Tuesday, 04 January 2011 08:31

Here's A Look At What The Goldman FaceBook Fund Will Look Like As It Ignores The SEC & Peddles Private Shares To The Public Without Full Disclosure

Yesterday, I attempted to pull the wool from some of the more complacent eyes of news media consumers by outlining the potential goals for Goldman's half billion "investment" in Facebook while at the same time pondering the market for a different type of media concern. A media concern that is heavy on the analysis and investigation, yet light on the political correctness and conflicts of interest (see Facebook Becomes One Of The Most Highly Valued Media Companies In The World Thanks To Goldman, & Its Still Private!). I definitely don't want to be condescending, but there is obviously (at least to me) a need for such an entity amongst the mainstream rags for as I read through the comment sections of the articles written on the topic, I see such naivete as, "Wow!!! If Goldman is putting their money in this, it must be serious!" I say do myself, "It's a damn shame if that is actually a real person's viewpoint and not a Goldman equity underwriting employee".

You see, this is not about Goldman's attempt to create capital gains through investment, its about their attempt to create income through commissions, fees and spreads.

… I would like you, dear reader, to let me know why or why not such a media concern as the one I intimated above should not make as much or more money than Goldman, et. al. and the financial engineering bunch, for the media concern actually imparts useful knowledge that actually adds to society, know? Am I being to idealistic in my search for the utopian world or is there truly a market for real knowledge and insider info. I'm all ears. Now, back to the topic at hand...

I am also relieved to see comments from more thoughtful readers such as (this is from Dennis Howlett's article over at ZDNet):

"Serious question here: neither article indicates what exactly gives Facebook it's value. In my post to the other article, I assumed it is advertising, but I can't even justify $50M on that business model. What exactly is being valued at $50B? Someone please explain this to me. Or is it indeed a pump and dump?"

The answer to this reader's question is that the monies being paid are justified in part by Facebook's popularity and control over X00 million eyeballs and stickiness, and in part by bubblicious marketing techniques that are dressed in the guise of Goldman's investment. I will attempt to explain both parts of this in this article.

Mr. Howlett popped over to BoomBustBlog with a link to his article making a case for the possibility of a Facebook IPO being the reason behind the Goldman engineering. I will excerpt a few lines to get us all up to the same page (before we move forward, if you haven't read Facebook Becomes One Of The Most Highly Valued Media Companies In The World Thanks To Goldman, & Its Still Private!, I strongly suggest that you do. It was alternatively titled "Goldman Creates a Facebook Hedge Fund for HNW Clients Historically Ripped Off By Such Vehicles, Spits In Face Of SEC...").

In my earlier piece I hinted that Goldman Sachs has a vested interest in building a case for a $50 billion valuation for Facebook that has nothing to do with the open market valuation. Larry Dignan thinks this is the pre-cursor to an IPO. Mark Zuckerberg has been quoted as saying that an IPO is not on the cards anytime soon. Peter Thiel, who originally staked $500,000 in Facebook said in September that Facebook would not IPO before 2012.

...  According to Bloomberg, Goldman took the lion’s share of the 2009 $923 million IPO fees:

Banks increased fees for initial share sales by 62 percent to 5.63 percent from the lowest level on record, even as the amount that U.S. companies raised from IPOs decreased by almost half to $16.4 billion this year, according to Bloomberg data. While the biggest surge in stocks since the Great Depression revived the IPO market and helped enrich bankers, almost 40 percent of offerings sold by underwriters in the second half of 2009 have left buyers with losses, the data show.

... Crunch the numbers: at a $50 billion valuation, with Goldman in the box seat as lead banker to an IPO and at the rates quoted in 2009, then it could pocket $2.8 billion gross in fees. And that’s on top of whatever it creams off the $1.5 billion fund it is creating as part of the deal that sees it currently investing $450 million. Assuming an IPO in the next 12 months then by my reckoning, Goldman’s ‘investment’ nets a 6x return.

If Goldman is successful (and remember that the Special Purpose Vehicle covering the $1.5 billion has to get past the SEC first but honestly - do they care?) then what happens to the Twitter’s of this world? Does its investors start clamoring for an exit? You bet.

That can only spell one thing: bubble times are here again.

Ya Damn skippy, sailor. Howlett hit it right on the head. What type of revenues, profits and growth justify a $50 billion valuation for a very young, private company with sparse net cash flows? The type that are marketed by those who are doing God's work! now, let's build on Mr. Howlett's and Dignan's ideas the BoomBustBlog way. We shall begin with the $1.5 billion dollar fund that Mr. Howlett alleges GS is creating around the Facebook cash injection. Yesterday's BoomBustBlog rticle, Facebook Becomes One Of The Most Highly Valued Media Companies In The World Thanks To Goldman, & Its Still Private! clearly detailed why and how many of these private equity and client funds routinely gut investors (we're talking up to 92% in losses!) while Goldman (and other GPs) still walk away with profits (see Even With Clawbacks, the House Always Wins in Private Equity Funds). I have posted the model that illustrates this bank wins, investor loses phenomenon as a live spreadsheet online for all paying BoomBustBlog subscribers to use at will. It's quite the comprehensive model and allows for the user to run a myriad of their own assumptions using any inputs they please. As subscribers will see, it is nearly impossible for Goldman to lose money on their Facebook private fund, no matter how badly Facebook shares perform. Please beware that is unlocked and fairly complex, so please do not make any formulae changes to it for it corrupts the experience for other users. Here is an excerpt for those who do subscribe to our research and services, YET!

Even with the fund taking 45%+ losses and the LP (limited partners, ex. Goldman's clients) losing every last single dime, Goldman easily pulls a 33% return. God forbid Facebook share actually do well, Goldman's numbers look... Well... Damn near illegal! Almost as if they can pump up a price without any fundamental justification or public disclosure of financials and still sell it retail to the public. Of course, such a thing could and would never occur - not with the every vigilant SEC to take our backs. Excuse me while a cough a up a lung from laughter...

You see, this is the dirty little secret of private equity funds. They are not in the business of investing money for client's maximum risk adjusted return. They are in the business of collecting fees. Those poor innocent (or not so, particularly when they are investing their clients monies, hence are in the same business) souls that actually believe as the commenter above quoted "Wow!!! If Goldman is putting their money in this, it must be serious!"simply the lamb being led to the private equity/IPO slaughterhouse. You see, there is no loss to GS - no matter how high they bid up the valuation nor how hard it comes crashing down. This gives them the incentive to shoot for the sky with the private equity deal, because when the IPO breaks, its bonuses bigger than nearly any have ever seen. Facebook makes and excellent marketing story as well. Boy Wunderkind CEO, a product nearly everyone uses and loves, and a mysterious dearth  of business model to give it a mystical effect. Don't forget the involvement of the "cream of the crop" of Wall Street banks, whose bankers, traders and analysts are all so much smarter than us guys from Brooklyn. Add this up, and you get "Wow!!! If Goldman is putting their money in this, it must be serious!".

I will continue this in a few hours via my next article that illustrates an actual Facebook offering, complete with valuations - which should be a doozy, Wait until we get to add up all of those Goldman fees - Facebook investors win or lose. Just to be clear, this is not hate for Goldman, but elucidation and clarification regarding exactly what business Goldman, et. al. are actually in and how they are able to generate the profits that they do. Many think that Goldman is the best and brightest on the Street. Those guys went to the same schools, studied under the same teachers, graduated and employed using the same strategies trading the same products as everybody else. Get over the mysticism marketing bullshit and you just have a politically connect, very well marketed investment bank that was just bailed out by the government. The same as every major IB in this country. I have no hate (nor love, for that matter) for Goldman but I am about setting the record straight. If you really think Goldman is really that good at anything outside of raking profits off the back of their clients, I suggest you take a long, strong look at their track record versus mine - Did Reggie Middleton, a Blogger at BoomBustBlog, Best Wall Streets Best of the Best?

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Total cumulated returns over 6 years
Fund LP GP
Optimistic case 160.00% 559.75% 682.55%
Base Case 50.00% 85.98% 278.76%
Adverse case -20.00% -75.33% 80.80%
Base case 2011 2012 2013 2014 2015 2016
Change in value of property 12.0% 10.0% 7.0% 7.0% 7.0% 7.0%
Operating cash flows 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%
Total return 12.0% 10.0% 7.0% 7.0% 7.0% 7.0%
Optimistic case 2011 2012 2013 2014 2015 2016
Change in value of property 50.0% 35.0% 30.0% 25.0% 20.0% 0.0%
Operating cash flows 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%
Total return 50.0% 35.0% 30.0% 25.0% 20.0% 0.0%
Adverse case 2011 2012 2013 2014 2015 2016
Change in value of property -20.0% -10.0% -5.0% 0.0% 5.0% 10.0%
Operating cash flows 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%
Total return -20.0% -10.0% -5.0% 0.0% 5.0% 10.0%
Last modified on Tuesday, 04 January 2011 08:39

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