Friday, 26 September 2008 01:00

Goldman Sachs valuation update: Buffet's strategic investment and public offering

First order of the day, news items:

Source: Reuters

A
rescue for the U.S. financial system unraveled late Thursday amid
accusations Republican presidential candidate John McCain scuppered the
deal. Wamu's demise will further devalue mortgage assets. I don't care how much the government buys, we (the tax payer) don't have enough wealth to synthetically support this derivative market (yes, MBS are derivatives).

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SYDNEY/SINGAPORE (Reuters) - Central banks across Asia
scrambled on Friday to meet a desperate demand for cash, both in their own
currencies and the U.S. dollar, as the White House's $700 billion bailout plan
ran into unexpected roadblocks. The asset securitization crisis is contagious... http://www.reuters.com/article/ousiv/idUSTRE48P11E20080926?sp=true

Fed keeps banks afloat as money market crisis deepens - what banks do you think they are referring to??? Goldman Sachs and Morgan Stanley. The run on the prime brokerage accounts of Morgan Stanley have been confirmed in both London and NY.

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Flight
from Morgan Stanley brokerage

Financial Times -
London,England,UK
By James Mackintosh in London Morgan Stanley lost close to a third of
assets in its prime brokerage last week, amounting to hundreds of billions of
dollars, ...

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Goldman
and Morgan Stanley Help Drive Discount Window Lending to a ...

By Jesse(Jesse) Scroll down to the excerpt from American Banker: Discount Window Borrowing Jumps to $262 Billion By Steven Sloan
September 26, 2008 WASHINGTON — During another turbulent week on Wall Street,
lending through the Federal Reserve Board's discount window skyrocketed to ...

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China banks told to halt lending to US banks: (Reuters) - Chinese regulators have told
domestic banks to stop interbank lending to U.S. financial
institutions to prevent possible losses during the financial
crisis, the South China Morning Post reported on Thursday.

The Hong Kong newspaper cited unidentified industry sources
as saying the instruction from the China Banking Regulatory
Commission (CBRC) applied to interbank lending of all currencies
to U.S. banks but not to banks from other countries. "The decree appears to be Beijing's first attempt to erect
defences against the deepening U.S. financial meltdown after the
mainland's major lenders reported billions of U.S. dollars in
exposure to the credit crisis," the SCMP said. A spokesman for the CBRC had no immediate comment.


As I have been crowing for about a year now, the investment banks are insolvent. Below is an updated analysis of Goldman Sachs after their recent capital infustions...

Goldman Sachs update following strategic investment by Berkshire Hathaway and public offering

On September 24, 2008 GS announced public offering of 40.65 mn shares at $123 per share for total gross proceeds of approximately $5 bn. Earlier on September 23, 2008 GS announced $5 bn strategic investment by Berkshire Hathaway in the form of perpetual preferred stock with an annual dividend of 10% callable at any time at a 10% premium. In addition, Berkshire Hathaway would also receive warrants to purchase $5 bn of common stock at a strike price of $115 per share exercisable at any time for a five year term. This combined offer would help GS to raise a total capital of $10 bn.

Public offering
# of shares

40.7

Share price $123
Total proceeds $5,000
Face value $0.41
Premium $5,000
Private offering
Total proceeds $5,000
Preffered dividend rate 10.0%
Annual preffered dividend $500
Total gross proceeds $10,000
Other preferred stock Redemption
Series Date Value
A Apr-10 $750
B Oct-10 $800
C Oct-10 $200
D May-11 $1,350

Impact of additional capital raised by Goldman Sachs

We believe that this additional capital would have the following impact on Goldman Sachs:

  • Help Goldman Sachs in reducing its leverage position
  • Improve Goldman Sachs liquidity position
  • As a result of improved liquidity position Goldman Sachs would have to sell fewer distressed securities to Fed resulting in lower write-downs
  • Increase preferred dividend to be paid by $500 mn per annum
  • Dilution in earnings for existing shareholders' equity

Impact on leverage and book value

Including the impact of preffered stock and public offering
4Q-2008 1Q-2009 2Q-2009 3Q-2009 4Q-2009 1Q-2010 2Q-2010 3Q-2010 4Q-2010 2011 2012
Total Assets ($ bn) $1,103 $1,095 $1,088 $1,084 $1,078 $1,092 $1,099 $1,105 $1,110 $1,133 $1,123
Tangible Equity ($ bn) $50.3 $49.4 $48.1 $46.8 $45.3 $45.6 $45.0 $44.9 $43.7 $44.1 $47.6
Book value per share $114 $112 $109 $106 $103 $103 $102 $102 $99 $100 $106
Adjusted Book value per share $103 $101 $98 $96 $93 $93 $92 $92 $89 $90 $97
Adjusted leverage 21.8 22.0 22.5 23.0 23.7 23.8 24.3 24.5 25.3 25.6 23.5
Excluding the impact of preffered stock and public offering (previous model)
4Q-2008 1Q-2009 2Q-2009 3Q-2009 4Q-2009 1Q-2010 2Q-2010 3Q-2010 4Q-2010 2011 2012
Total Assets ($ bn) $1,092 $1,083 $1,076 $1,071 $1,065 $1,079 $1,087 $1,093 $1,098 $1,121 $1,112
Tangible Equity ($ bn) $40.5 $39.6 $38.2 $36.9 $35.4 $35.8 $35.3 $35.4 $34.2 $35.1 $39.1
Book value per share $102 $100 $97 $94 $90 $91 $90 $90 $87 $88 $97
Adjusted Book value per share $90 $88 $85 $82 $79 $80 $79 $79 $76 $78 $87
Adjusted leveraege 26.9 27.3 28.1 28.9 30.0 30.0 30.6 30.8 32.0 31.9 28.4

Goldman Sachs currently has nearly $1,090 bn
worth of assets on an equity base (tangible) of $40 bn with an adjusted
leverage of 27x. Goldman Sachs effort to raise $10 bn of capital on
such a huge asset base looks minuscule. We believe that if
Goldman Sachs were to remain financially strong any kind of
re-structuring exercise must entail removing their toxic assets from
their balance sheet which are causing massive write-downs rather than
re-structuring its capital base.
Although Goldman Sachs
efforts to raise additional capital are expected to reduce its leverage
to 21.9x at the end of 2008 from 27x presently, GS's leverage post
capital raising efforts would continue to be on a higher side, in our
view.

Impact on write-downs

Additional capital raised by Goldman Sachs
would provide Goldman Sachs the flexibility to sells its assets to
Federal Reserve. In our previous analysis (Impact of Fed bail out
plan) we had estimated that under the base case scenario Goldman Sachs
would sell $34 bn worth of distressed securities comprising nearly 25%
of its level 1 assets, 50% of its level 2 assets and 80% of level 3
assets. However after considering the impact of additional capital
raised, Goldman Sachs now would have to sell $24 bn of distressed
securities under the base case scenario. This would mean that under the
base case scenario Goldman Sachs would now have to sell 17% of its
level 1 assets, 34% of its level2 assets and 55% of its level 3 assets
to Federal Reserve.

Following are our revised assumptions regarding sale of distressed security by Goldman Sachs:

Analytical impact (thru reduction of sale of distessed secutities to Fed resulting in lower write-downs)
GOLDMAN
Total Sales
Total Sale of disressed securities in 2008 and 2009 Previous estimates Difference Factor
(using goal seek)
Current estimates
Sells Aggressively 58,612 (10,000) 79% 48,612
Base case 34,453 (10,000) 69% 24,453
Sells Conservatively 19,965 (10,000) 49% 9,965
Assumptions regarding the proportion of MBS / ABS by MS
- 2009 (previous estimates)
Sells Aggressively Base case Sells Conservatively
Level 1- 50% 25% 10%
Level 2 - 70% 50% 25%
Level 3 - 90% 80% 50%
Factor 79% 69% 49%
- 2009 (revised estimates)
Level 1- 39% 17% 5%
Level 2 - 55% 34% 12%
Level 3 - 71% 55% 25%
Distressed securities to be sold to Fed
Base case
Old estimates
2008 $4,645
2009 $29,808
Total $34,453
Reduction of need of sale of distessed securities by GS to Fed -$10,000
Revised estimates (by using goal seek)
2008 $3,191
2009 $21,262
Total $24,453

Due to lower sale of distressed security by Goldman Sachs, it would have to take the lower ‘haircut'.
Total write-down on account of sale of securities to Fed under the base
case scenario is expected to reduce by nearly $1.8 bn to $4.4 bn as
against previous estimates of $6.1 bn.

Potential write-downs due to sale of distressed securities to Fed
GOLDMAN
Selling pace
Fed (Pricing scenario)
Low discount Base case Deep discount
Sells Aggressively 1,629 8,170 10,440
Base case 918 4,367 5,573
Sells Conservatively 378 1,789 2,285
Potential write-downs due to sale of distressed securities to Fed
GOLDMAN
Selling pace
Fed (Pricing scenario)
Low discount Base case Deep discount
Sells Aggressively 1,962 9,760 12,433
Base case 1,295 6,147 7,833
Sells Conservatively 754 3,573 4,563

Dilution effect and accounting impact

Accounting impact (increase in cash flow, book value per share, increase in assets and reduction in leverage)
4Q-2008 1Q-2009 2Q-2009 3Q-2009 4Q-2009 1Q-2010 2Q-2010 3Q-2010 4Q-2010 2011 2012
Preffered stock (series A-D) 3,100 3,100 3,100 3,100 3,100 3,100 2,350 2,350 1,350 0 0
Rate 4.5% 4.5% 4.5% 4.5% 4.5% 4.5% 4.5% 4.5% 4.5% 4.5% 4.5%
Preffered stock dividend 35 35 35 35 35 35 27 27 15 0 0
Preffered stock issued to Warren Buffet 5,000 5,000 5,000 5,000 5,000 5,000 5,000 5,000 5,000 5,000 5,000
Rate 10.0% 10.0% 10.0% 10.0% 10.0% 10.0% 10.0% 10.0% 10.0% 10.0% 10.0%
Preffered stock dividend 125 125 125 125 125 125 125 125 125 500 500
Total preffered dividend 160 160 160 160 160 160 152 152 140 500 500
Total Preffered stock 8,100 8,100 8,100 8,100 8,100 8,100 7,350 7,350 6,350 5,000 5,000

As a result of issuance of preferred stock to
Berkshire Hathaway, Goldman Sachs's preferred stock dividend would
increase to $35 mn in 3Q2008 to $160 mn in 4Q2008 with annual impact of
$500 mn of preferred stock dividend negatively impacting Goldman Sachs
earnings per share by nearly $1.07. Issuance of common equity of $5 bn
would increase Goldman Sachs shares by nearly 40.7 mn resulting in a
dilution impact of nearly 9.5% for its existing shareholders.

Impact on valuation

Owing to additional capital raised Goldman
Sachs shareholders' equity at the end of 2009 is expected to... The
balance of this analysis is for subscribers only. Subscribers
may download the pdf version of this analysis update, with a full
additional page of valuation metrics and my opinion of the current
value of Goldman Sachs shares here - spreadsheet Goldman Sachs - strategic investment and public offering (895.36 kB 2008-09-26 02:29:15)

More Free Stuff

Since the Goldman Sachs issue is so timely, I
have made the retail and professional/institutional research reports for
Goldman Sachs available for free. See the pdf retail_gs_report_sample 108.08 Kb for an example of our retail summary analysis, and download pdf professional_gs_report_sample 350.12 Kb for an example of the full blown analysis for professional individuals/institutions. You may subscribe by clicking this link.

Last modified on Friday, 26 September 2008 01:00