Goldman and IB: Where do you go from number one?

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By:
Mark Baker
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The co-head of investment banking wants the firm to 'win by more' in the businesses where it already leads, but ramp up its client coverage overall – and roll out its transaction banking platform.

Goldman Sachs's new revenue and return targets across the firm are predicated as much as anything on an ability to grow in well-established businesses where it already has leading positions; investment banking is the most obvious among those.

Can it do it?

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Gregg Lemkau

As co-head of investment banking, Gregg Lemkau had the enviable job on the firm's investor day of reeling off the number one market shares that Goldman enjoys, including announced and completed mergers and acquisitions, and equity underwriting.

He wanted the audience on January 29 to be in no doubt that "Goldman Sachs is the number one investment bank in the world". Its 10,000 clients served by 3,000 bankers were also testament to that.

But that didn't mean it couldn't grow. And in the same way that chief executive David Solomon had already outlined for the firm as a whole, Lemkau catalogued the triple approach of increasing Goldman's share with core clients and services, expanding the client footprint, and developing new solutions, including transaction banking.

GOLDMAN SACHS
INVESTOR DAY
1. We've done it before: Goldman tells investors why they should trust its ambitions
2. Goldman and IB: where do you go from number one?
3. Goldman hunts better returns from challenged markets business
4. Opinion: Goldman reveals it's no longer special
5. Goldman's Lemkau: The cat who got the cream
6. Goldman held an investor day and there were jokes

Old clients

When it comes to its legacy investment banking franchise, Goldman certainly looks like it is a mature player in a mature industry.

But as Lemkau noted, it has been finding growth in share even before its new plan, rising from 6% of the investment banking fee wallet 10 years ago to 8% today.

As of now, each incremental percentage point is worth about $750 million of revenue.

In M&A, Goldman faces what on the surface appears to be its greatest growth challenge. After all, the bank was on 20 of the 25 biggest deals in 2019. In the last decade it has racked up $26.3 billion in advisory revenues, nearly 40% more than JPMorgan, its closest rival.

But Lemkau reckoned that it could simply "win by more", as indeed it had done in 2019. More instructive, however, was the analysis that his group had done into Goldman's leading positions.

"Look at TMT [tech, media and telecoms], which is the biggest fee pool," he said. "We are number one, but there is still upside. If you break it into the T, the M and the T, all of a sudden we are not number one everywhere."

In media, the bank ranked between second and fourth globally for announced M&A since 2015, he said.

[Acquisition finance] is the ultimate punch-above-our-weight business
Gregg Lemkau

Tech M&A in the Americas is another top ranking for Goldman over that same period. But of the eight tech sub-sectors that the firm breaks out, it ranks fifth or below in two: communications and education.

And education technology provided an example of how the bank was addressing a coverage gap. Goldman had consistently underperformed, and so in late 2018 had brought in Adam Nordin as a partner from Barclays.

Nordin has run education technology divisions for 20 years: now Goldman was well on the way to being number one there, Lemkau assured the audience.

Addressing those gaps should also help the bank further outperform in equity underwriting, but there is more obvious scope to develop in debt, where Lemkau is targeting a consistent top-four ranking.

It is already there in high-yield, where it ranks second, according to Dealogic. But in investment grade it stood sixth in 2019, having been fourth in 2017 and 2018.

Lemkau noted, however, that current levels are far above the struggle that the firm had to land even in the top 10 a decade earlier.

The growth since then was proof that the firm could continue to deliver on new initiatives, he argued. The key had been to leverage its financial advisory franchise by building an acquisition finance platform, offering bridge financing that also helped to secure preferred positions on takeouts.

"This is the ultimate punch-above-our-weight business," Lemkau said.

New clients

The second opportunity was expanding the client footprint. Here Goldman is wading into crowded territory, since its universal bank rivals such as JPMorgan, Citi and Bank of America have in recent years been waking up to the opportunity that their networks afford them to expand investment banking coverage to the middle market.

Goldman covers 95% of US and European public companies with market capitalizations of more than $10 billion. But its share of companies in the $500 million to $2 billion range falls to just 44%.

Lemkau said the bank was now hiring and training bankers to focus specifically on this segment. Two years ago, Goldman added 1,000 clients to its coverage footprint through an increased effort on private equity portfolio companies. That work produced incremental revenues of $350 million in 2019 alone, Lemkau said, and the bank was now adding a further 1,700 companies to its targets.

But there was also work to be done in financial sponsors. One of Goldman's responses to the financial crisis was to invest heavily in coverage of private equity. That's worked out well: revenues were some $1.9 billion in 2019, up from $1 billion in 2009.

More importantly, private equity clients tend to provide a consistency of activity that other segments might not, by virtue of the variety of their needs and portfolios.

And there was still much more to be tapped. Goldman's 600 private equity clients owned 6,700 companies, and still had about $1 trillion of dry powder, Lemkau noted.

Transaction banking

The biggest unknown is transaction banking, the development of which forms the biggest part of the third pillar of the IB growth strategy and which Lemkau said was the most exciting.

The bank has been talking publicly about launching a transaction banking franchise for over a year, but only now is it approaching lift-off. But Goldman had been busy, said Lemkau, approaching the build from the perspective of the sophisticated customer of transaction banking services that it already was.

Simply put, Goldman was frustrated with the infrastructure and client experience provided by incumbents and thought it could do better. Its new platform looks more like a retail banking app.

In recent years incumbents too have been focusing on building portals that are more inspired by traditional consumer banking, but Lemkau said Goldman's was far beyond legacy offerings.

Having hired a team and built a platform, Goldman has been using it for its own transactions, processing $3 trillion of payments in five currencies so far. It has also been trialling the platform with a small group of clients; it plans to roll out the platform formally during the first half of this year.

Lemkau's confidence in eventual success comes from the fact that the firm starts from a position as trusted adviser to many corporate clients. The new effort is also considered to be "adjacent" to its investment banking franchise – adjacency being one of the factors that Goldman uses when evaluating new business opportunities.

The incumbents can keep their leading position for now. We will start with 1%
- Gregg Lemkau

Confidence also stems from a target that is modest. Transaction services is a very fragmented business. Goldman COO John Waldron reckons that no player has more than a 10% share. But even so it is striking the extent to which the bank's strategy is focused not on being a volume leader, but offering what it says is a better service to a small part of the market.

"The incumbents can keep their leading position for now," said Lemkau. "We will start with 1%."

That is still a big opportunity. The addressable US transaction banking wallet is about $80 billion in revenues and some $5 trillion of corporate deposits, Lemkau said, citing statistics from McKinsey.

He reckoned revenues of $1 billion and deposits of $50 billion were achievable in five-plus years.

In the meantime, though, there are costs to be absorbed. CFO Stephen Scherr didn't break out transaction banking specifically when presenting the J-curve for the bank's growth initiatives, lumping it together with consumer banking.

But even stripping out the effects of increases in reserves, the new businesses will not break even until 2021, with the deepest part of the curve having already passed in 2019.

Include those reserves – which are now exacerbated by the effects of the new CECL (current expected credit loss) accounting standard – and break-even pushes out more than another year, with a peak pre-tax loss of $1 billion expected in 2020.

The curve lacked a numerical scale, but it roughly indicates a total conversion of that loss into profit by about 2024.

It is hard to overstate the importance of the approach. Having a transaction banking business already doesn't look like traditional Goldman. Only having a 1% share of a market looks even less like it.

"Tolerating J-curves", to use Solomon's phrase, is a step even further.

If anything illustrates the way in which Solomon is recasting the bank as an experimental developer willing to embark on new ventures and see what works, this is it.