Those invested in Goldman Sachs (GS) should be hoping for a share buyout offer, triggered by the dire need to take the Wall Street investment bank private, prior to thoroughly revamping its business model. Otherwise, questions regarding Goldman's short and longer term viability will continue to linger, since management is still unable to publicly define a deleveraged business model suitable for a public listing.
The old business model (essentially incorporating securities trading, risk arbitrage, M&A advisory and bond underwriting) has obviously collapsed. Some elements of the older version do possess the potential to generate profits once the domestic and global economy takes a decisive turn for the better. But the days of exponential gains from leverage-loaded activity are well behind us. And, when calculating returns on equity by any deleveraged measurement, it is indeed difficult to justify a share price above the $20-$30 range today for Goldman's 395 million outstanding shares.
The $20-$30 range is not an arbitrary pick. It represents a number (market capitalization of approximately $11 billion) at which a significant investor would consider taking Goldman private from the perspective of a dividend yield of about 2.5% by early 2010. It also represents limitations on derivatives transactions like credit default swaps, collateralized debt obligations, foreign exchange and interest rate arbitrage and, finally, investment banking fees.
Not that the completion of the dual process of (a) deleveraging and (b) the recognition of inherent risks on outstanding derivatives will negatively impact Goldman alone; the sharp downsizing in profit forecasts as a consequence of that process, under way right across the financial spectrum, must also influence the balance sheets and business profiles of Morgan Stanley (MS), Citigroup (C), Bank of America (BAC) and a number of other candidates who, in part or whole, have been relying on above-average returns from within the investment banking matrix for the better part of this decade.
There is merit in the argument that Goldman's management is more than capable of formulating a credible answer to the current recessionary environment, particularly with assistance from Warrant Buffett ($5 billion invested in GS). But capability is one issue, actual results quite another. Goldman shares will continue to be under pressure until investors have in hand a cogent business model, the absence of which has not been explained thus far. The short-Goldman proposition is not a commentary on where Goldman is headed; rather, it reflects uncertainty and lack of clarity in the face of hard economic data which dictates that Wall Street's financial institutions will struggle to make money, from banking or investment banking activity, at least through 2009.
The situation is ripe for taking Goldman private, an event which will provide management with ample time to review and revise traditional assumptions, and to re-position an exceptional brand name, on the domestic front and internationally; Mr. Buffett, or somebody else with deep pockets, could well come up with the funds required. The alternatives are certainly grim, since it must be conceded that throwing a non-leveraged business model into the public arena at this juncture would invite widespread scrutiny, and possibly expose the weaknesses of the entire bailout exercise being currently undertaken by the Treasury and the Fed by revealing the inexplicable valuation inconsistencies being applied to rescue targets like AIG.
Disclosure: Short GS, C.
