Maximizing the Value of Goldman's Shares? The Answer is Disclosure

Goldman Sachs at 10x earnings. Does this make sense in light of Fortress's 30x P/E or Blackstone's likely stratospheric P/E in the wake of their upcoming offering? It is hard to know given Goldman's limited disclosure of their alternative asset management activities, which encompass a range of businesses and streams of cash flows to rival Blackstone's. But exactly how large, diverse and profitable is it? Don't you think that better understanding these facts could have a material, positive impact on the analyst community's peception of its growth prospects, stability of cash flows and, therefore, its P/E?

The common solution to this problem through much of the 1980's and 1990's was either a partial IPO of the mis-valued business unit or the issuance of a tracking stock, both of which are costly, complex and frequently mis-understood by the marketplace. A full sale or spin-off are also possibilities but not realistic in light of the strategic importance of Goldman's alternatives business to its overall franchise. But an interesting column in yesterday's Financial Times by Thorold Barker posited a simple and elegant yet potentially very powerful solution to Goldman's problem: better disclosure of its alternative asset management activities. And after considering this approach in light of the universe of possibilities, I came to a very clear conclusion: Mr. Barker is absolutely right. And Goldman should heed his words if they know what is good for their employees' pocketbooks - and those of their outside investors.

As a former financial engineer, I am not one to shy away from complexity if it either serves to materially increase value or reduce risk. That said, sometimes the easier solution is the better one. This is one of those cases. Let's consider for a moment that Goldman's alternatives platform should trade at a multiple similar to Fortress. It could be argued that Goldman's portfolio is both larger and more diversified than Fortress's, and should, therefore, trade at an even higher multiple. But let's say for the moment that it could fairly trade at 30x. Without running many numbers one can see that the rest of Goldman's business could effectively be gotten for free, which is truly insane if one looks at the comparables. Even if the alternatives franchise is valued at only 20x, one is still valuing the firm's market leading broker/dealer activities at close to nothing.

This is clearly a case where something has to give - either Goldman is being valued at some 50% of its fair market value or Fortress (and, shortly, Blackstone) are grossly overvalued. In truth, the right answer probably lies somewhere in between. But in any event, Mr. Blankfein and the Goldman Board should strongly consider some enhanced transparency of its alternatives business in order to drive a sharp upward spike in valuation. I think this is a small price to pay for tens of billions of value creation. And the PR benefits of better, more complete disclosure wouldn't hurt, either. And they'd be a trail blazer among the top tier of the investment banking community. The answer is clear. All that remains is to just do it.

Comments

[Roger]

KB, thanks for the post. You are correctly asking for details when I am painting with a broad brush. The answer: I don't have the nubmers. Nobody outside Goldman does. But you are right, we should, and it would be great to do the analysis properly and with empirical data.

Your point about free vs. cheap is a fair, but doesn't take into account other proprietary trading activities that are rightly hedge fund-like but not currently cosolidated into Goldman's asset management activities. The group I ran at Deutsche Bank, DB Advisors, was a multi-asset class hedge fund platform that was consolidated into the Equity division, not Asset Management, ergo, not included in the $2.4 billion number you cite for Goldman. And its numbers were huge. So there is no telling what other Fortress-like activities are not included in Goldman's alternatives activities. So free vs. cheap? Too fine a distinction for me to make.

The FT article didn't have the numbers, either (obviously - they're not privy to special access any more than we are), and didn't specifically outline a set of requirements for Goldman to get a valuation bump. But you can't compare Goldman's disclosure to Fortress' (or Blackstone's) disclosure - it is far, far less granular. So some effort would need to be made on Goldman's part to get the benefits of a valuation uptick. But as you say, it's not like Fortress is telling the whole world exactly how they make money. So I can't imagine why Goldman wouldn't consider the recommendation and thesis of my post.

Thanks for commenting.

[K B]

Interesting post, but I'm still left with a few questions:
1) "rest of GS' business could be gotten for free"--what income number for alternative asset mgmt are you using and where are you getting it? I couldn't find it disclosed. In 2006, GS's total asset mgmt business (i.e. including fixed income, equities, money markets, in addition to alternatives) only generated $2.4b in PRE-TAX earnings. Slapping a 30x multiple on all of these gives $73b---versus GS's current market cap in excess of $80b. What numbers did you use? If we ex out the other types of asset mgmt and make it net earnings, I'm sure it wouldn't leave the rest of GS being free. Cheap, but not free.
2) I can't access the FT article, so can you please summarize what spefically they would need to disclose for the market to not just lump alternative asset mgmt in with the rest of GS' businesses? I was under the impression that the Fortresses and Blackstones of the world disclosed VERY little, yet still trade high valuations. What does Fortress disclose that GS Alternative Asset Mgmt doesn't, and why would that make a difference?

Thanks, and once again, good post.

[Roger]

Michael, thanks for your kind words. Unfortunately, the issue is a little more textured than you are making it, but I appreciate your certainty and enthusiasm.

Let's look at two portfolios, both of which have similar growth prospects, though one (A) is made up of only one asset and the other (B) is made up of five assets. And let's further assume that the returns among B's assets are not perfectly correlated. What you'd have is B trading at a higher PE than A, notwithstanding comparable growth rates. Why? Similar expected growth with lower volatility. Pretty straight-forward, eh? I'd pay more for B than A in a heartbeat, as would every other rational market participant, diversification notwithstanding (which can, in fact, be good as my example shows).

So Michael, it is a little more complicated than just growth rates. Think of Fortress as a variation of A and Goldman's alternatives and prop trading platform as a variation of B. And I'm not so sure this is far from the truth.

Duh?!

[Yaser Anwar]

Excellent post. I think BX & FIG need to come down quite a bit.

Everyday we're bombarded with PE this PE that, their returns, much like HFs in the heyday (not that those days are behind them) have been glorified by the media, which has lead to these PE "dudes" capitalizing of this trend.

Sir- what do you think of the possibility of Goldman being taken private by Goldman? Sounds crazy but, as you've alluded to, they are quite undervalued. Wells Fargos and Merrills of the world sell more than GS. GS's VaR, a flawed way to metric, is grossly overemphasized, and sooner or later people will wake up to this fact. Let's hope they are still public by then.

[Michael Storm]

You say -

" It could be argued that Goldman's portfolio is both larger and more diversified than Fortress's, and should, therefore, trade at an even higher multiple.
"

Where in the world would you get that argument?

Larger, more diversified companies trade at a lower multiple.

Its about growth-rates, duh!