As Henry Markopolos readily admits, GE has reportedly been playing fast and loose with its revenues for decades, which is why thousands of analysts were shocked to see the dogged Madoff whistleblower publish a report Thursday morning warning about 'Accounting Irregularities' at the once-mighty industrial conglomerate, which amounted to almost $40 billion.
Markopolos continued that the fraud growing inside GE was "bigger than Enron and Worldcom combined" (which is difficult to imagine given GE's relatively puny market cap), and that most of the dirt could be found within its insurance unit, which will need to bolster its reserves by $18.5 billion in cash, and faulted the way the company is accounting for its oil-and-gas business. All told, he said, the accounting problems amount to $38 billion, or 40% of the conglomerate’s market value.
But in a tough interview with CNBC Thursday morning, Markopolos defended his findings, all while repeatedly refusing to disclose with whom he is working (It's reportedly a US-based mid-sized hedge fund)
"Years ago, I would sit down at analyst luncheons and everybody would joke about GE and how they were cooking their earnings under Jack Welch then of course again under Immelt...GE took off like a rocket under take numbers (that is, until the crisis)."
Everybody said, "it's 3% of the S&P 500, we should benchmark it because if we only have 1%, then we'd be short 2% after it took off like a rocket under fake numbers.
But what is Markopolos seeing right now that the rest of Wall Street has missed?
"The numbers are missing. They report top line revenues, bottom line profits, and nothing in between, expenses, research and development, selling, general administration costs - including cash flows, they don't provide working capital, in fact GE is the only company in its industry that doesn't provide working capital, in fact, GE's working capital is minus $23 billion, if you search for current ratio in their annual ratio it doesn't appear - name another company that does that...it's accounting 101," he said.
How severe is the problem? Serious enough to push it into bankruptcy? Yes, Markopolos says.
"They took a $15 billion reserve hit in Jan 2018 for long term care they have another $18.5 billion in immediate cash needs for reserves, they also have a $10.5 billion non-cash reserve hit they need to take on their GAAP books that's going to be a loss and destroy their equity ratios and it needs to be done before Q1 2021 when new accounting rules take place.
He also explained how he went through the statutory filings for 8 GE reinsurance counterparties for long term care and pulled the regulatory filings for the years 2013-2018 and saw "all the losses falling onto GE's books." "GE is losing $5.27 for each dollar of premium they're taking in."
"Those losses are unsustainable and they're growing at an exponential rate. That's not going away...and it's probably going to make this company file for bankruptcy."
But if GE's insurance liabilities take place over several decades, why take a charge for that now?
"Usually you reserve in advance so you can invest the money in the bond market and earn returns on it so you have the money to pay claims when they come due...and if you want to compare it to Unum...Unum's loss ratio for 2018 was 90%, which means they took in $1 of premiums and paid out 90 cents so they were profitable...for Prudential, 81%...for GE, 527% - many times greater. It's unsustainable and it's growing."
A lot has changed since the Enron and Worldcom scandals...what about the auditors, and boards...were all of these people missing the mark here?
"Yes, the gatekeepers have consistently failed...look at the Ratings Agencies during the financial crisis." Markopolos also didn't speak with the company before publishing his report so they wouldn't start destroying evidence.
Markopolos said he's pursuing GE because the shareholders deserve to know...but also because he needs to get paid. "I have a family to support."
Finally, as the interview wound down to a close, Markopolos offered a bizarre explanation for his decision to go after GE: It's recent move of its headquarters near Boston from Fairfield, Conn. "When you move to my home town, and you’re running a scam, I’m going to come after you." And while Markopolos's 'nobody commits accounting fraud in my backyard' sounds convincing, we'd certainly feel better knowing for whom Markopolos is working, and what their angle is, considering that betting against GE is nothing knew.