are more cautious about GECS’ aims for Budapest Bank including the EBRD’s Hungary team director Gyšrgy Karady. “I don’t think they [GECS] will turn it into a mini-GE Capital [very quickly]. I don’t think the consumer purchasing power is there. Strengthening the consumer finance part of Budapest Bank will take time,” he says.

Says a senior executive of Creditanstalt, which itself expressed interest in buying Budapest Bank: “Since GE Capital has very strict return-on-investment criteria, [the purchase] was surprising. GE Capital has a certain way of running a banking business. It will very gradually change Budapest Bank to fit its own parameters.”

It’s possible GECS’ modest inroads into eastern Europe are distracting analysts more than they are the company. At present the UK and France together account for around two-thirds of the company’s European assets, with the rest spread across the continent. As the balance sheet grows, the British/French section is likely to fall to between 30% and 40% of the total, but eastern Europe is not expected to be a major contributor to this change. Even a 10% share (around $5 billion by 2000), is considered ambitious by GECS executives. They point out that if Budapest Bank was fully acquired and consolidated it would only amount to about one-fifth of the assets needed to make up this quota.

To meet its growth targets GECS must therefore continue the search for suitable acquisitions in western Europe and it is doing just this. The approach taken is both exhaustive and obsessive. For each of 20 deals that GECS completed in Europe in 1995 (including the Lyon toll road), the company looked at 15 deals, making 300 in total. Fifty deals were presented to the board of which 30 were not accepted or fell apart, mostly on price. Currently, 80 projects are being considered and there is a monthly strategy teleconference with Wendt, who is based in General Electric’s headquarters in Stamford, Connecticut.

“We don’t hang around waiting until a business leader comes up and says he has a medium-sized auto-leasing company in Italy for sale. We are constantly in the market [looking for prospects],” says Mackenzie. “Rarely do investment bankers come to us with anything we don’t already know about.”

When GECS does decide to go after a company, it moves fast and negotiates hard. “One of GE Capital’s great strengths is that it is extremely pragmatic. I am sure the investment in Budapest Bank was well researched but there is an element of ‘let’s go there and see how it works’,” says Tilley of Consolidated Finance Insurance. “Things aren’t researched to death. They are researched enough so as not to do anything silly. Then it’s a matter of seizing opportunities.”

A final strength of GECS in building its European empire is that it never gives up on owning a business it really wants. Take the case of Irish aircraft lessor GPA Group, which GECS has been involved with since 1983. GECS was a founding equity investor in GPA but sold most of its stake at a profit in 1986 when its acquisition overtures were rebuffed. Six years later when GPA got into financial trouble, GECS was back. After extensive negotiations GECS gained agreement in May 1993 to buy 45 aircraft valued at $1.3 billion, to take over the management of GPA’s fleet and become the holder of an option to buy the company for $109 million expiring on March 31 1998. This way GECS gained the chance to assist GPA back to health without assuming any of the lessor’s considerable liabilities.

In last month’s $4 billion securitized refinancing of GPA (see this month’s Deal Insider), GECS came a step nearer to owning the company on even better terms. GECS argued successfully that the restructuring would harm its buy option by bringing to the company lower-rated debt at higher coupons and with more onerous call features than was previously the case. Morgan Stanley, which conducted the restructuring, solved this problem by locating a convertible bond embedded in GPA’s capital structure and laying it out for GECS as an option to buy the company for $59 million before October 31 2001.

Other oft-mentioned targets are a UK life insurer and a European fund manager. Either could be completed in weeks or stalked for years. GECS has methods for dealing with both situations and will be applying them as it completes its European conquest.

Free gift that could bring grief

The current debate in Hungarian financial circles is whether Budapest Bank – the most attractive of the state banks to be privatized – was given away for nothing. Together GE Capital Services (GECS) and the European Bank for Reconstruction and Development (EBRD) paid $87 million for a 60% stake. To make Budapest Bank more attractive, Ft12 billion ($84 million) of government securities were injected into its balance sheet. So the purchasers have gained a securities portfolio equivalent in value to what they paid, with the rest of the bank’s operations – including over 70 branches, brokerage and leasing activities and a bank in Romania – effectively thrown in for nothing.

At least, that’s one argument. Supporters of GECS say changing the culture of even one of the more progressive state banks is a Herculean task. They refer to the battles GECS’s parent company had to fight to turn around Tungsram, the Hungarian state-owned lighting company in which it acquired a majority stake in 1990. Two years later Tungsram lost $105 million and General Electric had to put in extra capital. The prospect of GECS having to do the same with the currently profitable Budapest Bank cannot be ruled out.

“One could argue that they [GECS and EBRD] paid nothing [for Budapest Bank] and certainly they got in for less than the headline figure. They got a very good deal,” says an executive at Budapest Bank. “But they face 3,000 people used to doing things their own way. The [bank’s] culture is difficult especially if you are not used to it.”

This executive says that so far GECS has taken a fairly cautious approach to making changes at the bank. An integration team of about 10 is looking at the operation, and close attention is being paid to reporting methods and ethics. Three GE Capital Europe staff – Tony Fekete, Allan Kennel and George Tappert – sit on Budapest Bank’s six-person board of directors. (The other three members are EBRD senior banker Kurt Geiger, Budapest Bank chief executive Bela Singlovics and Marta Sulyok-Pap, a professor at the Budapest University of Economics.) But there is no sense, says the executive, of GECS personnel acting as a shadow management. “Since it doesn’t have a traditional banking background, GECS doesn’t have a ready-made infrastructure to put in place,” says the executive.

Says Tony Fekete, who is director of business development central Europe for GE Capital Europe: “We are not like McDonald’s in that every business has the same flavour in every country. Our approach to business is consistent but the flavour doesn’t have to be the same.”

Insiders at Budapest Bank believe the outcome would have been entirely different had Credit Suisse bought the bank as the government originally intended. They think the strict regime of a Credit Suisse, with all its rules and procedures, would have been forcefully imposed on the bank. From this perspective it may be that the embarrassing pull-out by Credit Suisse in March 1995, after scores of analysts had spent several months combing the books, was for the best in the long run.

At the time it was a devastating blow and, while press reports talked about strategic differences between Credit Suisse and the Budapest Bank management, speculation inevitably turned to what might have been discovered in the books. With hindsight some commentators believe the critical factor in dissuading Credit Suisse may have been the ill-timed departure of Budapest Bank chief executive Lajos Bokros to become Hungary’s finance minister. Bokros is credited with introducing proper provisioning, systems and cutting costs at the bank, and generally turning it around.

With Credit Suisse out of the picture, and the Dutch ING Group declining to re-enter negotiations, the government was starting to grow anxious. Failure to sell a relatively attractive asset such as Budapest Bank would have been a big blow to the privatization programme. Adding impetus to get the deal done was the fact that the Ft12 billion of securities was due to revert to the government if the bank was not sold by the end of 1995.

“The government wanted to privatize Budapest Bank by all means. It had to be a success story,” says Gabriel Arkai, managing director of the Budapest-based joint venture BankAustria-Girocredit Investment. Says a senior executive based in Girocredit’s Vienna headquarters: “In German we have a saying that if a bride is on the market too long her price falls. Budapest Bank had definitely been on the market too long.The arrival of GE Capital was a fortunate outcome.”

These were just the kind of circumstances to excite the opportunistic tendencies of GECS. The company moved into negotiating mode and started putting together a deal. With the wind blowing in its favour, GECS managed to obtain a majority stake for $87 million, significantly less than the $100 million being talked about earlier. It persuaded EBRD to take a larger stake than the strategic investor, which is unusual in deals of this kind.

But the board composition means that GECS has operational control. “The government was keen to do the deal. We were also keen to do the deal,” says Fekete. “It was a deal that was acceptable to all sides. One of the advantages of GE Capital is that we can move quickly when we want to.”