Shares of General Electric, a multinational conglomerate based in Boston in the United States, fell as much as 15 percent on Thursday after fraud investigator Harry Markopolos, who blew the whistle on financier Bernard Madoff’s Ponzi scheme, said the company was concealing deep financial problems.
In a 175-page report, Markopolos accused GE of hiding $38bn in potential losses and asserted that the company’s cash and debt positions were far worse than it had disclosed.
“GE’s true debt to equity ratio is 17:1, not 3:1, which will undermine its credit status,” Markopolos said.
The report also says GE is insolvent and asserts that its industrial units have a working capital deficit of $20bn.
While investors sent GE shares sharply lower, the report echoes the assertions of some of Wall Street‘s more sceptical analysts, who have long raised alarms about several problems with GE: its low cash flow, frequent accounting charges, write-downs – and what analysts describe as its opaque financial reports.
GE Chief Executive Larry Culp, who is the first outside leader of the company and who took over in October, has made no secret of GE’s woes.
The industrial businesses have seen a $2.2bn cash outflow so far this year, and Culp said last month that GE may incur cash costs of $1.4bn this year from the grounding of Boeing Co’s 737 MAX jetliner. GE makes engines for the jet through a joint venture with Safran SA of France.
The report alleges that GE faces $38bn in future expenses that it has not disclosed. “GE’s $38bn in accounting fraud amounts to over 40 percent of GE’s market capitalization, making it far more serious than either the Enron or WorldCom accounting frauds,” the report says.
In a statement, GE said: “We remain focused on running our business every day and … will not be distracted by this type of meritless, misguided and self-serving speculation.”
GE said it “stands behind its financials” and operates to the “highest level of integrity” in its financial reporting.
It also said Markopolos was known to work for unnamed hedge funds that typically benefit from short selling a company’s stock.
A disclaimer in the report stated that it was drafted by Forensic Decisions PR LLC, which will get compensation from a third-party entity that could benefit from a decline in GE’s share price. The report did not name the entity.
Speaking on CNBC on Thursday, Markopolos said he would receive a percentage of any profits generated by the report, but declined to provide details about the compensation or name the fund involved, which he said was “a midsized US hedge fund.”
GE shares were down 13 percent at $7.84 in afternoon trading.
In the past two years, GE has announced more than $40bn in asset write-downs and accounting charges. The company has also said its accounting is being investigated by the US Securities and Exchange Commission and the US Department of Justice.
The report details GE’s exposure to long-term care insurance, the subject of a federal class-action lawsuit awaiting a decision on GE’s motion to dismiss.
It says GE’s financial statements about its insurance business do not correspond to those of eight insurers that Markopolos says hold about 95 percent of GE’s exposure.
Markopolos is best known for alerting regulators in the early 2000s to signs that money manager Bernard Madoff’s investment firm was a Ponzi scheme, a deception in which unusually high returns for early investors are generated with money from later investors. Madoff was arrested in 2008 and later sentenced to 150 years in prison for fraud.
John Hempton, cofounder of the Sydney, Australia-based Bronte Capital hedge fund, wrote in a blog post Thursday that GE’s 14.7 percent average profit margin in recent years was in line with the returns of its industrial peers – not “too good to be true”, as Markopolos alleges.
“GE remains the unequivocal leader” in medical imaging and jet engines and its currently depressed profit margin will likely rebound, Hempton wrote, adding, “Harry’s report is silly. The market should ignore it.”
Worried investors jangled phones on Wall Street on Thursday. Nick Heymann, an analyst at William Blair Co, said questions focused on $18.5bn of the $38bn in charges that Markopolos says GE is concealing. Markopolos said GE will need to set aside that money to cover its long-term care policies in addition to the $15bn it has already begun to set aside.
Heymann said the remainder of the $38bn was already largely known: charges related to an accounting rule change coming in 2021 and potential losses on GE’s 50.4 percent stake in subsidiary Baker Hughes, which it plans to sell.
“I don’t know the validity of the $18.5bn,” Heymann said. “I’m trying to figure it out.”
But he said that if the figure was accurate, Culp would not have recently raised GE’s 2019 financial targets.