Goldman Sachs, Investment Banking For Risk Tolerant Investors Only
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Goldman Sachs (NYSE: GS) is always among my favorite companies to write about, for there is never a dull quarter. In the wake of Moody's downgrading the debt of numerous enterprises with investment banking units, I thought it appropriate to see how Goldman's underlying business has been affected during this second quarter of 2012.
Goldman stock has not performed well this spring. I had thought we would see by now an extension of merger and acquisitions activity after the bleak second half of 2011. But the lethargy of the American economy, along with the absurdity of the European economic crisis and slowing growth in China, has put a lid on such capital markets expansion. The biggest deal so far this year, the initial public offering of Facebook (FB), did not have Goldman Sachs as the lead underwriter, and given the results this may have been a blessing for Goldman Sachs. But the relative failure of that endeavor also seems to have put a damper on any new large offerings.
If there was one salient feature this spring, it was personnel issues. Former board member Rajat Gupta was found guilty of insider trading and has begun serving a lengthy prison sentence. Goldman Sachs has been forced by courts to continue paying Gupta’s legal bills. Also in June, three high level partners announced their retirements. In fact, as business and revenues have been sluggish, Goldman has generally been reducing its headcount over the course of the last twelve months, reducing employees to 32,400, a drop of about ten percent since the start of the third quarter of 2011.
Goldman's credit rating was reduced by Moody's largely because of exposure to uncertainty in Europe. I do not believe there will be any significant impact tied to the debt rating reduction, as Goldman Sachs still has a rating well into investment grade status, and it was not in the bottom third of Moody's three tier system. At the May 31, 2012 Bernstein Strategic Decisions Conference, COO Gary Cohn noted a shift in European debt issuance from loans to bonds. Given Goldman's entrenched presence and sales capability, this evolution would be a welcome change.
Goldman has been a bank for less than four years and bears virtually no resemblance to the large commercial banks with which we are all familiar. But as an FDIC institution, it is subject to the same capital standards of any bank. At the end of the first quarter, it had about $950 billion in assets, which would place it as the country's fifth largest bank if we made no distinction. It passed the first quarter Comprehensive Capital Review (stress test) with ease during the first quarter, and it further added to its liquidity in the second quarter by selling just less than half its stake in Industrial and Commercial Bank of China (IDCBY) for $2.3 billion in April.
Another interesting development is that CEO Lloyd Blankfein has apparently happened upon a public perception improvement. He was vilified in Congress for Goldman Sachs' role in the 2008 banking crisis, at about the same time that JPMorgan Chase (NYSE: JPM) CEO Jamie Dimon became the face of responsible banking. Things have turned. Now, Dimon is under review from Congress and others because of JPMorgan's trading losses, and Blankfein is enjoying a period of relative stability at Goldman Sachs; according to some, he may be the next media darling of the financial industry.
Blankfein very recently indicated he expects nearly all of Goldman Sachs future growth to come from the BRIC countries, Brazil, Russia, India, and China. While not quite the global fiasco that I expect Citigroup (C) to be careening toward by doubling down on emerging markets, Goldman's move might not be coming at the best time, as the BRIC economies have lately seen their growth curves flatten.
Investment banking is a highly cyclical business, from year to year and even from quarter to quarter. It is more cyclical in my view than steel, construction, or automobile manufacturing. Over the past five years, Goldman Sachs has posted earnings of over $20 per share, and other years of less than $5 per share. This stock will never be for the faint of heart, or one I would have in my own portfolio. But if you are risk tolerant, and can wait out the inevitable cyclical up-tick in Goldman Sachs' core businesses, today's price may be an attractive entry point.
Most of Goldman Sach's domestic based competitors are the investment bank divisions of large bank holding companies like Citigroup and JPMorgan. But the company most like Goldman Sachs is Morgan Stanley (NYSE: MS), in that its focus is on investment and not on commercial banking. Morgan Stanley has thus far had a horrific 2012, highlighted by its lead role in the Facebook IPO, which will keep Morgan Stanley in courts for years defending suits.
Moody's recently downgraded Morgan Stanley's debt by two notches, to Baa3, and its short term paper to P2. Moody's maintained a negative outlook on Morgan Stanley going forward. Perversely, the market reacted positively as it was expecting a three notch downgrade. Like Goldman Sachs, Morgan Stanley has no retail branch system from which to secure low cost deposits. Morgan Stanley's stock price has fallen now to about one half of its book value, and again, it is going to take a while for the venerable institution to dig itself out of this mess. I would suggest this issue only to value oriented, highly risk tolerant, and patient investors.
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