Fall From Eminence; A Paradigm Shift In Goldman Sachs' Business Model

Nov.14.12 | About: Goldman Sachs (GS)

The challenging macroeconomic environment is forcing more and more investment banks to slash their costs and overheads in order to maintain their profit margins. Fitch, a premier US credit rating agency, declared in a report that further cost cuts and concentration are highly likely among US banks. The credit rating agency believes that banks will increasingly concentrate on areas in which they have a competitive advantage. Most of the investment banks are already taking steps to restructure their businesses. While UBS is aggressively decreasing the workforce of its investment bank, Goldman Sachs (NYSE:GS) and JPMorgan (NYSE:JPM) are concentrating on reducing costs and overheads.

Historically, Goldman Sachs has been famous for its quality products and professional workforce in the Financial Industry. However, in the current challenging environment, the bank has changed its strategy. To maintain profit growth and operational efficiency, Goldman Sachs, after utilizing the latest technology, will now focus on being a low-cost service provider. In a situation where the bottom line continues to suffer from the low volumes of transactions carried out by the bank, Goldman Sachs now aims to concentrate on volumes. As a result, the bank has increased its technology related headcount by 6% while the overall headcount of the bank remained lower than 2009 levels.

If implemented, the use of the advanced technology could result in the bank being able to carry out transactions with clients over several platforms, giving the bank an advantage over its competitors. Apart from that, it could result in increased operational efficiency and reduced costs. Looking at these prospects, the bank has already invested in multiple platforms for both fixed income and equities. Currently, around 60 to 70% of the equity business is being conducted through the use of technology, while a similar trend is seen in its fixed income business.

Moreover, the bank is also expected to take a hit from the Volcker rule, which is being proposed in order to contribute to a safer and more resilient financial system by restricting investments in private equity and proprietary trading. Where it will reduce the volatility in Goldman Sachs' bottom line, the rule will also result in lost revenues for the bank, once it is implemented.

In our previous reports, we had noted that the bank has suffered immensely from most of its talented workforce either leaving the bank or the bank's top executives being accused of losing moral fiber due to sidelining their clients' interests. Most recently, the bank announced the discontinuation of its prestigious two-year graduate program, where the bank hired young professionals from universities and benefited from their talent. The bank's CEO himself admits that in a people driven industry, recruiting and then retaining professionals is critical.

Recent Quarter's Performance:

The bank posted its third quarter s results, which were a big improvement from the results of last year. Revenues of $8.35 billion was up 133% from a year ago, against a consensus mean revenue expectation of $7.3 billion. Similarly, the bottom line of $2.85 per share exceeded its estimate of $2.12 per share by 34% compared to a loss of $0.84 per share at the end of the same quarter of last year.


The stock, which has seen an appreciation in its value of over 28% from the beginning of the year, trades at a discount of 20% to its book value. This is compared to a 46% discount in the case of Morgan Stanley (NYSE:MS) and a 20% discount for JPMorgan.





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In conclusion, where the recent quarter's results are encouraging, we believe the bank still faces problems in attracting and retaining professional workforce. Also, the bank is overvalued compared to its peers. Therefore, we do not recommend our investors to take a long position in the stock. However, proper integration of technology to increase operational efficiency could create a competitive advantage for the bank. Therefore, investors should be on the lookout for any updates on this front.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Business relationship disclosure: The article has been written by Qineqt's Financial Analyst. Qineqt is not receiving compensation for it (other than from Seeking Alpha). Qineqt has no business relationship with any company whose stock is mentioned in this article.