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 Goldman Sachs (NYSE: GS) is a leading global provider of investment banking and trading services. Specifically, the firm advises corporations on merging with or acquiring other companies, facilitates client equity and fixed income trading, manages assets for institutional investors and engages in both long-term (private equity) and short-term investments (propriety trading). Goldman has the distinction of being the oldest pure play US investment bank as well as the most profitable. Ironically, despite its long tenure in the industry, the firm is best characterized as an innovator. Since its IPO in 1999, the firm has continued to distinguish itself by being the first in many areas, including prime brokerage (trading and other services provided to hedge funds), electronic equities trading, and of course, China. Goldman has been extremely bullish on emerging markets. Since its entry into China more than a decade ago, the firm has worked to establish strong ties with the Chinese government and regulatory agencies. As a result, Goldman is one of only two US banks licensed to underwrite local issues, providing the firm with an important competitive advantage. In addition to its presence in China, Goldman has successfully penetrated India, Korea and several other countries. In 2007, over 56% of the company's pre-tax income was generated outside of the United States. Goldman, like its peers, is vulnerable to a number of factors including the overall health of the global economy, interest rates and the strength of the private equity industry. Ironically, the biggest risk to Goldman at this point may be Goldman itself. Goldman derives 68% of its revenues from trading-related activities. To date the firm has performed extremely well (far better than any of its competitors). That said, it has accomplished its outsize returns in part by taking greater risk in terms of capital risk. On any given day, the amount of Goldman's money invested in the equity and bond markets is far greater than its peers. However, it has proved more adept at managing this risk than any of its competitors. A series of hedges and short positions the company took against the subprime mortgage market in late 2006 have, so far, largely insulated it from the mortgage meltdown that began in July 2007 - a prescient decision that was unique among all the major investment banks. Goldman also has $20.4B in financing commitments to its private equity clients. If the firm is unable to sell this debt to institutional investors, a task they may prove difficult in the current environment, earnings could drop substantially.
[edit] History and Business OverviewIn 1869, Marcus Goldman founded M. Goldman & Company, a New York City-based investment firm dedicated to raising capital for companies. When Samuel Sachs joined Goldman in 1882, the firm changed its name to M. Goldman & Sachs. In 1896, the company joined the New York Stock Exchange. Goldman Sachs experienced substantial growth in the 1970s, opening its first international office in London in 1970. In 1972, Goldman entered into the areas of private wealth management and fixed income securities, and it began trading commodities in the 1980s after acquiring J. Aron & Company. The asset management division was founded later in the same decade to provide investment guidance to hedge funds and mutual funds. Goldman Sachs launched its initial public offering in 1999.
 Goldman Sachs engages in three principal business segments: investment banking, trading and principal investments, and asset management. [edit] Investment BankingThe Investment Banking Division (IBD) advises large institutions on mergers and acquisitions in addition to assisting them in raising money through debt and equity issuance. The company also underwrites IPOs. Clients include financial institutions, institutional investors, large corporations, and governments. Goldman has ranked number one in mergers and acquisitions for the last 8 years running. Part of Goldman's success in this area stems from its extensive relationship with CEOs at major corporations. It is also the number two equity underwriter. Goldman's ranking for debt underwriting is not quite as impressive. Underwriting decisions are typically made by CFOs, and Goldman's relationships in this area are not quite as extensive as with CEOs. [edit] Trading & Principal InvestmentsThis division generates over 66% of Goldman's revenues. This division both facilitates trades on behalf of clients and invests Goldman's own capital using various debt and equity instruments.
 Equities As its name implies, this division specializes in facilitating equity trades. This segment is also heavily involved in proprietary trading and derivatives. Goldman, along with its competitor Morgan Stanley, is a leader in electronic equities trading. Over the last decade, there has been a move toward electronic trading. Electronic trading eliminates the need for specialists, or people physically executing trades on stock exchange floors, and carries significantly smaller commissions than traditional trading. Goldman is unique in that it has embraced this trend, investing in making its operations as efficient as possible. Principal Investments Area (PIA) PIA engages in merchant banking activities and private equity ventures. PIA makes investments in other corporations, as well as in real estate. In addition to managing the firm's own investments, PIA is partially owned by limited partners, institutions, and high-net-worth clients, who earn a portion of the group's returns. Goldman Sachs is one of the few investment banks to maintain a separate private equity division. [edit] Asset Management & Securities ServicesGoldman's asset management division manages assets for large institutional investors such as pension plans, endowments, and trusts. Unlike most full-service investment banks, Goldman Sachs also provides loans to hedge funds through its Prime Brokerage business. Goldman's asset management business is distinct in that alternative assets compose a relatively high percentage of its assets under management relative to its peers. Investors wishing to gain exposure to alternative assets, which include investment vehicles such as hedge funds and private equity, can do so through Goldman's asset management services. Goldman is also second in prime brokerage, having entered the market earlier than most of its competitors. [edit] International Exposure and Emerging Markets Goldman first entered China in 1992, well ahead of most of its competitors. Over the last 15 years, it has cultivated strong relationships with the Chinese government and various regulatory agencies. As a result, Goldman is one of only two foreign banks licensed to underwrite domestic deals in China and trade in the Chinese markets. UBS AG (UBS) has similar rights, but the Chinese government didn't grant UBS these rights until 2006, two years after it allowed Goldman to begin operating in China. Since 2004, Goldman has participated in underwriting both equities and IPOs for Chinese companies such as China Mobile (Hong Kong) (CHL). It also had the opportunity to invest in the Industrial and Commercial Bank of China prior to its IPO, resulting in gains of nearly $1 billion between Q4 2006 and Q1 2007. Goldman Sachs is the most geographically diverse of its non-commercial banking peers, such as Morgan Stanley, Merrill Lynch, and Lehman Brothers. As seen in the graph to the right, Goldman derived 46% of its 2006 revenues from the outside the US. In 2007, 56% of Goldman's pre-tax income came from non-U.S. sources. In addition to Goldman's long history in China, the firm is firmly entrenched in several other countries, including key emerging markets. In India, Goldman participated in a joint venture for several years and is now significantly expanding its local presence. The firm is also well established in Japan and various European countries. [edit] Trends & Forces [edit] Private equity bubble to burst?After the tech bubble of the 1990s, private equity firms have been increasingly engaging in leveraged buyouts, borrowing substantial amounts of debt to finance their acquisitions of target firms. The past couple of years have seen progressively larger and more frequent deals. One such example of the latter includes Hertz Global Holdings (HTZ), which was taken private only to be returned to the public capital markets less than six months later. Private equity firms have paid increasingly higher prices for firms over the last several years, while including few covenants in their acquisition contracts. Covenants, or provisions that protect the interests of the private equity firm, can include things like paying back the PE firm with any excess cash generated by the acquired company. There are some worries that there are too many private equity firms chasing potential deals, leading to overvalued purchases; this trend is sometimes likened to a private equity "bubble". If this so-called bubble were to burst, investment banks that serve private equity firms would be among the biggest losers. Goldman is involved in the PE process at several different points, including sourcing deals, representing the company being purchased, and facilitating IPOs or any subsequent equity or debt offering. Additionally, Goldman itself has significant investments in private equity, exposing it to conditions in the PE market. [edit] Exposure to US economic fluctuations Investment banks are highly dependent on both global and U.S. economic cycles. When the economy is growing rapidly, companies typically borrow more money and engage in larger numbers of IPOs, leading to greater demand for Goldman's investment banking services. Also, the stock markets often move in the same direction as the overall economy. If the market is up, then demand for trading and other capital markets services increases. Conversely if the economy is depressed, demand for banking services decreases substantially. In addition to fluctuations in demand for services caused by economic cycles, Goldman itself derives a large portion of its revenue from trading and other investments. As such, poor conditions in the larger economy are likely to have a negative impact on both Goldman's portfolio and demand for its services. [edit] Benefit from low interest ratesInterest rates can be thought of as the cost of borrowing money. Though the impact of interest rates spans across the economy, businesses and lenders are particularly sensitive to fluctuations in interest rates. As interest rates increase, businesses are less likely to issue debt or equity given that the price of borrowing has increased. Interest rates have, however, been fairly low since 2004, which has played a significant role in driving business activities. Goldman has benefited from high levels of mergers and acquisitions, underwriting, and IPO activities over the last three years. The federal funds rate cuts in late-2007 and early-2008 by the U.S. Federal Reserve hope to revitalize this trend of strong business activity, which would benefit Goldman. [edit] Subprime lending: large lossesSubprime lending refers to the practice of extending credit or loans to borrowers to who fail qualify for prime or market rates due to their less than optimal credit scores. For the past decade, the interest rates associated with subprime mortgages have been about 2% higher than those associated with prime loans; the rationale is that borrowers with lower credit scores carry a higher risk of default and must therefore pay a considerable risk premium. Subprime borrowers can be extremely sensitive to interest rates. As rates rise, these borrowers, many of whom have adjustable-rate mortgages, find themselves unable to meet their debt obligations. Investment banks like Goldman Sachs generate profit by bundling subprime mortgages and reselling them to other investors in the form of mortgage-backed securities (MBSs). As an increasing number of subprime originators have been faced with bankruptcy (three more in June 2007 alone), both the value of existing MBSs and demand for additional MBSs have fallen significantly. This, in turn, has led to a fall in revenues for Goldman, who both securitizes mortgages and has some holdings of MBSs. Goldman has additional exposure to the subprime market in that it has made loans to several subprime lenders. The firm was the largest creditor for New Century, a subprime mortgage lender that went bankrupt in April 2007. While the exact amount of New Century's outstanding debt is unknown, it could be quite substantial. Goldman's Q2 2007 earnings were relatively flat Y-o-Y despite record performance in its investment banking, asset management, and equities trading divisions. This was due in large part to a subprime-inspired 29% fall in revenues in the sales and trading division. In the third quarter of 2007, however, Goldman reported record-high profits, which were up 80% over the same period in 2006. Going forward, the firm also faces substantial risk in the form of its financing obligations to private equity shops. The firm is committed to providing $20.4B in financing to private equity firms in order to fund leverage buyout activity. Typically, the firm would resell this debt to institutional investors. In the current environment this may prove extremely difficult. If Goldman is forced to keep the debt on its books, earnings could suffer substantially. [edit] High litigation riskAs a premier investment bank, Goldman is both blessed and cursed with a very high degree of visibility. The firm's tenure in the industry and its reputation are integral to its ability to win clients. Additionally, access to confidential information is inherent in the nature of the firm's work. Given these factors, any perceived violation of ethical standards on Goldman's part can have negative repercussions on the firm's bottom line. In an organization that contains tens of thousands of people, a single negative act by an individual can have disproportionately severe consequences for the entire firm. Recently, two Goldman employees were charged with insider trading. Their actions tarnished both their reputations and the reputation of Goldman Sachs as a whole. [edit] Competitive LandscapeGoldman has been the number one investment bank in terms of merger & acquisition underwriting for the last six years. Goldman competes most fiercely with other pure play investment banks such as Merrill Lynch (MER), Morgan Stanley (MS), and Lazard (LAZ). It also competes with J P Morgan Chase (JPM) and UBS AG (UBS) on the trading and asset management side. Goldman is more profitable than any of its peers; one reason for this is Goldman's diverse, yet focused, operations. Goldman, unlike many of its peers, does not maintain an extensive retail brokerage sales force, opting instead to focus on higher-margin businesses such as investment banking and private equity. Goldman also derives a large portion of its revenue from sales and trading, both proprietary and on behalf of clients. Trading, particularly proprietary trading, can be very lucrative, as Goldman has shown. On the other hand, revenues from trading tend to be volatile and subject to many external forces.
Note: Bear Stearns Companies (BSC) reported $529 million in revenue for all its underwriting activities but did not provide a breakdown of debt vs. equity underwriting in its Form 10-K.
 Goldman Sachs Group2004 Data 2005 Data 2006 Data 2007 Data 2008 Data Most Recent Data Available [edit] References
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