GE’s Should Merge Its Power Business With Siemens Unit – Barron's

Photograph by Michael Nagle/Bloomberg

A centuries-old industrial conglomerate announced it was cutting jobs and evaluating options to dispose of an ailing power-generation products division. But it isn’t General Electric (ticker: GE), we’re talking about. It’s the 172-year-old German conglomerate Siemens (SIE.Germany).

Siemens reported its fiscal second-quarter earnings Wednesday. Profits beat the German equivalent of Wall Street’s expectations and the stock jumped more than 4%.

The profits weren’t the story, though.

Siemens announced plans to separate and list its gas and power division. That unit makes many of the same products as General Electric’s power business, which generated a huge asset write-down earlier this year.

What’s going on? Does misery love company?

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The fossil-fuel power-generation business is undeniably tough. Revenues at Siemens’s gas-and-power unit have fallen 13% a year on average for the last two years. GE’s power business is shrinking at almost exactly the same rate.

When an industry is contracting and profit margins are falling, management teams often react by merging assets together and cutting costs. Economies of scale and efficiency can help offset declining revenues.

It’s a tough way to live—all managers would prefer revenue growth. Higher sales make it easier to raise prices and offset wage inflation, but not every industry can grow forever.

Could the GE and Siemens power units merge and pursue a strategy like that to improve profitability? It isn’t out of the question.

The big problem is market share. Siemens, General Electric and Japan’s Mitsubishi Heavy Industries (7011.Japan) are the large makers of power- plant turbines, used to generate electricity from fossil fuels. A very rough estimate based on reported segment sales gives a combined Siemens and GE power unit more than 70% of the market.

That would set off alarm bells for antitrust regulators around the globe.

But the deal could be possible if regulators are willing to define the power-generation business more broadly. Fossil-fuel power generation is losing out to renewable, distributed power generation. That’s the big reason Siemens’s and General Electric’s power revenues are falling.

According to the Energy Information Administration, 64% of U.S. power comes from fossil-fuel sources and 17% is generated by renewable sources. Ten years ago, those numbers were 71% and 10%, respectively. Renewable energy generation has become much larger than fossil-fuel power generation in terms of the new capacity being installed.

A broader definition of the market for Siemens and GE power products— one that includes renewable sources—could reduce the share held by a GE-Siemens power unit to a level regulators might accept.

GE declined to comment about potential combinations in the power generation industry. Siemens didn’t immediately respond to a request for comment.

Now that Siemens is planning to spin off its power unit, investors should press GE management about its plans for GE Power. Under new CEO Larry Culp, GE Power has been split in two, with new management appointed. Culp is focused on cutting costs to improve profitability.

But the Siemens plan changes the game for the industry and could offer GE a new path forward. GE investors would very likely cheer a GE Power spinoff or merger.

How bad is the power business?

The stock prices of the three big power producers can give some indication of the industry’s health. GE shares have lost 14% a year on average for the past five years, far worse than the 12% gain of the Dow Jones Industrial Average.

Siemens has fared better, but its stock hasn’t been great. Its shares have returned 6% a year on average over that time. That is 1 percentage point better than the German DAX index.

And Mitsubishi Heavy Industry has lost about 2% a year on average over the past five years, far worse than the 10% average annual gain of the Nikkei index over the same span.

GE has had a tougher time, in part, because it has the largest power business of the three. GE Power is roughly twice the size of Siemens’s power unit.

Write to Al Root at allen.root@dowjones.com

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