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(Investment Banking (10.6% of 2009 revenue; 6.4% of 2009 earnings)<ref name=seg >[stock: Goldman_Sachs_Group_(GS)/Filing/10-K/2010/F46738346#105 GS 2009 10-K Part 1 "Segment Operating Results" p.3]</ref>)
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In addition to assisting client raise money through debt and equity issuance, this division advises them on mergers and acquisitions. The company also underwrites [[IPO | Initial Public Offerings]]. Clients include financial institutions, institutional investors, large corporations, and governments.<ref>[http://www.sec.gov/Archives/edgar/data/886982/000095012309001278/y74032e10vk.htm GS 2008 10-K Part 1 "Investment Banking" p.6]</ref> In addition to assisting client raise money through debt and equity issuance, this division advises them on mergers and acquisitions. The company also underwrites [[IPO | Initial Public Offerings]]. Clients include financial institutions, institutional investors, large corporations, and governments.<ref>[http://www.sec.gov/Archives/edgar/data/886982/000095012309001278/y74032e10vk.htm GS 2008 10-K Part 1 "Investment Banking" p.6]</ref>
-In 2009, Goldman was replaced by [[J P Morgan Chase (JPM)]] as the number one ranked global adviser on mergers and acquisitions in terms of transaction volumes. Although Goldman has lost its top spot, overall market activity for mergers has dropped 53% from 2007 to 2008.<ref>[http://online.wsj.com/article/SB123076066898846511.html The Wall Street Journal "M&A Went MIA and May Stay That Way" 2 Jan 2009]</ref>+In 2009, Goldman was replaced by [[J P Morgan Chase (JPM)]] as the number one ranked global adviser on mergers and acquisitions in terms of transaction volumes. Although Goldman has lost its top spot, overall market activity for mergers has dropped 53% from 2007 to 2008 and by 42% from 2008 to 2009.<ref>[http://online.wsj.com/article/SB123076066898846511.html The Wall Street Journal "M&A Went MIA and May Stay That Way" 2 Jan 2009]</ref><ref>[http://www.financialexpress.com/news/global-m&a-deals-down-42-in-2009-dealogic/440851/ The Financial Express "Global M&A deals down 42% in 2009" 30 March 2009]</ref> However, the market is expected to pick back up again in 2010.
[[Image:GS_Daily_VAR.png|thumb|380px|right|Average daily value at risk]] [[Image:GS_Daily_VAR.png|thumb|380px|right|Average daily value at risk]]

Revision as of 18:17, April 11, 2010

Goldman Sachs (NYSE: GS) is a U.S. bank holding company known for a strong investment bank division. Goldman Sachs advises corporations on mergers and acquisitions, offers trading services, and manages the assets of large institutions, governments, and wealthy individuals. Goldman Sachs also uses its own capital to engage in long-term (private equity) and short-term investments (propriety trading).

Goldman had the distinction of being the oldest and most reputed pure play investment bank in the world, but became a bank holding company on September 21, 2008. Even though Goldman Sachs was not directly hurt by the subprime crisis, the banks stock price per share fell and the company incurred losses due to a drop in the overall market. The new holding bank status allows the company to run commercial banking operations and gives its depositors insurance through Federal Deposit Insurance Corporation (FDIC). Deposits, in turn, allows Goldman Sachs to reduce its leverage ratio and hence reduce the risk of bankruptcy.[1]

Goldman Sachs also accepted $10B under the Troubled Assets Relief Program (TARP), however, to protect itself from increased government regulation, it moved to quickly leave the program. Goldman Sachs bought back $10.04B worth of preferred shares from the government on June 17th 2009, after having received permission do so.[2][3][4] Goldman Sach's ability to repay the loans with relative quickness demonstrates its relative strength in the investment banking sector.

However, as a bank holding company, Goldman faces more regulation than it previously faced. [5] Goldman Sachs had accomplished its high returns in the past by taking greater risk in terms of capital risk. However, as a holding bank, it is not allowed to take on such risk and so its future performance may be impacted.[6]

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History and Business Overview

GS has frequently performed above the market despite worsening economic conditions. Although the company did report a fourth quarter 2008 loss, GS regained profitability the following quarter.[7] These losses and the overall market condition, forced Goldman Sachs to accept $10B in capital injection under the Troubled Assets Relief Program (TARP). In addition, Goldman received $5 billion in equity investment from Berkshire Hathaway (BRK) and announced that it plans to raise another $10 billion from other investors. However, the company has since then repurchased the TARP assets in June 2009.[8]

Since the 2008, the company has outpaced the market enough to draw public scorn. With strong profits and expected strong bonuses, the company has set aside $500M to invest in small businesses. These efforts are a combination to both improve the economy and their public image.[9]

The company's operations can be broken down into three divisions:

Investment Banking (10.6% of 2009 revenue; 6.4% of 2009 earnings)[10]

In addition to assisting client raise money through debt and equity issuance, this division advises them on mergers and acquisitions. The company also underwrites Initial Public Offerings. Clients include financial institutions, institutional investors, large corporations, and governments.[11]

In 2009, Goldman was replaced by J P Morgan Chase (JPM) as the number one ranked global adviser on mergers and acquisitions in terms of transaction volumes. Although Goldman has lost its top spot, overall market activity for mergers has dropped 53% from 2007 to 2008 and by 42% from 2008 to 2009.[12][13] However, the market is expected to pick back up again in 2010.

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Average daily value at risk

Although only 23% of Goldman's revenue comes from investment banking, the impact of this segment reaches far beyond its measurable revenue contribution. Goldman is the most effective of the major investment banks when it comes to leveraging its relationships to cross-sell additional services to its clients. It is estimated that investment banking is indirectly responsible for an additional 10% of Goldman's revenues.

Trading & Principal Investments (76.1% of 2009 revenue; 87.3% of 2009 earnings)[10]

This division facilitates trades on behalf of clients and invests Goldman's own capital using various debt and equity instruments. There are three subdivisions in the Trading & Principal Investments segment:

  • Fixed Income, Currency, & Commodities (FICC) facilitates trades of asset-backed securities, securitized loans, currencies, and commodities (ex: oil, corn, or chocolate futures). It seeks opportunities to profit through the movements of interest rates and credit products.
  • Equities specializes in facilitating equity trades, and is considered to be a leader in electronic equities trading. Electronic trading is efficient because it eliminates the need people physically executing trades on stock exchange floors, and carries significantly smaller commissions than traditional trading. This segment is also heavily involved in proprietary trading and derivatives. [14]
  • Principal Investments Area (PIA) engages in merchant banking activities and private equity ventures. PIA makes investments in other corporations and real estate, which totalled $15.13B in 2008.[15] 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.

Asset Management & Securities Services (13.3% of 2009 revenue; 6.8% of 2009 earnings)[10]

Goldman'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.

Trends & Forces

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Alternative assets make up a larger percentage of Goldman's assets under management (AUM) relative to its peers

Transformation into a bank holding company decreased bankruptcy chances

Goldman Sachs was largely insulated from the subprime crisis due to bets placed by the banks propriety trading desks. Propriety trading is the practice of risking the banks own capital on a certain position. Still, its stock price per share fell from $169 on Sept. 8, 2008 to $86 on September 18, 2008 because of speculation that it could be the next bank to fall after the collapse of Lehman Brothers (LEH) and the fire-sale of Merrill Lynch (MER) to Bank of America (BAC) on September 15, 2008. On September 21, 2008, it became a bank holding company, which helped prevent the bank's market capitalization from plummeting further.

The new status allows the company to run commercial banking operations and gives its depositors insurance through Federal Deposit Insurance Corporation (FDIC). Most importantly, the new status allows Goldman to use deposits to support its leverage. On the day of their transformation, it had a leverage of 26. This meant that for every dollar in equity, or borrowed money, the bank had $26 in assets.[16] This decreases the chances that Goldman Sachs will face bankruptcy since its investments are increasingly backed by deposits, and not loans.

However, President Obama and Paul Volcker, the President's chief economic adviser, have pushed for increased regulation on the financial industry. In particular, the so-called Volcker Rule would prevent holding banks from also undertaking proprietary trades. The Volcker Rule hopes to prevent holding banks for taking on too much risk and causing possible future financial crisis. This is especially problematic for Goldman since it converted to a holding bank in order to receive government funds and have FDIC coverage. In addition, the proprietary trades are one of Goldman Sach's greatest strengths. This rule, if implemented, would force Goldman to re-convert itself into a normal investment bank and prevent it from simultaneously being a holding bank. Goldman Sachs has repeatedly stated that it does not want to lose its bank charter and does not plan on converting back to a pure investment bank on its own.[17]

Strong international and emerging markets presence provides large outlet for growth

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Goldman first entered China in 1992, well ahead of most of its competitors. Over the last 17 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. Goldman Sachs has repeatedly raised its economic expectations in China. Despite the economic recession, Goldman Sachs raised its expected GDP growth for China to 9.4% in 2009. In addition, the company increased its investments in a variety of consumer and raw material stocks in late 2009.[18] Although other banks have gained access to the Chinese markets in a variety of segments, Goldman Sachs has remained a leader. In a 2008 survey run by PriceWaterhouseCoopers on foreign banks in China, Goldman Sachs ranked number one in performance, presences, and momentum in Investment Banking, Corporate Finance, Mergers and Acquistions, and Equity and Capital Markets.[19]

Goldman Sachs is the most geographically diverse of its non-commercial banking peers, such as Morgan Stanley, Merrill Lynch, and Lehman Brothers. Yet despite this relative diversity abroad, Goldman Sachs has decreased its revenue share from abroad. From 2007 to 2008, the portion of Goldman's revenue attributed to the US increased from 51% to 70%. This rise was largely due to a fall in the portion of revenues from Asia, which fell from 20% to 4%.[20] 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.

Benefit from low interest rates

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Interest rate trends over time

Interest 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 the Federal Reserve cuts the interest rate at which it lends out money, banks are able to gain access to "cheaper" money. For example, in July 2009 it was 0.5%, compared to 2% in July 2008 and 5.25% in September 2007.[21][22] These extremely low rates can allow Goldman Sachs to borrow money with low interest and increase its profit margins.

Subprime lending: large losses

Subprime 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 reported a $2.12B loss in earnings for Q4 2008 - its first quarterly loss in its history. Although Goldman stayed relatively out the subprime mortgage market compared to some of its competitors, the almost 30% drop in the global equity market drastically hurt the company's returns. Goldman's chief financial officer argued that the losses were a result of a market wide trend and that the firm would reverse the losses as the market turned around.[23] In April 2009, Goldman sold 6.1 million shares to raise $5.75B and sold $2B in five-year debt. By June 2009, the firm raised enough capital to repay the U.S. government for its original $10bn capital infusion under the Troubled Assets Relief Program (TARP).[24]

Private equity bubble 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. 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". With more than $500B in private equity debt that will have to be renegotiated by 2010, some experts predicts up to 30% of buyouts could default. In addition, the weakened economic state makes finding big deals more difficult and so harder to pay off losses from past deals.[25] 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. In August 2008, as many in the industry became cautious on PE investments, Goldman actually bought a portfolio of private equity investments for $1.5 billion.[26]

Competitive Landscape

Although Goldman has been the number one investment bank in terms of merger & acquisition in the past, it recently was surpassed by its rival J P Morgan Chase (JPM). In addition, Goldman competes most fiercely with other pure play investment banks such as Citigroup (C) and Lazard (LAZ). It also competes with J P Morgan Chase (JPM) and UBS AG (UBS) on the trading and asset management side. Goldman, unlike many of its peers, has not maintained 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, has allowed Goldman Sachs to stay insulated from the subprime crisis.

2008 metrics Goldman Sachs Morgan Stanley[27]
Gross Earnings ($B) 22,222 24,739
Pre-tax income ($M) 2,336 1,707
1-yr revenue growth (%) -51.7 -11.6
Equity origination revenue ($B) 1,353 1,045
M&A advisory revenue ($B) 2,656 1,740
Debt underwriting revenue ($B) 1,176 845




References

  1. Bloomberg.com, Retrieved September 23, 2008
  2. Market Watch "Goldman Sachs repays about $10 bln in TARP funds" 17 June 2009
  3. Blogging Stocks "Goldman Sachs wants to give back TARP money, but can it?" 6 Feb 2009
  4. Street Insider "Goldman Sachs (GS) Receives Permission to Repay TARP Funds" 9 June 2009
  5. Wall Street Journal, retrieved September 22, 2008
  6. Wall Street Journal, retrieved September 22, 2008
  7. The Wall Street Journal "Goldman Faces Loss of $2 Billion for Quarter" 2 Dec 2008
  8. All American Patriots - Banking "Goldman Sachs Buys Back TARP Preferred Stock" 17 June 2009
  9. USA Today "Goldman Sachs CEO polishes firm's image" 25 Nov 2009
  10. 10.0 10.1 10.2 [stock: Goldman_Sachs_Group_(GS)/Filing/10-K/2010/F46738346#105 GS 2009 10-K Part 1 "Segment Operating Results" p.3]
  11. GS 2008 10-K Part 1 "Investment Banking" p.6
  12. The Wall Street Journal "M&A Went MIA and May Stay That Way" 2 Jan 2009
  13. The Financial Express "Global M&A deals down 42% in 2009" 30 March 2009
  14. GS 10-K 2008 Item 1 "Equities" p.10
  15. GS 10-K 2008 Item 1 "Principal Investments" p.10
  16. The Wall Street Journal, Retrieved September 23, 2008
  17. Reuters "Volcker: Choice is prop trading or bank charter" 12 Feb 2010
  18. The China Post "China stocks remain 'bright spot': Goldman Sachs" 1 Sept 2009
  19. PriceWaterhouseCoopers "Foreign Banks in China" 3rd Survey Jun 2008
  20. GS 10-K 2008 Notes to Consolidated Financial Statements: "Geographic Information" p. 205
  21. Bloomberg.com, US Rates and Funds
  22. Federal Reserve Board "Open Market Operations" 16 Dec 2008
  23. The Wall Street Journal "Goldman Sachs Reports $2.1 Billion Quarterly Loss" 16 Dec 2008
  24. All American Patriots - Banking "Goldman Sachs Buys Back TARP Preferred Stock" 17 June 2009
  25. The Guardian: Business "Private equity 'next bubble to burst,' unions warn" 3 Feb 2009
  26. Goldman Goes All In on 'Secondary' Bet - WSJ.com
  27. MS 10-K 2008 Item 6. "Selected Financial Data" p.34
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