Sector

Financial Services

Background

Marc Rubinstein is the author of Net Interest and a former hedge fund manager. We cover what it means to sit at the center of the capital system, the core segments of an investment bank, and the mystery and the prestige that has followed Goldman since its days as a private partnership.

Cover

Date

May 19, 2022

Episode Number

58

Goldman Sachs Business Breakdown

Background / Overview

Goldman Sachs, a 150-year-old institution founded in 1869, is a leading global investment bank headquartered in New York City. Historically operating in the shadows of public perception, it has evolved from a private partnership (until its 1999 IPO) into a publicly traded bank holding company regulated by the Federal Reserve since 2008. Employing approximately 45,000 people, Goldman operates at the nexus of the global financial system, facilitating risk transfer and capital allocation. Its business model is unique in its focus on institutional clients—corporations and large investors—while recently expanding into consumer-facing operations. The firm’s culture, rooted in its partnership structure, emphasizes a tight-knit network of 440 senior managing directors, fostering a small-firm feel despite its scale.

Goldman’s business spans four core segments: Global Markets (sales and trading), Investment Banking (M&A and underwriting), Asset Management, and Consumer & Wealth Management. Each segment operates as an economically separable unit, with distinct revenue models, cost structures, and capital requirements. The firm’s ability to manage risk, leverage its balance sheet, and maintain a prestigious brand has positioned it as a market leader in investment banking and trading.

Ownership / Fundraising / Recent Valuation

Goldman Sachs is a public company listed on the NYSE (GS). Its valuation is driven by its price-to-book ratio, a function of its return on equity (ROE) relative to its cost of equity. The firm targets an ROE of 14–16%, and with an assumed cost of equity around 10%, its price-to-book ratio typically hovers around 1.5x. Specific enterprise value (EV) or transaction multiples are not detailed in the transcript, but the firm’s market capitalization reflects its $1.5 trillion balance sheet and $100 billion in capital. No recent fundraising or private equity ownership is noted, as Goldman has been public for over two decades.

Key Products / Services / Value Proposition

Goldman’s core value proposition lies in facilitating risk management and capital allocation for institutional clients, with a recent pivot to consumer services. The firm’s services can be broken down by segment:

1. Global Markets (Sales & Trading): Acts as a market maker, intermediating trades and providing financing (e.g., margin lending, warehouse loans). Revenue comes from bid-offer spreads and financing fees, with volatility driving profitability.
• Value Proposition: Provides liquidity and risk transfer for institutional clients, leveraging Goldman’s balance sheet and risk management expertise.
• Volume/Revenue: Generates $14–16 billion annually, with $5 billion from financing, $5–10 billion from fixed income intermediation, and $4–8 billion from equities.
• Profitability: High capital intensity but lower labor costs yield strong margins.
2. Investment Banking (M&A and Underwriting): Advises on mergers and acquisitions and underwrites IPOs and debt offerings, earning fees based on transaction value.
• Value Proposition: Offers unparalleled expertise and deal access, commanding premium fees due to brand and market leadership.
• Volume/Revenue: Generates ~$12 billion (20% of 2021’s $60 billion revenue), with fees of 3% for IPOs, 0.5–0.6% for M&A, and basis points for debt offerings.
• Profitability: Labor-intensive but low capital intensity results in high returns on equity.
3. Asset Management: Manages $2.5 trillion in assets under supervision, earning management fees (~0.2%) and incentive fees, alongside principal investing.
• Value Proposition: Leverages deal flow and market insights for stable, recurring fees and high-return proprietary investments.
• Volume/Revenue: Generates ~$15 billion, with $11 billion from principal investing and $4 billion from third-party fees.
• Profitability: Stable, fee-based revenue with high margins; principal investing is capital-intensive but declining.
4. Consumer & Wealth Management: Includes Marcus (online banking) and ultra-high-net-worth wealth management, focusing on deposit gathering and transaction banking.
• Value Proposition: Offers competitive deposit rates and corporate cash management, leveraging Goldman’s technological and banking infrastructure.
• Volume/Revenue: Contributes ~$9 billion (15% of revenue), driven by $350 billion in deposits.
• Profitability: Lower margins due to competitive pressures but enhances funding stability.

Segments and Revenue Model

Goldman’s four segments are economically distinct, each with unique revenue drivers:

• Global Markets (40% of revenue): Earns revenue through bid-offer spreads and financing fees. Spreads widen with “good volatility,” while financing includes prime brokerage and corporate lending.
• Investment Banking (20% of revenue): Fee-based model tied to transaction value, driven by M&A advisory and underwriting (IPOs, debt offerings).
• Asset Management (25% of revenue): Recurring management fees (~0.2% of AUM) and incentive fees, supplemented by principal investing returns.
• Consumer & Wealth Management (15% of revenue): Deposit-driven revenue from Marcus and transaction banking, plus wealth management fees.

The revenue model is cyclical, tied to macroeconomic conditions and risk appetite. Global Markets and Investment Banking are volatile, while Asset Management and Consumer segments provide stability.

Splits and Mix

• Revenue Mix (2021):
• Global Markets: 40% (~$24 billion)
• Investment Banking: 20% (~$12 billion)
• Asset Management: 25% (~$15 billion)
• Consumer & Wealth: 15% (~$9 billion)
• EBITDA Mix: Not explicitly provided, but Investment Banking and Asset Management likely contribute higher EBITDA margins due to lower capital intensity. Global Markets, while capital-intensive, benefits from operating leverage. Consumer margins are lower due to competitive deposit rates.
• Geographic Mix: Global operations, with significant presence in the US, UK, and Asia. No specific revenue split provided.
• Customer Mix: Primarily institutional (corporates, investors), with growing consumer exposure via Marcus.
• Channel Mix: Direct client relationships for institutional services; digital platform (Marcus) for consumers.
• Historical Mix Shifts: Shift toward consumer banking and third-party asset management to reduce volatility and capital intensity. Principal investing is declining as a share of Asset Management revenue.

KPIs

• Revenue Growth: Record $60 billion in 2021, up from $45 billion in 2009 and $15–25 billion historically. Cyclicality tied to risk appetite.
• Market Share: 15–20% in Investment Banking (M&A, underwriting), 20% in equities (tied with Morgan Stanley), and top 3 in fixed income.
• ROE: Target of 14–16%, a key driver of valuation.
• Compensation Ratio: Declined from 50% to 30% over 20 years, reflecting increased capital intensity and technology spend.
• Efficiency Ratio: Now a key target, driven by non-compensation costs (e.g., $4 billion annual tech spend).
• Deposit Growth: $350 billion in deposits, up significantly from a low base, reflecting consumer banking push.

Headline Financials

• Revenue Trajectory: Cyclical, with peaks in 2009 ($45 billion) and 2021 ($60 billion). Long-term growth aligns with GDP, but short-term volatility is driven by risk appetite.
• EBITDA Margin: Not detailed, but Investment Banking and Asset Management likely achieve 40–50% margins due to low capital intensity. Global Markets benefits from operating leverage, while Consumer margins are lower.
• FCF: Not quantified, but FCF is driven by net income (post-interest and taxes), low maintenance capex (primarily tech spend), and working capital cycles tied to trading inventory.

Value Chain Position

Goldman operates midstream in the financial value chain, sitting between capital providers (investors, corporates) and capital users (corporates, governments). Its primary activities include:

• Risk Intermediation: Matching buyers and sellers of risk (e.g., oil price hedges between Mexico and airlines).
• Capital Allocation: Underwriting securities and advising on M&A.
• Asset Management: Managing third-party and proprietary investments.
• Deposit Gathering: Raising stable funding via Marcus and transaction banking.

Goldman’s go-to-market (GTM) strategy leverages its brand, global network, and risk management expertise. It targets institutional clients through direct relationships and consumers via digital platforms. The firm’s competitive advantage lies in its ability to manage complex risks, access deal flow, and maintain a prestigious reputation.

Customers and Suppliers

• Customers:
• Institutional: 12,000 corporate clients (M&A, underwriting, transaction banking) and institutional investors (asset management, trading).
• Consumer: Retail depositors via Marcus and ultra-high-net-worth individuals.
• Suppliers: Primarily funding sources (debt markets, deposits) and technology vendors. Goldman’s $4 billion tech spend underscores its reliance on infrastructure providers.

Pricing

• Investment Banking: Fees are sticky, with 3% for IPOs, 0.5–0.6% for M&A, and basis points for debt offerings. Pricing is driven by brand, expertise, and market leadership, with low price sensitivity due to mission-criticality.
• Global Markets: Bid-offer spreads vary with volatility; financing fees are market-driven. No fixed take rate, making revenue projection challenging.
• Asset Management: ~0.2% management fees on AUM, plus incentive fees. Principal investing returns are tied to market performance.
• Consumer & Wealth: Competitive deposit rates for Marcus; wealth management fees are premium due to high-net-worth client base.

Contract structures are short-term for trading and underwriting, medium-term for M&A advisory, and long-term for asset management and deposits, providing a mix of visibility and volatility.

Bottoms-Up Drivers

Revenue Model & Drivers

Goldman generates revenue through:

• Fees: Investment Banking (transaction-based), Asset Management (AUM-based), and Consumer & Wealth (deposit and wealth management fees).
• Spreads: Global Markets earns bid-offer spreads, widened by volatility.
• Financing: Interest income from margin lending, warehouse loans, and corporate lending.
• Principal Investing: Returns on proprietary investments in Asset Management.

Revenue Drivers:

• Pricing: Driven by brand, market leadership, and mission-criticality. Investment Banking fees are sticky; trading spreads are volatile.
• Volume: Tied to macroeconomic conditions, risk appetite, and market activity (e.g., IPOs, M&A, trading volumes).
• Mix: Shift toward stable, recurring revenue (Asset Management, Consumer) reduces reliance on volatile Global Markets and Investment Banking.
• Growth: Organic growth via new products (Marcus, transaction banking) and market share gains; inorganic growth limited (no major M&A noted).

Cost Structure & Drivers

• Variable Costs: Primarily compensation (30% of revenue, down from 50%) and trading-related costs (e.g., inventory holding). Compensation is the largest variable cost, tied to revenue performance.
• Fixed Costs: Technology ($4 billion annually), infrastructure, and regulatory compliance. Fixed costs drive operating leverage, especially in Global Markets.
• Cost Analysis:
• Compensation: ~30% of revenue.
• Technology: ~7% of revenue ($4 billion / $60 billion).
• Other (rent, admin): Not quantified but likely 10–15% of revenue.
• Operating Leverage: High fixed costs (tech, infrastructure) enable margin expansion as revenue grows, particularly in Global Markets and Asset Management.
• EBITDA Margin: Likely 30–40% overall, with Investment Banking and Asset Management at 40–50% and Consumer lower due to competitive pressures.

FCF Drivers

• Net Income: Driven by revenue growth and margin expansion, offset by interest and taxes.
• Capex: Low maintenance capex, primarily tech spend ($4 billion annually, ~7% of revenue). No significant growth capex noted.
• Net Working Capital (NWC): Volatile due to trading inventory and receivables. Cash conversion cycle is short, as trading assets turn over quickly.
• FCF Margin: Not quantified but likely robust due to low capex and high margins, though NWC fluctuations introduce volatility.

Capital Deployment

• M&A: Limited, with a focus on organic growth (e.g., Marcus, transaction banking). Partnerships (e.g., Stripe, Apple) are preferred over acquisitions.
• Buybacks: Not detailed but common for banks to return excess capital.
• Organic Growth: Investments in consumer banking and third-party asset management to diversify revenue and reduce capital intensity.

Market, Competitive Landscape, Strategy

Market Size and Growth

• Industry Revenue: The top 15 global investment banks generate ~$210 billion annually across M&A, underwriting, equities, and fixed income.
• Growth: Long-term growth aligns with GDP, but short-term cyclicality is driven by risk appetite and market conditions. 2021 was a peak year, unlikely to be repeated soon.
• Market Segments: Geographically global, with key markets in the US, Europe, and Asia. Product segments include M&A, underwriting, trading, and asset management.

Market Structure

• Consolidation: The top three players (Goldman, JP Morgan, Morgan Stanley) hold ~50% of the market, up from 33% 5–7 years ago, driven by scale advantages and technology spend.
• Competitors: JP Morgan and Morgan Stanley are direct peers, with Citi strong in fixed income. Boutiques (e.g., Lazard) and private equity firms (e.g., Blackstone) compete in M&A and capital provision.
• Barriers to Entry: High, due to capital requirements, regulatory constraints, and brand reputation. Minimum efficient scale (MES) is large, limiting new entrants.

Competitive Positioning

Goldman is a market leader:

• Investment Banking: #1 alongside JP Morgan (15–20% market share).
• Equities: #1 with Morgan Stanley (20% market share).
• Fixed Income: #3 behind JP Morgan and Citi.
• Asset Management: $2.5 trillion AUM, with a shift toward third-party fees.

The firm’s brand, risk management expertise, and technology investments ($4 billion annually) provide a competitive edge. Partnerships with tech firms (e.g., Stripe, Apple) enhance its consumer reach.

Hamilton’s 7 Powers Analysis

1. Economies of Scale: Goldman’s $1.5 trillion balance sheet and $4 billion tech spend create a large MES, deterring smaller competitors. Scale enables operating leverage in Global Markets and Asset Management.
2. Network Effects: Limited, but Goldman’s deal flow and client relationships create a self-reinforcing cycle of access and trust.
3. Branding: Goldman’s prestigious reputation commands premium fees and attracts top talent, reinforcing its market leadership.
4. Counter-Positioning: The Marcus platform and transaction banking leverage Goldman’s banking infrastructure to compete with traditional banks, unencumbered by legacy branch networks.
5. Cornered Resource: Access to proprietary deal flow (e.g., pre-IPO stakes in Chinese banks) is a historical advantage, though reduced post-crisis.
6. Process Power: Superior risk management and mark-to-market discipline (e.g., shorting housing in 2007) provide a performance edge.
7. Switching Costs: High for institutional clients due to Goldman’s expertise and relationship depth; lower for consumer deposits.

Strategic Logic

• Capex: Defensive tech investments ($4 billion annually) to maintain competitive advantage and regulatory compliance.
• Vertical Integration: Limited, but transaction banking integrates upstream with corporate clients.
• Horizontal Integration: Expansion into consumer banking and third-party asset management diversifies revenue.
• Partnerships: Strategic alliances (e.g., Stripe, Apple) leverage Goldman’s risk management with tech firms’ distribution, mitigating FinTech threats.

Valuation

Goldman’s valuation is driven by its price-to-book ratio, a function of ROE (14–16%) relative to cost of equity (~10%), yielding a ~1.5x multiple. The firm’s $100 billion capital base and $1.5 trillion balance sheet support its market capitalization. Volatility in Global Markets and Investment Banking constrains multiples, but stable Asset Management and Consumer segments enhance visibility. The top three players’ increasing market share and scale advantages support a premium valuation relative to smaller peers.

Key Dynamics and Unique Aspects

Goldman’s business model is unique in its ability to sit at the center of the financial system, intermediating risk and capital with unmatched expertise. Key dynamics include:

• Risk Intermediation: Goldman’s core competency is matching risk (e.g., oil hedges) and sourcing risk (e.g., structured products), leveraging its $1.5 trillion balance sheet.
• Cyclicality vs. Stability: Global Markets and Investment Banking are volatile, tied to risk appetite, while Asset Management and Consumer segments provide recurring revenue, reducing overall volatility.
• Consumer Pivot: The Marcus platform and transaction banking, enabled by Goldman’s 2008 bank holding company status, diversify funding ($350 billion in deposits) and revenue, a departure from its institutional focus.
• Operating Leverage: High fixed costs (tech, infrastructure) and declining compensation ratios (50% to 30%) drive margin expansion as revenue grows.
• Cultural Edge: The partnership structure (440 senior directors) fosters a small-firm culture, enabling rapid information sharing and talent retention, a competitive advantage in a 45,000-person organization.
• Regulatory Adaptation: Post-2008 regulations increased capital requirements ($100 billion vs. $35 billion in 2007) and forced a consumer pivot, turning a cost center into a revenue opportunity.

Critical Analysis

While Goldman’s market leadership and scale are formidable, risks remain:

• Volatility: Global Markets’ “black box” nature complicates earnings forecasts, constraining valuation multiples.
• Competition: Private equity firms and M&A boutiques challenge Goldman’s capital provision and advisory roles, while tech partnerships introduce execution risks.
• Fee Pressure: Direct listings and SPAC-driven IPO alternatives threaten underwriting fees, though sticky pricing mitigates this risk.
• Regulatory Costs: Ongoing compliance burdens high fixed costs, though Goldman’s tech investments position it to absorb these better than smaller peers.

Goldman’s strategic shift toward consumer banking and third-party asset management is a double-edged sword. It reduces volatility but introduces competitive pressures in crowded markets. The firm’s ability to leverage its risk management expertise and brand will determine its success in these new arenas.