TO IPO OR NOT TO IPO?

GOLDMAN SACHS

Presented by Arun Jose, IIM LucknowAyush Gutgutia, IIM Lucknow

Why has Goldman Sachs enjoyed the greatest reputation among its peers?

Question #1

THE NUMBERS…. speak for themselves

#1M&A Advisory

#2Debt & Equity Underwriting

#1IPO

Underwriting

#1Debt & Equity Underwriting

But how did they achieve this?But how did they achieve this ?

FIRST RATE CLIENT LIST

Historical IPO’s and M&A’s

Ambassador Culture

Sidney Weinberg sat on board of 30+ companies

attending 250+ meetings per year

Worked in secret with Henry Ford II to take FMC public

Largest IPO to date

HOLDING FIRM TO ITS VALUES

Short term profits should never be earned at the expense of long term relationships. Reckless risk taking should be replaced by cautious business development

-The Two Johns

HOLDING FIRM TO ITS VALUES

• Avoided reckless risk taking• 1st WS Firm to institutionalize ethics• Did not represent hostile bidders• White knight strategy• Intensely trained customer-centric

workforce

…..led to Goldman being viewed as a trustworthy partner

BUILDING QUALITY TALENT POOL

Although our activities are measured in billions of dollars, we select our people one by one. In a service business we know that without the best people we cannot be the best firm.

-Hank Paulson, Ex-CEO, Goldman Sachs

BUILDING QUALITY TALENT POOL

• Hired the best talent• Strong focus on retention• Promoted talent from within it’s own ranks• Interesting deals low turnover• Promoted team effort (8th commandment)• Compensation linked to seniority not

performance

…..led to employees remaining loyal and working hard to climb the ladder

Why did it take so long to decide on the IPO issue?

Question #2

The firm does not have to follow the rest of Wall Street. The challenge is keeping our culture, our profitability and our growth. It is human nature not to tinker with a good thing

-John Weinberg, Managing Partner, Goldman Sachs

IPO would bring many challenges

• Currently operating at a good level• Capital base growing compared to

competitors• IPO could dilute culture and work ethics• Increased regulatory scrutiny• Dissolution of partnership model• High compensations and voting rights

Capital base growing comparably to publicly traded competitors

• Highest ROE

• 5th largest capital base

• Base salary: $45,000• Bonus: $15,000 to $25,000Analyst• Base salary: $75,000• Signing Bonus: $25,000• End of year bonus: $40,000 - $50,000

Associate

• Salary & Bonus:$4,00,000-$7,00,000Vice

President

• Base Salary: $2,00,000• Stake in company • Returns $3 to $6 million annually

Partners

Goldman Sachs pays deeply for retention

Did Goldman Sachs have enough capital to grow? Can it grow fast enough to retain its

position?

Question #3

Gradually shifting philosophy

• Rubin’s philosophy of “No risk No profit” led Goldman to become involved in principal transactions risking it’s own capital in exchange for higher returns

• Revenues of $886MM(1990), $1150MM(1991) & $1460MM(1992)

• Opened offices globally – Frankfurt, Milan, Seoul, Beijing, Mexico City and Shanghai

New philosophy required larger capital expenditures

The Disaster of 1994

• Suffered substantial losses with annual expenses rising to $3.6B(twice that of 1990)

• 30% partners(who signed in 1992) departed

• Assets fell from $115B(1993) to $95B(1994)

• Capital to assets dropped 50%

There was a rapid flight of capital in 1994

You cannot run a multinational global business on partnership capital…a risky

business on top of a risky capital structure

-Unnamed Former Partner, Goldman Sachs

CHANGING INDUSTRY DYNAMICS

• Industry consolidation(1995-97) Morgan Stanley – Dean Witter Travelers – Salamon Brothers UBS-Swiss Bank Corp Travelers – Citicorp

• Transition towards asset management Low fees & high volatility in traditional business Greater understanding of asset management

HOW THE INDUSTRY LOOKED LIKECompany Debt Equity Capital

Merril Lynch 43.1 8.3 51.4

Morgan Stanley 25.8 14 39.7

Salamon Smith 19.1 8.5 17.6

Lehman Brothers 20.3 4.5 24.8

Goldman Sachs 15.7 6.1 21.8

Bear Stearns 10.9 3.9 14.8

Paine Webber 4 1.9 5.9

Donaldson Lufkin 2.3 2.3 4.5

Credit Suisse 2.6 1.2 3.7

BT Alex Brown 1.2 1.2 2.4

Goldman Sachs was losing ground on the competition

Although Goldman Sachs was against having a larger organization for fear of

culture dilution it was in need of capital infusion so that it could stay in competition with the other players in

the market

Could they retain their capital base?

Question #4

Disaster year – 1994• Annual expenses - $3.6 billion (twice of 1990)• Poor risk management• Friedman’s retirement in Aug ‘94, lost $42MM in Q4

Outcomes:• Decline in partner confidence• Departure of more than 40 partners• Devastated employee morale• Weakened partnership capital

Improving Bottom Line:• Reduced operations cost by large scale lay offs• Salary structure was reformed

• Capital-to-assets ratio halved since 1990

• Halved partners share from 80% to 40%

Sumitomo Bank and Bernice Pauahi Bishops Estate: Received 20% of annual earnings/losses as it raised

$1344MM

Would M&A be a better route?

Question #5

M&A opens several doors…

• Access to new market segments

• New innovation opportunities

• New revenue streams and new capabilities

• Stronger positioning at merger time, thereby maximizing ROI

… But also closes quite a few

• Compatibility issues• Legal costs• Short term opportunity cost• Cost of takeover• Potential devaluation of equity• Intangible costs

M&A presents several bottlenecks that might not be cleared and cannot be an ideal solution

Would increased scurrility in going public damage Goldman Sachs?

Question #6

What could an IPO bring about?

• Uncertain about impact on culture• Large size might erode excellence• Employees might lose motivation • Might dilute prestige and uniqueness• Harder to retain employees in a public

firm• Morgan Stanley lost its charm after IPO

Partners were extremely concerned that going public might negatively affect image

What will be impact IPO on senior partners, non partner employees Sumitomoto &

Bernice, Limited partners, shareholders, customer, competitors?

Question #7

Stakeholder Impact

Partners Wealth increase by $50 million plus

Senior partners Potentially realization +$100 billion

Non-partner employees

50% of 1997/98 compensation in addition to a bonus for each year of service

Sumitomo & Bishops Estates

Vote their shares of common stock

Limited partners Premium over the book value of investment- 25% to 55% depending on choice of cash/stock

Customers New avenues

Competitors Competitive environment

Would the agency problems increase or decrease after IPO? How might moral

hazard & selection (ESOPs) might arise?

Question #8

A public currency in the hands of an expansive management team is like a bazooka in the hands of a nine year old.

-Unnamed Senior Partner, Goldman Sachs

Increasing Agency Problems

• Only 14% equity is diluted to the public• Employees will be more concerned with

increasing transactional profits to meet earnings expectations over long-term shareholder wealth

• The loss of lucrative pay packages at partner level will lead to greater employee turnover

• Lack of accountability of capital will lead to reckless spending

….Hence Goldman incorporated ESOP’s with lock-in period to reduce agency problems

But ESOP’s wont solve everything!

• Employees will take decisions in a bid to increase short term share prices

• More riskier decisions would be taken to improve annual profitability metrics

• Values might be compromised to attain annual targets

….Hence ESOP’s could be a source of tremendous moral hazard

Would the contract monitoring be based on outcome or behavior based (before and

after the merger)?

Question #9

Behavioral changes to be expected

Before Merger: Behavior Based• Monitoring mechanisms • Equity of agents at stake• Partners are principals

Post Merger: Outcome Based• Effective in curbing agent opportunism

THANK YOU