Goldman Sachs's GSTrUE : A Child of Regulatory Decay

Includes: BX, FIG, GS
by: Roger Ehrenberg

You just can't stop innovation, especially in the financial markets where money is the principal motive. But even as the valuation of global exchanges continue to get bid up, they are under siege from a wide variety of sources.

"Dark pools." ECNs. Crossing networks. The list goes on. But most of these execution venues are for publicly-traded shares, the goal being to keep the flow and, therefore, the information content of the trade out of the public eye. This is precisely how Liquidnet, among others, got so big so fast, taking huge amounts of flow off the public exchanges.

But now there is a new game in town, and it relates to IPOs: Goldman Sachs' (NYSE:GS) GSTrUE ("GS Tradable Unregistered Equity OTC Market") program. The Wall Street Journal carried a profile of this strategy, specifically as it relates to the pending offering for Oaktree Capital Management, a top alternative asset management firm. And it made the point that this is a particularly attractive structure for firms like Oaktree, Fortress (NYSE:FIG) and Blackstone (NYSE:BX), who place significant value on keeping their operations confidential and staying out of the limelight. But I'd like to put forth a much broader vision:

One that sees this offering as "letting the genie out of the bottle" as it relates to new equity issuance, just as Liquidnet and others showed the power of off-exchange trading for public shares. And with the U.S. regulatory environment - particularly Sarbox - having a dampening effect on new listings, it just amplifies the threat to U.S. equity exchanges that have already lost business to the LSE and other global trading platforms.

I don't know if Chris Cox reads my blog and is hearing my message. But whether he does or not, I hope he is taking this threat seriously. Very seriously. And now, some excerpts from the WSJ story and my commentary.

Oaktree Capital Management LLC, a Los Angeles "alternative investment" firm, plans to raise almost $700 million by selling a stake in itself. But unlike rival firms selling shares -- such as Fortress Investment Group LLC, which has done so, and Blackstone Group, which plans to -- Oaktree won't trade publicly. Instead, it will trade on a new private market being developed by Wall Street firm Goldman Sachs Group Inc.

Not only does the maneuver enable Oaktree to avoid most regulatory requirements of a traditional share offering, the deal is structured so shareholders will have practically no say in how Oaktree is run.

Right, so it is akin to the Blackstone offering but without the regulatory headaches. Now, I would hypothesize that Oaktree will trade at a discount to its conventional public market value due to the newness of the TrUE structure and lower levels of liquidity (as some firms that would have invested in Oaktree might not, due to their charter, be able to buy shares on this new exchange). That said, I'd assume that Goldman has done a market sounding to gauge the demand for a "structured" offering of this sort for a blue-chip firm like Oaktree, calculated the discount, and together with Oaktree determined that the benefits of avoiding burdensome regulation and disclosure outweigh the valuation give-up. My guess is that this is a substantially NPV-positive trade.

The newly issued shares will trade in a private market developed by Goldman, dubbed "GS Tradable Unregistered Equity OTC Market" or GSTrUE. Only institutions and highly sophisticated investors will have access to the market. At its launch, Oaktree will be the first and only issue on the market.

If successful, Goldman's new market could accelerate the trend away from public listings and thus steal some of the hottest offerings, which would otherwise go to the New York Stock Exchange and other public markets. Alternative-investment firms like Oaktree and Fortress have traditionally sought to remain out of the limelight, making private markets like this especially appealing.

If I were going public, and if my story was a solid-institutional story, then I would certainly consider raising money on the new Goldman market. And even though the TrUE structure is exclusively accessible to accredited (read: institutional) investors, institutions are the increasingly dominant player in the global trading landscape. So I don't see this feature materially impacting the liqudity of the market as it develops. It will end up being more of a professional market, just like Liquidnet. And that fact hasn't hurt its growth or development.

Eventually, Goldman hopes to build GSTrUE into a trading platform where shares in a host of private companies can exchange hands. For its experiment to succeed, however, Goldman must first demonstrate that its market can be an attractive alternative to public markets like the NYSE.

An important first test: Can Oaktree achieve a valuation for its shares as lofty as Fortress and other firms have received on public exchanges? A second is whether the market will have enough liquidity to make it attractive to investors.

I discussed this above. Though the article doesn't specifically address the cost/benefit calculus of these two factors (valuation and liquidity) relative to the benefits of avoiding the regulatory (and accounting, legal and tax) burden of being a U.S. publicly-listed company, I think the trade is pretty straight-forward.

Goldman and Oaktree have assessed the market, done the math, and determined that this is a value accretive trade. In this circumstance Oaktree is not unlike Fortress: FIG blazed the trail of being the first publicly-traded hedge fund GP in the U.S., while Oaktree is boldly testing its brand and appeal on a new type of market. You've got to give the Oaktree team credit. IMHO, this is a game-changer.

You've also got to hand it to Goldman. They're smart and visionary to be sure. But this opportunity exists because of the badly broken regulatory regime in the U.S. Necessity breeds invention, and nowhere is this more true than in the financial markets. Commissioner Cox and his friends in Congress better get on the ball - and quick - if they hope to stem the bleeding of new issuances flying off of U.S. shores and onto foreign and alternative exchanges like GSTrUE. Chris, hear me, please. The time for change is NOW.