Saturday, January 24, 2009

Why Immelt Should Pick Preserving the Dividend

Recent news over GE potentially having to cut its dividend in order to save capital to retain its AAA bond rating haven't raised an important issue. The main reason the bond rating is important is because it facilitates lower borrowing costs. Lower its rating and it has to pay more to borrow. However, cut the dividend and the general confidence of what was always a very stable long term investment following is thrown in the trash.

So, weighing these differences would seem to be prudent. The problem is the stock and its credit default insurance costs are already acting as though it lost its rating. So, why try to preserve it? Also - the rating is something that will be in question continually, dampening the stock continuously for the next 12-24 months. Since S&P is destined to become more strict now that they realize their is perception of their proximity to the cause of the current situation - GE is being held hostage by the very institution that created the problem in the first place.

So I say - let the rating slide - everybody expects it. Then phrase it in a way that makes it look like you chose to remain committed to the dividend for the shareholders and couldn't care what an agency rates GE. The fallout from this will certainly be lower than the cost of eliminating the dividend. The stock will again be bought up by mutual funds and the "blue chip" will remain.

If GE is intent on growing its infrastructure business and shrinking its capital business, then debt financing should become a smaller part - so making this financing more expensive will help speed the adjustment. Orders from customers will need to be financed by others, but that is more healthy for GE anyway.

As the economic crisis matures, the borrowing costs which have been so much higher will have been lowered through global interest rate cuts. Credit default insurance will subside meaning that the debt market is about as bad as it will get. Therefore - being one level below AAA in a matter of 12 months will probably be the same as being AAA right now. However, if you cut the dividend, investor confidence will be shot for years.


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