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Piece of mind

7 September 2011 By Rob Cox

Goldman Sachs has often helped chief executives boost their companies’ shares by breaking them into pieces. The U.S. bank run by Lloyd Blankfein is currently advising Kraft Foods on its split and counseling McGraw-Hill on whether it should do the same. So it’s logical that some inside Goldman have run the numbers on their employer. The results are compelling. Should the firm’s stock linger below its book value, or assets less liabilities, of about $130 a share for much longer, a breakup could be hard for the firm’s board to resist.

There’s no suggestion for now that Goldman is considering such a radical maneuver. Most of its peers are also trading at a discount to book value, suggesting a sector-wide issue rather than something Goldman can easily tackle individually. And the company has a long-held view that the individual pieces – an industry-leading investment bank, a massive securities trading operation and an asset management arm – function best in combination.

Yet based on current market metrics, Goldman’s parts are potentially worth a lot more than the whole. And many of the justifications that the firm has given in the past for maintaining its structure look out of step with the changing global regulatory framework.

The starkest illustration of this mismatch comes in asset management. The Volcker Rule provision of the U.S. Dodd-Frank Act stipulates that a bank’s own money cannot comprise more than 3 percent of a private equity fund it manages. At present Goldman’s own capital accounts for a third of the $20 billion fund overseen by GS Capital Partners. Once the Volcker Rule becomes effective, the benefit of investing Goldman’s money alongside clients’ cash will be much diminished.

It could, however, be the simple dollars and cents that eventually talk loudest. Valuing each of the firm’s pieces is art as well as science, partly because the company’s published financial statements do not show the profitability of each segment in detail. But the available information does support a rough sum-of-the parts analysis.

First take Goldman’s investment banking unit, which includes advising companies on mergers and acquisitions and underwriting on behalf of clients. If the group extends its first-half performance for the rest of the year, it will make about $5.4 billion in revenue. On a multiple of four times sales – a deserved premium to smaller rival Greenhill which trades at three times – the unit could be worth $22 billion.

Then there’s asset management, which oversaw $844 billion of assets as of June 30. This includes Goldman’s private equity funds, with all the Volcker Rule uncertainty over their future. It’s hard to value this business because its profitability isn’t clear. The firm is also restructuring the unit. But valued at 10 percent of assets under management – roughly in line with Blackstone Group – Goldman’s alternative investment activities alone may be worth $15 billion. At 2 percent of assets, the rest of the unit would fetch a price of around $14 billion.

Add these pieces up and fold in a near $7 billion stake in Industrial and Commercial Bank of China and some other investments held directly on the Goldman balance sheet, and their value already exceeds the company’s $53 billion market capitalization.

That means Goldman’s Institutional Client Services arm, which generated 53 percent of revenue in the first half of 2011, comes for free. This business houses one of the industry’s top prime brokerages servicing hedge funds, as well as desks dealing in equities, fixed income, currency and commodities around the globe.

This business has its problems. In the six months ended in June, revenue declined 25 percent from the same period in 2010 partly as a result of new rules that prohibit banks making market bets with their own money. And there may be more bad news to come as the business further adjusts to new regulations. And while Goldman is a bank holding company with access to Federal Reserve lending, investors might balk at funding a standalone trading business in a crisis.

Nonetheless, it’s hard to see how Wall Street’s most profitable trading business over the last decade can have no value at all to shareholders. Breaking up Goldman may not be the legacy Blankfein hoped to carve out of his tenure. But if clients regularly take the firm’s advice to break up, it would be hypocritical of him not to consider the possibility himself.


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