Harry Markopolos, Madoff whistleblower, last week released a report on General Electric, the parent entity of our portfolio holding GE Power. The report accused GE to have committed a $38bn fraud by accounting manipulation mainly in its insurance business by creating lesser reserves than warranted.

It could be fatal if these allegations were to be true, as the current market capitalisation of GE itself is about $70 bn. The stock cracked 10% on the day of release of this report. However, it subsequently recovered the following day when GE's management issued a press release with a point by point rebuttal explaining how accounting is as per prevailing guidelines. Though no management would outrightly accept of any such wrong-doing, we take cues from subsequent recovery in GE's stock to infer that explanations were found reasonable by equity investors, including large institutional investors who would have an army of subject matter experts in complex areas to judge & comprehend actuarial assumptions in insurance segment, accounting policies of various other segments and consolidation with subsidiaries etc.

We must also note that before releasing the report to the public, early access was sold to a hedge fund which would benefit by shorting the stock, as shared in the disclaimers section of the report.

One thing we never want to do as part of our process is to compromise on management quality. We could make mistakes on the business selection or on valuation, something we have done in the past and may do in future too as nobody can get it right 10/10 times, however, corporate governance standards is something we have been very picky about.

While GE Inc. has had its fair share of capital allocation goof ups, we cannot deny the fact that it has been one of the blue-chip companies for over a century. There was also a change in the leadership team in 2018 - Larry Culp took charge of GE as its new CEO. Culp earlier worked at Danaher Corp., a $20bn diversified conglomerate and a Fortune 500 company. He joined Danaher in 1990 and led it as CEO since 2001. The firm under his leadership had an impressive track record of focussing on sustainable growth, cash flows and sensible capital allocation. On 13th August 2019, he bought $3mn worth of GE stock from the market increasing his holding in GE by 50%.

Even the Indian entity has a new CEO - Prashant Jain who was earlier the CEO of Power Generation Services at Seimens.

We see good earnings potential based on the current order book of Rs 10,000 Cr. which can continue to scale up through the year. It has little dependence on global entity as exports are limited and air quality control systems opportunity is domestic both from the demand as well as supply standpoint. It has a debt-free balance sheet with over Rs 1,000 Cr. in net cash. With restructuring behind, the P&L can finally start throwing a good set of numbers.

We recently met the senior leadership team at GE Power and came back positive. We will shortly release the management meet note.

While the rub-off risk is high if the allegations were to be true but we don't want to exit GE Power in haste. We will continue to monitor the developments at parent entity closely and take appropriate action as warranted. For now, we continue to hold.