高盛 (GS) 2004 Q3 法說會逐字稿

Good morning.

My name is Morgan, and I will be your conference facilitator today.

I would like to welcome everyone to the Goldman Sachs third quarter 2004 earnings conference call.

After the speakers' remarks there will be a question-and-answer period.

If you would like to ask a question during this time, simply press star, then the number 1 on your telephone keypad.

If you would like to withdraw your question, press the pound key.

If you are asking a question during the Q&A time and you are on a hands-free unit or a speakerphone, we would like to ask that you use the handset when asking your question.

Also, this call is being recorded today, September 21st, 2004.

Thank you.

Mr. Andrews, you may begin your conference.

Good morning.

This is John Andrews, Director of Investor Relations at Goldman Sachs.

I'd like to welcome you to our third quarter conference call.

Before we begin, let me remind you that today's call may include forward-looking statements.

These statements represent the Firm's belief regarding future events that, by their nature, are uncertain and outside of the Firm's control.

The Firm's actual results and financial condition may differ, possibly material from what is indicated in those forward-looking statements.

For discussion of some of the risks and factors that could affect the Firm's future results, please see the description of certain factors that may affect our business in our current annual report on Form 10-K for the fiscal year ended November 2003, and Item 5 on our quarterly report on Form 10-Q for the second quarter of fiscal 2004.

I would also direct you to read the forward-looking disclaimers in our quarterly earnings release, particularly as it relates to our investment banking transaction backlog.

And you should also read the information on the calculation of non-GAAP financial measures that is posted on the Investor Relations portion of our website, gs.com.

This audiocast is copyrighted material of the Goldman Sachs Group, Inc. and may not be duplicated, reproduced, or rebroadcast without our consent.

Our Chief Financial Officer, David Viniar, will now review financial results.

David?

Thanks, John.

And I'd like to thank all of you for listening today.

I'll give a brief overview of our results and then take your questions.

Our third quarter results were resilient, despite a tough environment for several of our businesses.

Net revenues of $4.5 billion were down 18% from the second quarter, and net earnings declined 26% to $879 million, or $1.74 per diluted share.

Annualized return average tangible equity was 19% for the third quarter and 25% year-to-date.

To place these numbers in context, this is our fifth best quarter in terms of EPS, despite the usual seasonal slowdown combined with some marked changes in the environment.

And after only 3 quarters, we have already exceeded our prior record for full-year earnings.

Once again, the breadth of our franchise was a key driver of performance, as strength in fixed income currency and commodities, securities services, and certain other businesses offset the difficult environment in equities.

I also want to mention our investment in Sumitomo Mitsui Financial Group, which had a significant impact this quarter.

While in the second quarter we had an unrealized gain of $561 million, or 37 cents per share, during the third quarter we took an unrealized lost of $245 million, or 16 cents per share.

The impact of this investment accounted for all but 4 cents in the difference between EPS this quarter and last quarter.

As we said when we made our investment in SMFG, it increases volatility of our quarterly results, but we're willing to accept that near-term volatility for what we believe will be an attractive long-term outcome.

Year-to-date, of course, our unrealized gain from SMFG exceeds $500 million, and since inception, net revenues from the investment are over $800 million.

I'll now review each of our businesses, beginning with Investment Banking.

Net revenues in Investment Banking were $890 million, down 7% the from second quarter.

Advisory net revenues of $451 million were down 12%, reflecting, in part, a 10% decrease in Goldman Sachs' completed global M&A versus the second quarter.

Goldman Sachs, once again, ranked number 1 in global announced and completed M&A for calendar 2004 year-to-date.

During the third quarter, we advised on a number of significant transactions which closed, including the $66 billion merger of Aventis and Sanofi, the $5 billion sale of Oxford Health Plans to UnitedHealth, and Softbanks' $3 billion acquisition of Japan Telecom.

We also advised on several key transactions announced during the third quarter, including Temasek's $1.6 billion offer to acquire Neptune Orient Lines, the $3.7 billion acquisition of Texas Genco by a consortium of private equity firms, and Bayer's 2.4 billion euro acquisition of Roche Consumer Health.

Third quarter underwriting net revenues of $439 million were flat compared to prior quarter, with equity underwriting slightly up and debt underwriting slightly down.

Although equity markets were less favorable than at the beginning of the year, industry transaction volumes for IPOs actually increased, despite the decline in overall common stock issuance.

On the debt side, we continued to see reasonable levels of activity, despite the flattening yield curve.

Overall, our underwriting franchise remains very strong.

Calendar year-to-date, we ranked first in global common stock and second in worldwide equity and equity-related offerings.

During the quarter, we underwrote a number of significant transactions, including a Ping An's $1.8 billion IPO, Freescale Semiconductor's $1.7 billion IPO and $1.3 high-yield offering, and Schering-Plough's $1.4 billion convertible offering.

The Firm's investment banking backlog was down in the quarter.

While a number of IPOs and secondary offerings came to market during the summer, the pace of new deal announcements on the equity underwriting side slowed.

As we have said consistently over the past year, we expect the recovery in investment banking activity to be gradual, rather than rapid.

Of course, much depends on the direction of equity markets, the broad economy, and CEO and investor confidence.

Let me now turn to Trading and Principal Investments, which consists of FICC, Equities, and Principal Investments.

Trading and Principal Investments produced net revenues of $2.7 billion in the third quarter, down 26% from the second quarter.

Within Trading and Principal Investments, FICC, once again, produced a very strong performance, with net revenues of $1.9 billion, essentially flat compared to the second quarter.

We always draw attention to the breath of our business, and this quarter it was particularly significant.

While currencies had a weak performance in essential trendless market, our commodities businesses benefited from strong price trends in energy products, which drove higher customer volumes.

We also saw strong performances from our credit products, interest rate products, and mortgages business in the third quarter.

In Equities, third quarter net revenues of $910 million were down 16% from last quarter, as market conditions remain challenging.

Most major indices were flat or down, and negative sentiment, combined with seasonal factors to drive lower volumes in customer activity.

Equities commissions of $608 million were down 16%, and Equities trading net revenues fell 14% to $302 million.

Turning to risk, average daily value at risk in the third quarter was essential unchanged at $70 million.

If you look at the components of the VaR, you can once again see that we adjusted risk levels in response to opportunities in the market.

Commodities VaR increased, while equities VaR decreased.

Principal Investments produced negative net revenues of 79 million in the third quarter.

I've already mentioned the $245 million unrealized loss on the SMFG position.

Partially offsetting this, we had $166 million of net revenues from other corporate and real-estate investments.

At quarter-end, our investment in SMFG was carried at fair value of $2.1 billion, our corporate portfolio had a carrying value of 1.1 billion, and real estate portfolio, $700 million.

Now I'll turn to Asset Management and Securities Services, which reported net revenues in the quarter of $941 million, up very slightly from the second quarter.

Within this segment, Asset Management produced net revenues of $596 million, down very slightly from the second quarter.

Our total assets under management increased 11 billion to $426 billion.

Inflows in the third quarter were 10 billion, with market appreciation of 1 billion.

Year-over-year assets under management were up 17%.

Securities Services net revenues were a record $345 million in the third quarter, up 5% from the prior record quarter.

This reflected increased customer balances.

Now I'll turn to expenses.

Compensation expense in the third was $2.3 billion, accrued at 50% of net revenues.

Noncompensation expenses of $968 million were down 3% compared to the second quarter.

Brokerage and clearing expenses were down 10%, reflecting lower activity levels in some trading businesses.

Headcount at the end of the third quarter was approximately 20,300, up 4% from the end of the second quarter, which primarily reflects our normal seasonal pattern of analysts and associates starting in the summer.

Our tax rate for the first nine months of fiscal 2004 was 32.3%, compared to 32.4% for the first half of the year.

During the quarter, the Firm repurchased 4.8 million shares, leaving our remaining share repurchase authorization at 12 million.

Our third quarter saw a changed environment from the first half of the year.

Investment Banking performed reasonably, given the expected summer slowdown, although the backlog was down, reflecting uncertainty in the market.

I want to reiterate our view that the recovery in Investment Banking will be dependant on continued global growth and CEO confidence.

Of course, corporate activity also depends on markets, and equities markets have become progressively less favorable as 2004 has continued, a point which I'm sure this audience understands.

Although Securities Services has continued to strengthen, it will require an improvement in the market environment for Equities' net revenues to grow.

We still believe we have one of the strongest and most effective equities franchises in the world, with leading market positions in the most attractive parts of the business.

But we are always subject to broad market trends.

FICC, once again, delivered a very impressive performance in quite different market conditions from earlier in the year.

In the third quarter, the Fed raised short-term rates and the yield curve flattened somewhat, while credit spreads remain tight, most energy prices trended significant higher, and currency markets drifted.

In these more challenging circumstances, the breath and depth of our franchise, once again, proved to be critical.

In Principal Investments, the SMFG convertible preferred, which we continue to believe is a terrific long-term investment, had an unrealized loss after 4 consecutive quarters of gains.

But we were pleased by the positive results in our traditional corporate and real estate investment business.

We increased our assets under management, despite the tougher market environment.

And, as I mentioned a moment ago, Securities Services delivered another record performance.

I want to emphasize that despite the changes in market sentiment and the many geopolitical concerns which we all face, our net revenues year-to-date, are up 33% compared to the same period in 2003, and our pre-tax earnings have increased 63%.

The operating leverage that comes from our business model and franchise strength has been on display even though several of our businesses are still far from their peak potential.

As I have said before, we are in businesses which operate in inherently uncertain markets, and the future will never be straightforward to predict.

However, we are pleased with the strength of our franchise and the performance we've been able to deliver so far in 2004.

Now, I'll be happy to take your questions.

I would like to remind everyone, in order to ask a question, please press star, 1 on your telephone keypad.

We'll pause for a moment to compile the Q&A roster.

Your first question comes from Guy Moszkowski with Merrill Lynch.

Please go ahead with your question.

Good morning.

Good morning, Guy.

I was wondering, first of all, just with respect to the comments that you made about the -- the investment banking backlog, if you could, first of all, distinguish a little bit more between the equities side, where you did give us a little bit of a flavor and what's going on in M&A.

And also, is there anything that you can tell us about what you have been seeing in September, since the end of the quarter, in terms of actual stuff being added to the backlogs and changes in expectations?

I'll answer you the first part of your question.

Which is, you know, I kind of implied this when I was talking, in saying, you know, you can actually see this somewhat, Guy.

It's one of the things about our business that is pretty public.

You can see that a lot of equities transactions were -- were completed during the quarter, and there were not that many deals filed.

And that was, you know, substantially, most of the change in backlog.

As far as September, I think it's too early to tell.

Okay.

And is there anything that you can say about M&A?

Well, you know, look, M&A over the course of the year has been, you know, somewhat better than the year before, but it's been very lumpy.

It's been characterized by a few large transactions, which have really driven it a little higher.

But overall, the business has not recovered all that much.

Yeah.

Fair enough.

Can we turn, now, to the equity business, and in particular, the equity principal strategies business?

Yes.

Seems to be, you know, part of the decline in the equities business.

What can you tell us about what the sort -- the main drivers of the decline are that we're seeing?

Obviously, there was a bigger decline as you moved from the first quarter to the second, but it continued in the third.

Is it a matter of opportunity, of volatility?

What's going on there?

The short answer would be yes and yes.

You know, there've just -- as the markets have declined, ad activity levels have declined, we've seen fewer opportunities, we've seen lower volatility, and we've seen a, you know, generally weaker environment for the equities business, overall.

I think that's affected both the Principal Strategies Business, and the Equities Products Group.

We've seen lower customer activity -- excuse me -- and we've seen fewer proprietary opportunities.

And on the -- on the principal strategy side, how do you think about acceptable returns on the capital that you deploy into that business?

And at current levels, are you still finding those returns acceptable?

We think about returns the same way we do of every one of our businesses.

We think all of our business should generate, you know, we start with the point of view that you generate a 20% return.

And, you know, certainly over the last 2 quarters, that business has not generated a 20% return.

But, you know, we don't analyze our businesses on a quarter-by-quarter basis.

You know, if we got out of every business anytime it didn't produce a 20% return in a quarter, it would not be very good.

So it's clearly had, you know, 2 quarters that were below acceptable returns, but over the long term, we've seen that before.

It's been a very, very good business for us.

Okay.

Fair enough.

The final question I'd like to ask you is, on the impact of the flattening yield curve which, of course, you know, the yield curve has been flattening recently.

What impact will an investor be able to discern on Goldman Sachs if that -- if that trend continues?

Well, you know, there wasn't much.

You know, it flattened fairly significantly in the -- in the third quarter, and there wasn't much of -- of an impact.

And part of this goes back to what I've mentioned before about the breadth of that business.

We are on so many parts of the FICC business, you know, all of the big complexes, currencies, commodities, mortgages, credit products, interest rate products, that, you know, one factor doesn't change things very much.

People, generally, have had the point of view that if there's a flat yield curve, or if interest rates go up, that business will kind of stop.

And I think everyone's seeing that's really not the case.

The business is much broader, much more global than it used to be.

Okay.

That's very helpful.

Thanks, David.

You're welcome.

Your next question comes from Glenn Schorr with UBS.

Please go ahead with your question.

Thanks, Dave, and appreciate the brevity.

We should get John Andrews to read the disclaimer as fast.

I'll pass that on.

Just one question.

You made another commodity purchase in the power trading, I guess there were, like, 12 interest and 12 plants and a natural gas pipe.

Right.

I know, obviously, we appreciate the non-correlated revenue stream, and how well it's done, and the point of the cycle that it's been, so all that's good.

I guess question is, 1, what did this add?

Was it a piece of the map, so to speak?

Was it a regional component?

What did this add that you didn't have?

And then, also importantly, plenty of competitors talk about the attractiveness, theoretically, of the commodity business and how they want to be in it, but almost everyone talks very specifically about not wanting to be a physical player.

And can -- so can you talk about how you balance, sort of, illiquid assets on the balance sheet with the information flow?

Sure.

You know, first of all, we found the purchase attractive for self reasons.

Probably the single biggest reason was that many of these plants were additional interest in the plants we had already owned through the Cogentrix purchase, which allowed to us control more facilities.

With power plants, sometimes you're buying interests.

And we had several of them in Cogentrix, and I said, this -- this put us over 50% in many of the plants, which gave us control of those facilities, which is much better for us.

So that was -- that was as big a reason as any other, as well as the fact that we found the price attractive and we found the assets attractive.

You know, we think that the -- that owning physical assets gives us an advantage in trading -- in trading power.

First of all, it does give us a better information flow.

Second of all, the ability to both deliver and accept physical delivery.

In the case, you actually have to, to us is a very important factor in being able to trade -- trade the products.

And so we find that it does give us a big -- a big leg up in the trading business.

And suffice to say, this counts as one of those capital deployment buckets that you believe, over time, 20-plus%?

You bet.

Super.

That was my only question.

Thanks, Dave.

You're welcome.

Your next question comes from Mark Constant with Lehman Brothers.

Please go ahead with your question.

Morning, thing -- couple things, number 1, actually, to the last point in Glenn's question, the control investment, the ability to restructure contracts, have you already started to reap the benefit of contract restructurings on previous power investments?

Or is this incremental, just in in terms of these new transactions?

Or has that not started to show up on the revenue side?

I think that has not yet started to show up on the revenue side.

Okay.

And on the Investment Banking pipeline comment that you made, please just refresh my memory, does that include any subjective evaluation of -- on, sort of, unfiled, unscheduled transactions that might potentially add or detract from -- from business volumes?

Or is that simply your reflection of -- of transactions in which you've actually been mandated?

Our --our backlog is a revenue backlog.

So when I'm talking about decline, it's decline in, you know, what we expect the revenue to be from our backlog.

So it's not a deal volume.

It's a revenue backlog, it is transactions we've been mandated, and it's also probability weighted on our expectation of the transactions closing.

Okay.

And finally, on the estimate of SMFG-mark, I know that the 10% number that you put in the Qs is -- has the comment about the relationship not being linear.

But this was, you know, not in -- the 245 was less than the simple common stock decline, it's obviously it's not a common stock, either, it's a convert, but it still wasn't quite in proportion, it was a smaller amount.

Was there a change in the volatility in the implicit in valuing the convert this quarter?

Is there a change in liquidity discount?

Does the first lockup expires?

Or is that just a big example of how it's nonlinear?

It is nonlinear, we have not changed any of the assumptions in the model.

The model has stayed exactly the same, but one of the things you have to realize, first of all, there's, you know, intra -- it's a convert, so it has a yield, which mutes the volatility, somewhat.

In addition, as you get closer and closer to the expiration of certain of the restrictions, it will change the linearity in some ways.

So those are 2 of the factors that make it nonlinear.

Got it.

Okay.

Thanks.

You're welcome.

Your next question comes from William Tanona with J.P. Morgan.

Please go ahead with your question.

Hey, David.

Good morning.

I know you guys don't like to, you know, disclose what potential revenues could be for the power asps themselves, but since you're under long-term contracts, can you, kind of, give us a sense to what we might be able see for revenue increase, as well as cost of power as a result of National Energy and Gas?

We don't disclose, you know, potential future revenues from the contracts.

The one thing you have to remember, the only thing, even if I would, would be, you know, what the actual contractual revenues on the power we have -- we have agreed to sell by contract is, and what the costs are, and that's really not the purpose of buying it.

The purpose of buying it is both to restructure those contracts and to help our trading revenues.

And, you know, frankly, that's very hard to predict.

Okay.

In terms of, you know, activity levels being down so dramatically on the equities side in the third quarter, I was a little bit surprised to see you guys posting record prime brokerage revenues.

Can you help me understand, you know, why that is?

I would have assumed that some of the hedge funds would have been de-levering this quarter.

The hedge fund activity is still quite strong.

You know, although hedge funds have not performed particularly well over the last several months, there's still a lot of activity with the hedge funds.

There's still formations of new hedge funds.

And so, you know, the volume of business there continues to be quite strong.

Okay.

And, you know, just listening to Lehman's conference call, you know, they mentioned that volumes are down much more internationally in equities, than they were in the U.S.

You know, was that, kind of, the same for you?

And was, also, the global shares business down more dramatically than your derivatives business?

On a percent -- if you actually look, for example, at volumes on the London Stock Exchange, I think they were down more than volumes in the U.S.

Stock Exchange and NASDAQ, but I would tell you that activity levels were lower, really, around the world.

And I, you know, wouldn't see that much of a difference internationally versus the U.S.

You just saw lower activity levels across the world.

And I think you saw it in the shares business as well as the derivatives business.

Okay.

Thank you.

You're welcome.

Your next question comes from Douglas Sipkin with Wachovia.

Please go ahead with your question.

Yeah.

Good afternoon.

Hi.

Just to follow up on the Securities Services question, were there pockets of the hedge fund world that were stronger or weaker this quarter in terms of activity?

I know you guys have a global prime brokerage business, i.e., you know, maybe equities were weaker where as other areas, global macro, or something like that was a bit stronger.

Can you comment on that?

And I could be wrong, but I recall in the past, there's some seasonal uptick in some of your clearing business -- not clearing business, prime brokerage businesses this quarter.

I'm not quite sure I recall, though, some sort of seasonal factors, but, in any event, obviously, you know better than I. So if I can clarify that, that would be helpful.

Thanks.

Sure.

First of all, I don't think there was any particular pocket that was stronger or weaker.

We saw a fair amount of activity across the board in the hedge funds, in formation of new hedge funds.

So I wouldn't -- I wouldn't attribute that to any pocket.

On your second question, you are not wrong.

You are actually correct.

I think if you go back historically, you will see a slight uptick in the third quarter each year.

There is certain financing trades that, basically, happen in the third quarter, based on, you know, seasonality of when dividends paid.

It's not dramatic, though.

It is -- it is a slight increase, but there is typically a seasonal increase.

And if you, kind of, go through each of the last few years, you will find the best quarter being the third quarter by a little bit.

Great.

Thanks a lot.

You're welcome.

Once again, if you would like to ask a question, please press star, then 1 on your telephone keypad.

Your next question comes from Jeff Harte with Sandler O’Neill.

Please go ahead with your question.

Good morning.

Nice quarter.

Thank you.

As I look at the fixed income trading number, and then, kind of, look at the VaR numbers you put up and seeing the commodity portion of VaR really increase as, kind of, a percent of the VaR, should I expect there to be a general relation between the VaR and, maybe, the components of fixed income trading?

Are those numbers too -- unrelated might be the wrong term -- but is -- is it reasonable to make an assumption like that?

Well, we would like to think that most of the time you will see a relationship between VaR and results, because, clearly, our VaR is going to increase when we see more opportunities.

And that's what happened in the commodities business this quarter.

There were -- there's lots of activity, there were customers buying and selling and hedging, and so, there was lots for us to do, which caused us to do more transactions, which caused risk to go up.

Now, I, honestly, can't tell you that every single time when our risk goes up, our results are going to be better.

Sometimes the risk goes up and our results are worse.

But, you know, certainly, by and large, you're going to see, when there's more activity, our results will be better, and then we'll likely take more risk.

So there is, clearly, a correlation.

Okay.

The -- the additional, what was it, 166 million in principal investments, were there any individual large transactions in there, or was it just a -- ?

No 1 transaction or 2 transactions that drove it.

There were a series of dispositions, public offerings, that -- that were in the third quarter that were all contributed to -- meaningful to the profits.

And the decline in the share count, any implications toward your view of capital, or is it more just average share price down during the quarter?

I think it's the latter.

It was, you know, the -- our intent, and we said, is to -- is to roughly keep share count flat.

And, obviously, we can't do that exactly, because you never know, you know, what we're buying back on a daily basis, and, you know, from the -- the way you account for share count, the stock price affects the closing balance of number of shares.

As the stock price went down, the share count ended up a little bit lower.

And then one 30,000-foot question.

In the -- at the end of your remarks, you made a comment that several businesses are far from what you called peak potential.

What do you consider -- when you say that, what do you consider a peak potential for some of those businesses?

Well, maybe without directly answering the question, it's pretty clear that when you look at our Investment Banking business, we know it is not operating anywhere near its peak.

And, you know, even if you say that the, you know, the years of '99, 2000, you're not going to get quite there anytime soon, there's a long way between where we are and where we've been, you know, in those years.

So we know there's a lot of room to go in those businesses.

And when you look at some of, you know, equities trading commission business, you don't have to go much farther back than the first quarter of this year, when you saw an improving market, to see that, you know, you could have dramatically improving results in those businesses, again, without being anywhere near where we were in 1999-2000.

So there's a lot of room to go in those businesses.

Okay.

Thank you.

You're welcome.

Your next question comes from Michael Lipper with Lipper Advisory Services.

Please go ahead with your question.

Want to focus for a moment on the asset management side.

Could you tell me whether the inflows were weighted significantly into the last part of the quarter?

And second, as the mix of profitability shifted within the assets?

The answer to the first question is no, there was nothing dramatic anywhere in the quarter, you know, pretty even across the quarter.

And, you know, the -- the mix of profitability, you know, we disclose what the assets under management are in money markets, fixed income, equities, and alternative investments, so you can see that.

And we even disclosed what the inflows were in each of those businesses.

So, you know, you can see there.

And, you know, obviously, equities alternative investments have higher fees than fixed income and money management -- and money markets, and that really has not changed very much.

I would have expected with those inflows a somewhat better profit coming out of this area.

The couple things you have to remember is, first of all, we'll see more revenues from those inflows in future quarters rather than this current quarter.

And the other thing that is in there is performance fees.

There was a -- a slight decline in performance fees during the quarter, just -- and that's really based on timing more than anything else of when performance fees kick in, but it was -- it was very slight, not materially, not even worth mentioning, which is why the revenues were virtually flat.

Thank you.

You're welcome.

There are no further questions at this time.

Thanks.

This is John Andrews again.

We'd like to thank you for calling in today.

The call will be available on replay, both on our website, and at the numbers listed at the back of the press release, early this afternoon.

Again, thanks for calling in.

This concludes today's conference call.

You may disconnect at this time.