Goldman Sachs is rethinking how it makes private-equity bets with its own money – and one analyst thinks that shift will be a big driver of its stock price

Goldman Sachs CEO David Solomon Paul Morigi |Getty Images

Goldman Sachs CEO David Solomon Paul Morigi |Getty Images

  • Goldman Sachs executives took a moment on the company’s fourth-quarter earnings call to explain more about their strategy for transitioning the bank’s private-investing platform to be more reliant on outside money.
  • While execs have touted the plan for months, it was CEO David Solomon’s description of a plank in that strategy that got analysts’ attention on Wednesday.
  • Solomon said as the firm makes future investments with its balance sheet, it will lean away from private-equity investments in favor of credit or infrastructure, as a way to free up precious capital from regulatory scrutiny that doesn’t like private-equity investments.
  • D.A. Davidson’s David Konrad said he thought the strategy was one of two mentioned on Wednesday’s earnings call that will a big driver of the stock going forward.

Goldman Sachs executives took a moment on the company’s fourth-quarter earnings call to explain more about their strategy for transitioning the bank’s private investing platform to be more reliant on outside money.

Execs including CEO David Solomon have touted the strategy in recent months, saying Goldman is ramping up a fundraising machine to pool billions of dollars in client money and place it into funds making investments in private equity, credit, real estate, and infrastructure.

Solomon has restructured the management of the business to bring disparate teams from across the bank under one umbrella, and tapped a new team to coordinate activities across the firm.

But it was Solomon’s description of a plank in that strategy that got analysts’ attention on Wednesday.

The CEO said that as Goldman Sachs raises more outside money, it will also shift the types of investments it’s making with its own money. And in doing so it will free up a scarce resource that has been weighing down its profitability metrics.

Solomon said the bank will make fewer private-equity investments with its own money, bowing to regulators who require the bank to use more of its capital to support the investments. The bank currently manages $22 billion in public and private-equity investments, which get a dim view from authorities because they can often swing wildly from one quarter to the next.

Private-equity behemoth Blackstone, by comparison, holds just $1.8 billion in such investments, Oppenheimer & Co. analyst Chris Kotowski said on the call.

“We will continue to use balance sheet, but we will remix that balance sheet,” Solomon told analysts on Wednesday. That will include “shifting some out of equity into more credit- or infrastructure-type assets.”

The description and some other bits Solomon shared elicited a comment from Jim Mitchell, an analyst with Buckingham Research, that the explanation was “really helpful.” David Konrad, an analyst who just initiated coverage on Goldman Sachs at D.A. Davidson, said in an interview he expected the change to be a “big driver of the stock” price in future months.

“The straight private-equity investments are so tough on RWA levels and also the stress test,” Knorad said, referring to risk-weighted assets and semi-annual stress tests that dictate how much capital Goldman Sachs must use to support specific businesses. “It’s a very low return on equity.”

In the decade since the financial crisis, regulators have forced global banks to stockpile their capital. The efforts have made the industry safer, but also cut profitability metrics in half. It’s forced banks to think more deeply about how they structure the business, and favored activities that get more favorable treatment from regulators.

The strategy represents a significant departure for Goldman Sachs, whose merchant banking division has worked with the firm’s investment bankers over the last 30 years scouring the globe looking for attractive investment opportunities. Many of those investments were made with Goldman Sachs money, as well as that of its employees. It hasn’t historically had to maintain a massive fundraising apparatus to attract outside money.

That’s now changing. In the future, Solomon said, the bank won’t increase the amount of balance sheet it devotes to those investments and will instead grow the business by raising more outside funds.

“Historically we have managed some institutional money, but we’ve managed very significant private wealth money in addition to using our balance sheet,” Solomon said. “The primary growth plan for the business is to over time raise a significantly increased amount of institutional capital.”

Even so, Solomon defended the firm’s use of its balance sheet and explained why he thought that would be a differentiating factor for the bank as it competes with the likes of Blackstone or KKR or Carlyle in raising institutional money.

“If maybe we were starting today from scratch with a white sheet of paper, you might develop the business differently,” he said.

“We’ve built out a very, very broad, deep global network of investors all over the world and we think that’s a real asset to capital allocators. We’ve done that because we’ve built up strength investing off our balance sheet and historically, candidly, one of the things investors have liked is they liked the fact that we partner with them and we have skin in the game,” he added.

Having the ability to use the balance sheet will continue to be an asset, he said.

“As we grow new products and services in the space around the world and add to what we’re doing, it is easier to fund the acceleration of that if you do have the capacity to use balance sheet to jump-start some of those businesses,” the CEO said.

Solomon directed analysts to the firm’s first investor day, scheduled for Jan. 29, for more details about what they can expect from the strategy over the next five years.

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