Alex Bossert

Goldman Sachs

Summary:

Goldman is trading for the cheapest price in its history as a public company. Goldman is a great

business that dominates just about every business segment they are in. Goldman has been hit

from every angle recently. Some of the challenging factors include subpar loan demand, low

M&A, IPO and other investment banking business, regulatory threats, market deleveraging,

lower company leverage, constant criticism etc. This has resulted in one of the world’s premier

investment banks trading at less than 75% of tangible book. Goldman is worth over $200 per

share and investors are ignoring many positive factors going forward. Over the course of

Goldman’s history they have been very nimble in shifting assets to the highest ROI areas,

assuming that ROE will be at these very depressed levels forever is not an accurate conclusion.

Goldman is trading at a large discount to the liquidating value of its assets that are nearly all

mark to market. Investors are ignoring the opportunities and tailwinds that exist. There is a huge

potential to grow significantly overseas and competition has been reduced from the financial

crisis. In addition, the reduction of the firm’s temporary liquidity will add a few billion to the

bottom line. Increased leverage and a return to more risk taking will also boost results. Large

share buybacks at such an advantageous price will further enhance value. Goldman is a low

downside bet that could be worth up to $270 in a few years or 3x the current price.

Alex Bossert

Reason For Mispricing:

Goldman has been in the negative spotlight constantly for the past 4 years. The majority of the

public hadn’t heard of Goldman before the financial crisis. Now, the public is well aware of

Goldman after nearly all negative press since the financial crisis. One example is the picture of

the giant blood sucking squid in a May 2011 Rolling Stone article. In addition, outrage was

flared after the company was charged with fraud in April of 2010 and the allegations that came

out of Carl Levin’s April 2011 investigation. Just about every market factor is aligned against

Goldman right now, subpar loan demand, low M&A, IPO and other investment banking

business, regulatory threats, market deleveraging, lower leverage etc. Investors are assuming that

they won’t earn their cost of capital going forward and their business model is broken, none of

this is the case. However many factors will be turning to their favor such as less competition,

growth overseas and the reduction in the temporary liquidity they are holding. Goldman allocates

capital to the best risk adjusted area and it’s able to move very quickly evidenced by the move to

short the housing market that took only months to execute. Goldman is always able to move into

new opportunities and they have continued to do well even during the financial crisis.

Strength Of The Business:

There is no doubt Goldman is the best investment bank. Goldman gets the best talent year after

year. In 2010 and 2011, 300,000 students applied to Goldman. Goldman offered spots to just 4%

of those who applied. 9 out of 10 candidates accepted a position at the firm. At rival Morgan

Stanley, for example, only 70-84% accepted the company’s job offer.

I have a friend who was just hired by Goldman. He went to the University of Michigan. He said

500 people applied and he was one of 10 who got a job offer. The students who are applying to

Goldman are the very top students in their class from the top business schools. Goldman in turn

only accepts the very top of those applicants to hire.

Back in 2010 Charlie Munger said that Goldman is the best investment bank and he is

disappointed they are getting all the blame because he thinks they acted the best. Since

Goldman’s IPO in 1999 through 2011 book value per share has grown 16% per year, Return on

equity has averaged 18.5% and pretax margins has averaged 31%. Keep in mind that these

numbers include the recession years 2008-2011. From 2008-2011 book value per share grew

15% and return on equity averaged 12%. Goldman has never lost money as a public company

except for the 4th

quarter of 2008.

Goldman has performed much better than its competitors. Goldman has averaged an ROE 10%

better than its competitors. Their risk management has been much better than rivals. Goldman

marks its assets to market aggressively. If they can’t find publically available prices they do their

best to sell some of the securities to determine the price. The best in class risk management gives

much more confidence in the value of their assets. Goldman will benefit significantly from the

reduction in competition. Big financial firms have exited business lines, Lehman went bankrupt,

Bear Stearns and Merrill were significantly hurt and subsequently acquired, Morgan Stanley has

Alex Bossert

also lost some luster and now JP Morgan is facing large losses from a mistake in their European

trading operations. European banks are also very distressed and Blankfein mentioned that

Goldman is gaining business and market share from competitors in this region.

Another reason Goldman has performed better is because of their former partnership structure. In

the 1999 IPO, a small percent of the stock was sold to the public. The majority was retained by

partners. Goldman has retained the ownership culture and this has contributed to their

outperformance and better decision making.

Goldman has the highest capital and liquidity ratios in the industry. They will not be hurt by

Basel 3 as much as competitors.

Furthermore, Goldman has moved back up to number one in recent M&A tables.

Going Forward:

Goldman is a powerhouse in the United States but they have very little presence abroad. In 2011

85% of pretax earnings were generated in the United States. In a recent interview with CEO

Lloyd Blankfein he said Goldman has only recently began to expand abroad into China, Russia

and India. Goldman can be as strong as it is in the US, abroad. Goldman makes the most money

when economies expand, these emerging markets present huge profit potential. They have been

to conservative growing abroad. A recent Fortune article quoted president Gary Cohn saying

that the issues facing banks in Europe are helping Goldman as they are gaining clients from

failing banks.

Valuation:

Goldman is made up of four divisions. The investment banking and investment management

segments are great businesses. They are relatively stable, best in their industry and very little

capital is required to run them. In 2011 the investment banking business did $1.4 billion in pre-

tax earnings during a depressed environment. In 2007 this business did $2.6 billion. This

business requires only $5 billion in capital.

The other good segment is the investment management business. This segment did $1 billion in

pre-tax earnings last year, compared to $1.7 billion back in 2008. This business only requires $1

billion in capital.

Pre-tax earnings for these two businesses during 2011 was $2.4 billion. This is a very depressed

operating performance for both segments. These two segments require only $6 billion to operate.

So at trough earnings they are generating a 40% return on capital. At 13x depressed earnings

they are worth $31 billion or 65% of Goldman’s total market cap.

Alex Bossert

The two remaining parts of Goldman’s business, “Investing and Lending” and Institutional

Client Services” are not as good because they are much more volatile, require more capital to run

and will be effected more by increased regulation. However last year they made $4 billion in

combined pre-tax earnings. The 3 year average pre-tax earnings of these two segments is $11.4

billion. Based on the value of the other two segments above, the “Investing and Lending” and

Institutional Client Services” segments are trading for $17 billion. This doesn’t make sense when

they have been generating over $11 billion in pretax income on average.

CEO Lloyd Blankfein said that a 12% ROE (2010) is the result of a very poor opportunity set.

He said this is the result of a lower third quartile opportunity set and is far below their potential.

Goldman has moved in the last few years to reduce risk and increase liquidity to ensure they

make it through the uncertain environment. Holding down operating results is $171 billion in

temporary liquidity compared to a more normalized level of $60 billion. This excess liquidity is

coming from long term debt and is reducing ROE significantly. The firm is currently leveraged

at 13x compared to a historical average of 20x. Goldman’s ROE will be significantly higher

when these numbers return to normal levels.

In the first quarter of 2012 Goldman made $2.1 billion or a 12% ROE annualized.

Summation:

Tangible book value per share was $124 at the end of the first quarter. At 75% of book value,

this is the cheapest Goldman has ever traded at except right after the Lehman bankruptcy. In

May of 1999 Goldman Sachs went public at $70 per share. Thirteen years later the stock is only

35% above its IPO price but tangible book value per share has increased from $23 in 1999 to

$124 today. In addition, earnings per share has increased from $5.60 per share in 1999 to $15.22

in 2010. According to Boykin Curry’s Value Investing Congress presentation, the liquidating

value of Goldman a year ago was $150 per share.

If book value grows 12% going forward (even at a 12% ROE book value will grow faster

because of accretive buybacks), tangible book value will grow to $174 by the end of 2014. At a

multiple of 1.2-1.4x book value the company is worth $208-$243 when very depressed growth

levels are assumed. If Goldman is able to generate ROE’s of 14-16%, it’s worth up to $270 per

share.

Goldman is trading cheap because of the harsh criticism they have received, the current

depressed earnings and because investors assume new regulation will hurt them significantly.

However all of these factors are not permanent issues. Investors are completely missing that

Goldman has many opportunities and tailwinds going forward.

There is a huge potential to grow significantly overseas and competition has been reduced from

the financial crisis. In addition, the reduction of temporary liquidity will add a few billion to the

bottom line. Increased leverage and a return to more risk taking will also boost results.

Alex Bossert

Share buybacks at such an advantageous price are frosting on the cake. Goldman repurchased

9% of its stock last year. Due to options exercises they reduced shares outstanding by 3%.

Goldman repurchased a little under 1% of its stock in the first quarter. They said buybacks will

continue.

Buffett was confident enough in their business to invest back during the financial crisis.

Berkshire received 43.5 million in warrants to purchase stock at $115 per share. The stock is

trading for 20% less than Buffett’s investment.

Appendix:

List of sources:

Charlie Munger’s comments on Goldman: http://www.youtube.com/watch?v=SgGtd1tdTDY

Scathing Rolling Stone article: http://www.rollingstone.com/politics/news/the-people-vs-

goldman-sachs-20110511

Gurufocus article on Goldman: http://www.gurufocus.com/news/177743/buy-goldman

http://www.gurufocus.com/stock/GS

Bill Nygren thinks Goldman is cheap: http://www.gurufocus.com/news/176258/bill-nygren-on-

goldman-sachs-gs

Recent Interview With Goldman CEO Lloyd Blankfein:

http://www.bloomberg.com/video/91388482-blankfein-interview-april-25.html

Interview With Lloyd Blankfein: http://www.advisorone.com/2012/04/26/goldmans-blankfein-

feels-shame-for-underestimating

Alex Bossert

Greg Smith – Resigning Goldman Managing Partner Op Ed:

http://www.nytimes.com/2012/03/14/opinion/why-i-am-leaving-goldman-

sachs.html?_r=2&pagewanted=1&src=twr

600 page Congressional report on Goldman and the financial crisis:

http://www.whatthefolly.com/wp-content/uploads/2011/04/FinancialCrisisReport.pdf

Greg Smith now writing book about Goldman: http://finance.yahoo.com/news/former-goldman-

exec-smith-lands-

181530727.html;_ylt=AnpX44Xv_WNguDX5_Lu.sHOiuYdG;_ylu=X3oDMTNycmJuNmQzB

G1pdANGUCBUb3AgU3RvcnkgTGVmdARwa2cDZjNjNjBkNDQtZTYxZS0zMDY3LTgxM2

UtMzc5YTg5M2U2OTcyBHBvcwMxBHNlYwN0b3Bfc3RvcnkEdmVyAzZiYjllOTQwLTdhO

TQtMTFlMS1iZWFlLTIxM2NlYTBiNjI0ZA--

;_ylg=X3oDMTFvdnRqYzJoBGludGwDdXMEbGFuZwNlbi11cwRwc3RhaWQDBHBzdGNhd

ANob21lBHB0A3NlY3Rpb25zBHRlc3QD;_ylv=3

Article discussing some of what was in the senate report on Goldman:

http://www.huffingtonpost.com/2011/04/15/goldman-sachs-levin-investigation_n_849708.html

Press release - SEC charging Goldman with fraud: http://www.sec.gov/news/press/2010/2010-

59.htm

Goldman job candidate acceptance rate: http://www.thestreet.com/story/11311573/1/goldman-

sachs-still-a-nice-place-to-work-blankfein.html

Goldman job candidate acceptance rate 2: http://news.efinancialcareers.com/88164/90-of-

students-accept-offers-from-goldman-sachs-70-84-accept-offers-from-morgan-stanley-the-

hedge-fund-manager-who-flyered-car-windscreens-with-his-cv-aged-16/

Goldman Sachs IPO: http://www.businessweek.com/1999/99_20/b3629102.htm

Goldman’s Risk Management: http://www.efinancialnews.com/story/2010-04-19/inside-

goldman-sachs-risk-management

Alex Bossert

Global M&A Activity: http://www.mergermarket.com/pdf/Press-Release-for-Financial-

Advisers-Year-End-2011.pdf

2011 Annual Report: http://yahoo.brand.edgar-

online.com/displayfilinginfo.aspx?FilingID=8445531-913-

1125552&type=sect&dcn=0001193125-12-085822

Value Investors Club Write Up 1: http://valueinvestorsclub.com/value2/Idea/ViewIdea/61010

Sumzero Write Ups: http://www.sumzero.com/pro/companies/421

Goldman Presentation at Bernstein Strategic Decisions Conference May 31st 2012:

http://video.webcasts.com/events/pmny001/viewer/eFrame.jsp?mei=42775&cf=gold006&tp=

Goldman First Quarter Conference Call: http://www.goldmansachs.com/investor-

relations/presentations/first-quarter-2012-results.html