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Friday, 26 September 2008 05:00

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

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First order of the day, news items:

US Bailout in Chaos, WaMu Is Biggest Bank Failure

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 - icon 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 retail_gs_report_sample 108.08 Kb for an example of our retail summary analysis, and download 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.

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