GE Plays Hard But Fair: A New Preferred Stock Exchange is Offered Two weeks ago, General Electric made a surprise announcement by forcing an inequitable exchange on its existing preferred share class of General Electric Capital Corporation (“Old Preferred Stock”) into less valuable preferred stock of General Electric Company (“New Preferred Stock”). After a good amount of investor consternation, GE has announced a sequel to the initial exchange that should reduce anxieties: http://www.sec.gov/Archives/edgar/data/40545/000119312515406931/d104648ds4.htm The new exchange offers, on a 1:1 basis, a single new preferred security (NePS) with a non-­‐
cumulative fixed dividend rate of 5.00% for five years; then a floating rate dividend at a spread of 3mo. LIBOR +3.33% to perpetuity. The exchange also offers an additional cash payment of 1pt to the Series A holders and an additional cash payment of 1/2pt to the Series B holders. In or initial report, we calculated the breakeven prices for each of the three New Preferred Stocks (NPS) relative to the three Old Preferred Stock (OPS) to be: • B/E Px. NPS 4.00% = OPS 7.125% Series-­‐A Px./ exchange ratio = $118.88/1.2345 = $96.29 • B/E Px. NPS 4.10% = OPS 6.25% Series-­‐B Px./ exchange ratio = $113.75/1.1843 = $96.05 • B/E Px. NPS 4.20% = OPS 5.25% Series-­‐C Px./ exchange ratio = $105.00/1.0941 = $95.97 The morning after the exchange settled (December 7th), the bid for any series of NPS was $88.25 per share. This equated to an unrealized loss of 8%, which even took into account the full existing exchange ratio that was intended to generate “at least equivalent value” – clearly, the exchange ratio was insufficient to provide holders of OPS at least an equivalent value in NPS as the shares were structured. Consequently, shareholders moving to perfect OPS appraisal rights through the Delaware Court of Chancery became a forceful movement to seek recovery of “fair value” in cash. But, the door remained open for GE to offer a remedy in a constructive and timely fashion. This new preferred stock exchange, managed by Bank of America/Merrill Lynch, appears to be fair under three important scores: 1. The NePS has a more current market dividend of 5%, which is much improved from the weighted average 4.08% dividend on the NPS. 2. The NePS has a floating rate reset of an extra 102bps, relative to NPS. 3. The exchange pays some consideration to the Series-­‐A and Series-­‐B holders, which appears to recognize that these two series, in particular, were neutered the most relative to their special rights formulating future cash flows. A member of the Principal Financial Group® Page 1 of 2 The sum of these three scores should ultimately (albeit, belatedly) add up to an exchange of “at least equivalent value”. We can support this by considering where a reasonably equivalent preferred stock (i.e., in ratings, fixed dividend, fixed term and reset spread) is valued – US Bancorp 5.125%: When we price the NePS to the same 6.08% yield-­‐to-­‐perpetuity value as US Bancorp’s preferred, we calculate an expected price of $96.40 per share -­‐-­‐ this price aligns with the breakeven prices stated above, which intend to support a measure of “fair value” in considerations paid of the OPS. We can, therefore, be satisfied that a path to fair value is available through this new exchange, rather than pursuing a potentially lengthy and complicated court appraisal of OPS. Additional value (i.e., the original 4% exchange premium) could be earned up if GE calls the NePS at its $1,000 per share liquidation preference, but we should not expect GE to redeem the shares. Importantly, the cash consideration available to Series-­‐A and Series-­‐B holders helps to provide some needed recompense. Despite GE playing hard against preferred shareholders, they have now amended their OPS game plan to also play fair pursuant to the appraisal demands. We will hold judgement on any “good intentions” until GE calls the stock, irrespective of disclosure that states investors should not expect the company to redeem any shares. Phil Jacoby CIO, Spectrum Asset Management December 18, 2015 Spectrum Asset Management, Inc. is a leading manager of institutional and retail preferred securities portfolios. A member of the Principal Financial Group® since 2001, Spectrum manages portfolios for an international universe of corporate, insurance and endowment clients; mutual funds distributed by Principal Funds Distributor, Inc.; and preferred securities separately managed account solutions distributed by Principal Global Investors, Inc. A member of the Principal Financial Group® Page 2 of 2