What’s next for GE’s share price after fraud ‘bigger than Enron’ allegations?

Following several months of worries among investors about how US industrial conglomerate General Electric’s [GE] turnaround has been going, it now faces allegations that the corporation is on the cusp of a ‘fraud bigger than Enron’, and is heading for bankruptcy. The report, by Bernie Madoff whistleblower Harry Markopolos released on 15 August, claims to have uncovered $38bn in accounting irregularities at GE. The release caused the company’s shares to close down by over 11% – its worst single-day fall in 11 years. GE denied the allegations.

Markopolos’s report “is market manipulation – pure and simple,” GE CEO Lawrence Culp said. The report contains “false statements of fact”, he added, arguing that Markopolos appears to be less interested in providing accurate financial analysis and more focused on “generating downward volatility in GE stock so that he and his undisclosed hedge fund partner can personally profit” from the move. The CEO was referring to the fact that Markopolos was hired by an undisclosed third party to complete the report.

After the report was released, billionaire hedge fund manager Stanley Druckenmiller and Culp both bought GE shares. The next day, the share price rebounded by almost 10%.

What’s next?

Much will now depend on how US regulators respond to Markopolos’s allegations against GE. The US Securities and Exchange Commission (SEC) and Justice Department are already investigating GE over separate, potential accounting issues, and GE has said it is cooperating with investigators. Markopolos said he intends to present his report to the SEC.

Some have called Markopolos’s report sensationalist and said it cannot be considered objective because he and his partner company – thought to be a hedge fund shorting the firm – stand to profit from declines in GE’s shares. “Our initial reaction is that we believe that there are sufficient shortcomings in [Markopolos’s] report’s assertions and we continue to believe in CEO Larry Culp’s ability to improve the company over time,” Citigroup analyst Andrew Kaplowitz said.

“Our initial reaction is that we believe that there are sufficient shortcomings in [Markopolos’s] report’s assertions and we continue to believe in CEO Larry Culp’s ability to improve the company over time” - Citigroup analyst Andrew Kaplowitz

Before 15 August, GE’s shares had been up by close to 25% in 2019. In late July, GE reported better-than-expected Q2 results, with adjusted earnings per share of $0.17, which was ahead of the consensus estimate of $0.12. But despite the positive results, the share price slipped more than 10%, before recapturing some of those gains by the end of the week. So with the new allegations once again putting attention on the struggles facing GE, does its stock now offer any renewed upside potential?

Focus to shift to Q3 results

In the second quarter, GE was looking like a rebound, with several hedge funds buying up shares because they were impressed by Culp’s turnaround plans. But the share price’s performance at the start of this month to 15 August shows that things are not all well when it comes to prevailing investor sentiment: a return to climbing profits isn’t happening fast enough.

GE share price vitals, Yahoo finance, 19 August 2019

Worries about how Boeing’s grounding of its 737 Max airplanes could affect GE’s engine business, lingering questions related to the effectiveness of GE’s turnaround plans, the US government's investigations and whether Markopolos’s allegations end up revealing actual irregularities in GE’s balance sheet, will all be on investors’ minds ahead of the company’s Q3 results on 30 October.

If Markopolos’s allegations prove unfounded, it will surely lead many to conclude that his only motivation in publishing the report was to profit from shorting GE’s stock. That could make the share price ripe for a solid pop. But the lingering question is that if Markopolos’ s only motivation was to drive down the price for a hedge fund on the back of baseless fact, why would he have staked his entire professional reputation to do so? If the allegations end up leading to more questions about GE’s accounting practices, along with any negative findings from US authorities’ ongoing investigations, the former industrial heavyweight could experience a very frightening Halloween.