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Monday, 19 October 2009 05:00

Get Your Federally Insured Hedge Fund Here, Twice the Price Sale Going on Now!

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In reviewing the last couple of quarter's results of Goldman Sachs operating results, I have come to the conclusion that Goldman is a Federally insured, publicly traded hedge fund!

Reggie Middleton on Goldman Sachs Preliminary 3Q09 results

Goldman Sachs generated net revenues of $12.4 bn in 3Q09 as compared to $6.0 bn in 3Q08 and $13.8 bn in 2Q09. The revenues grew primarily on back of strong performance in its trading and principal investment segment while traditional investment banking arm and asset management segment continued with its lacklustre performance.

The Company's core investment banking revenues declined to $899 mn in 3Q09 from $1,294 mn in 3Q08 and $1,072 mn in 2Q09 with both financial advisory and underwriting business delivering poor performances. Revenues from the financial advisory business declined 47% y-o-y and 12% q-o-q to $325 mn in 3Q09 owing to slow down in industry-wide M&A activities, while underwriting revenues declined 15% y-o-y and 46% q-o-q to $574 mn primarily due to lower debt underwriting volumes.

Revenues from Trading and Principal Investments were $10,027 mn in 3Q09, down 7% compared with $10,784 mn in 2Q09 but were up significantly over the corresponding quarter last year. Trading and Principal Investment revenues were principally buoyed by strong trading performance in its Fixed Income Currency and Commodity (FICC) segment which surged to $5,991 mn compared with $1,595 mn in 3Q08 on back of wide bid-ask spreads. Although bid-ask spreads compressed marginally in 3Q09 (which caused 12% q-o-q decline in FICC trading revenue) they remain wide by historical standards. As industry wide competition intensifies and bid-ask spread get restored to historical levels, revenues from FICC segment could witness some pressure going forward. As a note to all of those groupie types that believes Goldman walks on water, the monopolistic dearth of competition will only last for so long with a clear lack of barriers to entry. This bodes ill for a company whose only valid value driver is predicated upon a lack of competitors leaving wide operating margins.

Besides FICC, revenues from equities and principal investment also contributed to higher trading revenues with their respective share of $2,775 mn and $1,261 mn, respectively in 3Q09 compared with $1,562 mn and $(453) mn in 3Q08, respectively. As of September 30, 2008 revenues from Trading and Principal Investments contributed to 71.1% of Goldman Sachs net revenues compared with 15.2% for JP Morgan, 8.1% for Citi, 34.3% for Morgan Stanley and 16.3% for BAC. Further, the GS' average daily VaR, a measure of the market risk on its investment portfolio, was still higher at $208 mn at the end of 3Q09 as compared to $181 mn in 3Q08 - and this was with the no competition Federal ZIRP (zero interest rate policy) subsidy. Thus, as the free ride of historically cavernous bid/ask spreads continue to normalize, one should expect significantly more volatility of earnings in GS as compared to its competition.

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The Asset Management segment reported a y-o-y 29.3% decline in revenues to $1.5 bn as total assets under management dropped to $848 bn versus $863 bn 3Q08 while yield on AUM declined to 0.11% in 3Q09 from 0.13% in 3Q08 due to decline in composition of high yielding assets (it appears as if there are some GS clients who are not eating the green shoots). GS' net interest income increased 48.9% y-o-y to $1.7 bn during 3Q09 as interest expense dropped 83% compared to 66% drop in interest income ~ most likely the result of extensive cost management and cutting, but not truly discernable until the SEC reporting documents are released.

In line with increase in net revenues, compensation expenses increased 84.5% to $5,351 m in 3Q09 compared with $2,901 mn in 3Q08. Resultantly, the ratio of compensation expenses-to-net revenues improved to 43.3% in 3Q09 from 48.0% in 3Q08. Non-compensation expenses increased 2% y-o-y to $2,227 mn from $2,182 mn in 3Q08 with ratio of non-compensation expenses to revenues improving substantially to 18.0% from 36.1% a year ago.

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In aggregate, GS' net income available to common shareholders' increased to $3,028 bn, or $5.25 per share in 3Q09 versus $810 mn, or $1.81 per share in 3Q08 and $2.7 bn, or $4.93 per share in 2Q09. The bank's tangible book value per share increased to $92.7 in 3Q09 from $83.1 in 3Q08 while book value per share improved to $101.2 in 3Q09 versus $94.8 in 3Q08.

On July 22, 2009 GS repurchased 12.2 mn shares from US Treasury which was issued under US Treasury's TARP Capital Purchase Program for $1.1 bn which resulted in a reduction of shareholders' equity. Although GS' continues on its endeavour to de-lever its balance sheet the bank still has a long way to go before it could boast of a healthy one. As of 3Q09 the bank's tangible equity capital ratio stood at 6.1%, implying a leverage of 16.4x while its toxic level 3 assets stood at $50.0 bn, or 94% of its tangible equity.

Although GS' had beaten street expectations (which everyone at BoomBustblog.com should recognized as the game that it is), the company's share price has significantly run ahead off its fundamentals. Since December 2008, the company's tangible book value per share has increased by a modest 3.2% while its share price has increased by a whopping 92.1% with its Price-to-Tangible Book value per share ratio currently standing at 1.77x compared with 1.45x in 2Q09 and 0.45x in 4Q08. Based on closing price as of October 18, 2009, GS' price-to-tangible book value per share is at 1.99x while average price-to-tangible book value per of its peers stood is 1.55x, implying a premium of 28% for the Goldman Sachs brand name. As I said, an expensic, federally insured, publicly traded hedge fund with a strong lobby arm and an even stronger brand management department.

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Readers should take into consideration that this is the exact same argument that I posed a year and a half ago when I first shorted Goldman Sachs at $185! Where is it trading today? $186.43. This is after it had to be rescued by the government for fear of collapse!

Let's revisit history with an excerpt from Goldman Sachs Snapshot: Risk vs. Reward vs. Reputations on the Street
Saturday, 05 July 2008, it's deja vu all over again...

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I rode Goldman down to the $100 to $75 band, but it eventually
bottomed somewhere around $50. Now it's right back where it started
from, pre-bailout. Does it deserve to be there??? Inquiring minds want
to know...

The Legacy Goldman Sachs direction neutral strategy empirical analysis is still available to Pro subscribers. Click Goldman Sachs Option Strategy Pro Analysis 2009-08-05 09:52:44 1.02 Mb to access or proceed to the downloads section. I will be providing a refresh of this analysis the third week in October.

Below is a complete listing of the fundamental research that we are using to compile the direction neutral strategy analysis for the tickers listed above. Some of it is free for non-subscribers. I would recommend that pro subscribers reread the documents to brush up on my take on the companies listed herein.