September 4, 2015 / 3:39 PM / 2 years ago

GE set for cost cuts as EU decision on Alstom deal nears

The General Electric logo is seen in a Sears store in Schaumburg, Illinois, September 8, 2014.Jim Young

(Reuters) - General Electric Co is expected to win regulatory approval next week for its purchase of the power equipment business of France's Alstom, allowing the U.S. industrial conglomerate to finally carry out a major cost-cutting program 16 months after first announcing the deal.

The European Commission has set a Sept. 11 deadline to decide on the roughly $13.5 billion deal, the biggest acquisition ever for GE, which will bring together two of the world’s largest manufacturers of power plant hardware.

European regulators have expressed concerns over the combined company's control of the gas turbine market. GE has not disclosed what changes it has agreed to make to win clearance from European competition regulators.

In May, GE told investors it expects $3 billion in cost reductions over the next five years as it combines its operations with those of Alstom, more than double the previous target when the deal was first announced in April 2014.

GE has also projected the deal would add 15 to 20 cents per share to earnings in 2018, or nearly 10 percent of GE's overall profit expected that year by Wall Street, according to Thomson Reuters I/B/E/S.  

To hit those goals, GE will consolidate manufacturing operations, cut duplicated overheads, and make savings on purchasing expenses, according to GE presentations on the deal. But to gain the blessing of the French government last year, GE committed to add 1,000 jobs in the country, possibly handcuffing the conglomerate's ability to reap savings from Alstom's home base.

Outside of France, GE said last year that 18,000 of Alstom's 65,000 total employees involved in the deal worked in Europe, where works councils can make job cuts difficult.

"The challenges in making it work is you’re buying a huge European-centric organization, and history has said it’s hard to get synergies in Europe," said Peter Bates, portfolio manager for T. Rowe Price's global industrials fund, adding that he still thinks GE will be able to pull off the integration.

GE is also in the middle of its own cost cutting plans, which aim to reduce industrial sales and administrative expenses to 12 percent of revenue, from just under 16 percent in 2013, while improving gross margin by about 0.5 percentage points in 2015 and 2016.

Meanwhile, GE has stressed the benefits of having Alstom as part of its operations. The French company has a strong franchise in steam turbines and sells equipment GE has previously lacked, such as heat recovery steam generators. Those are needed for "combined cycle" power plants that increase efficiency by using both gas and steam turbines. Such plants are expected to account for more than 70 percent of future gas turbine purchases, GE said last year.

GE also stands to profit from servicing Alstom-made equipment. RBC Capital Markets analyst Deane Dray says service revenue could be the "jewel" of the deal, noting that GE's service margins for thermal equipment are nearly twice those of Alstom's. 

GE still has obstacles to climb. Sluggish global economic growth could temper power demand in the near term, especially in emerging markets, and undercut revenue prospects.

Meanwhile, Alstom's financial performance has weakened as the deal has been reviewed, with sales in its energy business down 7 percent and orders down 12 percent in its most recent fiscal year.

"Even with some top-line risk, they should be able to make the deal work based on the cost synergies," UBS analyst Shannon O'Callaghan said.

Reporting by Lewis Krauskopf in New York; Editing by Bill Rigby

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