Having said that, T2 Partners will be "monitoring" the situation.
Our comments on "Why I Am Leaving Goldman Sachs"
The op ed in today’s New York Times by retiring Goldman Sachs Executive Director Greg Smith is the talk of Wall Street. We think we know Goldman well, as the company has been our prime broker for the past seven years and Goldman (both stock and call options) is one of our largest positions, so we wanted to add our comments.
Our direct experience as a client of Goldman has been universally positive. The many people we have dealt with there have all been exceptionally talented and high-grade, and never once have we had a negative experience in which we felt that they took advantage of us or didn’t do what they said they would do.
That said, we are not naïve. In all of our dealings with Wall Street firms, we assume that they are looking out for their own bottom lines, not ours. And we are certainly aware that the old, gentlemanly culture in which integrity and a customer-first attitude generally prevailed is long gone – not just at Goldman, but across all of Wall Street – and, in fact, across the entire financial industry (the reasons for this and what should be done about it are the subject for another day).
When we think about investing in any company – especially a financial one, which is heavily regulated, leveraged, and particularly difficult for an outsider to analyze – we factor into our investment equation our assessment of the company’s culture and values, and, if we have any concerns, what the potential associated risks are, such as unexpected losses and regulatory action. In light of our view of the moral decay across the U.S. financial sector, we aggressively haircut our estimates of intrinsic value in the sector – some companies more so than others. But at some price, of course, any stock is a buy, and last August and September we felt that the negativity surrounding the financial sector was way overdone and hence made a big – and, so far, very profitable – bet on Goldman and a number of other U.S. financial firms.
With the run-up in Goldman’s stock – after falling below $90 as recently as December, it’s now over $120, just above tangible book value of $119.72 as of 12/31/11 – we’ve been debating whether to trim or exit our position, so today’s op ed is timely. But is it relevant to our investment thesis? We think probably not, for two reasons:
1) The argument that Goldman has become increasingly profit driven, sometimes at the expense of clients’ best interests, and that some employees use vulgar and disrespectful language is hardly news. What’s the next “shocking” headline: “Prostitution in Vegas!”?
2) We highly doubt that Goldman is as truly corrupt as Smith makes it out to be. Goldman has more than 30,000 employees (including nearly 12,000 vice presidents, of which Mr. Smith is one) and has gone through wrenching changes in the past year, including savage cuts to bonuses and extensive layoffs, so it doesn’t surprise us that there are many disgruntled employees, especially those who are leaving. Is Smith one of them? It’s hard to tell, but here’s an email sent to me this morning by a former partner at Goldman (who generally agrees that the firm’s culture is not what it once was):
There are a couple of things out of place. 1) This guy has been at firm for 12 years and is only a VP…a piss ant of sorts. He should have been an MD-light by now, so clearly he has been running in place for some time. 2) He was in U.S. equity derivatives in London…sort of like equities in Dallas…more confirmation he is a lightweight. Somewhere along the line he has had sand kicked in his face…and is not as good as he thinks he is. That happens to a lot of high achievers there.
In summary, we think it’s likely that Goldman does the right thing for its clients the vast majority of the time – but not as certainly as it used to in the old days. Times have changed and the trend is unfortunate, but it is not unique to Goldman. In fact, we believe that Goldman still has a better culture and is more ethical than most of its competitors – though this is a very low bar to be sure.
Our investment thesis on Goldman is simple: when all the dust settles, it will remain the premier investment banking franchise in the world – and, if so, will be worth a substantial premium to tangible book value. Smith’s column is a warning flag that we’ll be monitoring closely, but we believe our investment thesis remains intact and the stock is still cheap, so we’re not selling.
UPDATE: He goes on:
A few additional thoughts, upon further reflection: we think Greg Smith’s op ed will ultimately prove to be a good thing for Goldman Sachs and, to a lesser extent, the investment banking industry. Here’s why: every company and industry has a certain percentage of people who regularly do the wrong thing, especially when it results in making a quick buck. Our long experience in the hedge fund and investment banking industries leaves us with no doubt that such people are overrepresented in the financial sector, where there are ample opportunities to make a lot of money quickly by screwing others.
There are plenty of such people at Goldman – we don’t think Greg Smith is making them up – but we are quite certain that he paints a grossly distorted picture of the firm: based on everything we know, the people and behavior he describes are not typical of the firm. But to the extent they exist at all, this is bad news both for shareholders like us, as well as the tens of thousands of hard-working, high-integrity employees at the firm.
To put some numbers around it (which we’re making up, but you get the idea), in the old days we’d guess that Goldman people did the right thing 99.9% of the time, which means the “ethical error rate” was a mere 10 basis points. Then, after the company went public and as sheer greed and insanity gripped the entire industry, Goldman probably slipped to only doing the right thing 95% of the time. This might sound okay, but it’s not – the 50x increase in the ethical error rate led to horrible consequences, both for the firm and our country, especially when the rest of the industry was doing similar things – or much worse. So where is Goldman today? We’d guess that it’s rebounded to 99%, a big improvement – but still a lot worse than it was in the old days.
We would like to see Goldman get back to 99.9%, and think that Smith’s op ed, however unfair, will help that happen. It has created a shock wave that is reverberating through Goldman – and, hopefully, the entire industry – that will likely remain in everyone’s mind for a long time to come, making it more likely that no-one at Goldman will go anywhere close to any ethical lines. In other words, Smith’s article was bad for the small number of people doing the wrong thing at Goldman, and very good for shareholders and the vast majority of Goldman employees.