Investment Thesis
Goldman Sachs’ (NYSE:GS) ambitious venture into consumer banking through Marcus, launched in 2016, aimed to diversify revenue streams and mitigate the cyclical nature of investment banking. However, this initiative resulted in significant financial burdens and strategic missteps. Marcus has struggled to integrate Goldman’s Wall Street culture with consumer banking norms, leading to internal conflicts and high turnover. Additionally, the decision to develop consumer banking technology in-house, instead of through acquisitions, introduced operational challenges. Under CEO David Solomon’s leadership, significant organizational changes in 2020 further complicated Marcus’ trajectory, signaling a de-prioritization of the consumer banking venture. With poor execution and a slowing economy, Goldman does not appear to deserve to trade at an above-sector median valuation.
Introduction
Goldman Sachs’ introduction of Marcus in 2016 marked a significant strategic shift for the firm. As a leading global investment bank with little previous legacy in consumer finance, Goldman Sachs leveraged its technological and financial expertise to launch Marcus by Goldman Sachs, a dynamic online platform offering personal loans and savings accounts. Named after the firm’s founder, Marcus was designed to address common consumer finance pain points, such as confusing jargon and hidden fees. It was developed based on extensive consumer feedback, aiming to provide simple and transparent financial products.
The venture into consumer finance began in earnest in 2015, with a significant step forward in April 2016 when Goldman Sachs Bank USA (GS Bank USA) acquired GE Capital Bank’s U.S. online deposit platform, doubling its client count and enabling the provision of online banking services. Marcus quickly grew, originating $2 billion in loans by the end of 2017 and expanding its offerings to include a personal finance management app and an online savings platform in the United Kingdom. A notable collaboration with Apple in 2019 led to the launch of the Apple Card, the first credit card product issued by Goldman Sachs, marking a significant milestone in the firm’s 150-year history. This multi-product platform, which operated without traditional brick-and-mortar branches, aimed to build a large, differentiated, and profitable digital consumer platform, reflecting Goldman Sachs’ ambition to develop a lasting consumer franchise.
Marcus Has Been A Failure
Goldman Sachs’ entry into consumer banking with Marcus was marked by ambition but resulted in significant setbacks. Launched in 2016, Marcus aimed to diversify Goldman’s revenue streams and leverage its existing resources, including a banking license and a strong balance sheet, to mitigate the cyclical nature of its investment banking operations. However, the venture culminated in substantial losses and strategic miscalculations.
Strategic Missteps and Management Issues
The failure of Marcus can be attributed to a series of strategic and management missteps. Initially, the project attracted talented executives from both within and outside Goldman, like Harit Talwar from Discover Financial Services (DFS), aiming to blend Goldman’s expertise with new consumer finance skills. However, internal conflicts soon emerged, particularly regarding Goldman’s Wall Street pay structure and work culture, which did not align well with the consumer banking sector’s norms. This discord led to high workloads and tension among the team.
Goldman’s decision to build its consumer banking technology in-house, rather than through acquisitions, resulted in significant challenges. The firm’s engineers had to contend with the task of developing consumer banking systems from scratch, a process that proved to be both time-consuming and complex.
Leadership Changes and Focus Shift
Under CEO David Solomon’s leadership, significant organizational changes were made in January 2020, which further complicated Marcus’s trajectory. The consumer banking unit was merged with wealth management, led by executives lacking retail financial services experience. This reorganization left Marcus without significant representation on Goldman’s management committee, signaling a de-prioritization of the consumer banking venture.
Several key figures associated with Marcus, including Talwar and Ismail, left the firm, followed by other executives and engineers. These departures underscored the challenges Goldman faced in retaining talent and maintaining strategic focus in its consumer banking efforts.
Financial Losses and Revised Strategy
With this, Marcus has become a significant burden for Goldman Sachs. The bank disclosed a $470 million loss related to the partial sale of the Marcus loans portfolio, contributing to an accumulated $3 billion in losses in its consumer banking franchise since 2020.
Despite these setbacks, some components of Marcus performed well, like the Apple card, which gained top rankings in consumer satisfaction. However, these successes were overshadowed by the overall financial losses incurred by the consumer operations.
Impact on Goldman Sachs
The rise and fall of Marcus did not significantly distract Goldman from its core profit engines. The firm continued to report strong performance in investment banking and trading, even amidst a decline in dealmaking activity. However, the Marcus venture’s failure represented a missed opportunity in a lucrative market segment where competitors like Morgan Stanley successfully expanded. Goldman’s strategy has now shifted to a narrower focus, with plans to run credit cards for major companies and offer online savings products and buy-now-pay-later loans. The firm has also shelved its ambitions to become a leading digital consumer banking platform, a significant climbdown from its initial objectives.
The Rest of the Bank is Suffering From the Economic Slowdown (Job Cuts are Coming)
Goldman Sachs’ decision to initiate a significant round of layoffs is indicative of the broader economic challenges it faces. This move marks the most considerable reduction in staff since the 2008 financial crisis and reflects the firm’s response to a tough economic environment.
Scale and Scope of Job Cuts
In early January 2023, Goldman Sachs announced it would cut thousands of jobs across the firm, with over 3,000 employees expected to be let go. This number represents a significant portion of its workforce, considering the firm had 49,100 employees at the end of the third quarter of the previous year. The layoffs are set to impact most major divisions of the bank, with a particular focus on the investment banking arm. This decision comes in the wake of a major slowdown in corporate deal-making activity due to volatile global financial markets.
Impact of Economic Factors
These job cuts are a direct response to several adverse economic factors. Global investment banking fees nearly halved in 2022, dropping from $132.3 billion to $77 billion. This reduction is a consequence of high interest rates, geopolitical tensions, and soaring inflation. Additionally, the total value of mergers and acquisitions (M&A) globally slumped by 37% to $3.66 trillion by the end of 2022, further affecting Goldman Sachs’ revenue streams. The bank’s equity capital markets transactions also decreased significantly, reaching the lowest level since the early 2000s and representing a 66% drop from 2021’s levels.
Internal and Sector-Wide Trends
Goldman Sachs’ layoffs also reflect a broader trend in the banking sector, where other major players like Morgan Stanley (MS) and Citigroup Inc. (C) have similarly reduced their workforces in recent months. This sector-wide trend is primarily due to a decline in dealmaking activity on Wall Street. For Goldman Sachs, specifically, the layoffs are not only a reaction to the current economic downturn but also part of a larger strategy. The bank typically trims about 1% to 5% of its staff annually as part of its performance review process. These new cuts, however, are additional and come after a two-year pause during the pandemic.
CEO (and Management) is Feeling the Heat From Investors
Goldman Sachs’ CEO, David Solomon, and the management team are facing increasing pressure from investors due to a series of challenges and setbacks. This growing investor discontent is fueled by various factors, including underperformance in key ventures and broader economic concerns.
Strategic Challenges and Investor Skepticism
Solomon has acknowledged the need to consider strategic alternatives for Goldman’s consumer arm, particularly after the costly misadventure with Marcus, which lost $3 billion in almost three years. The bank is contemplating actions like selling a loan portfolio of $4.5 billion from Marcus or de-risking certain units. These moves indicate a strategic shift and an admission of the challenges faced, especially since Marcus’s troubles significantly impacted the bank’s fourth-quarter 2022 earnings (and have impacted the bank since).
On the personal front, Solomon has made a significant change by stepping away from his side career as a DJ. Known for his DJing endeavors, Solomon has decided to focus solely on his role at Goldman Sachs, ceasing his public performances. This decision comes amid increased scrutiny and criticism that his DJ hobby was a distraction from his responsibilities as the head of one of Wall Street’s leading financial institutions.
Market Response and Cost-Cutting Measures
In response, Goldman has undertaken significant cost-cutting measures, including cutting 3,200 jobs and halting the filling of vacancies, which are expected to reduce payroll costs by $600 million. These actions reflect the bank’s efforts to align its workforce with the current economic realities and strategic priorities.
Global Economic Concerns
Solomon has also expressed caution regarding Goldman’s operations in China, anticipating tougher conditions in the coming years. He indicated a cautious approach to investing in the bank’s own franchise, reflecting broader concerns about persistent global economic challenges, such as inflation and the impact on capital markets. While Solomon noted a slight improvement in market sentiment, he acknowledged the risks and uncertainties in the economic outlook, signaling a more guarded stance in the bank’s strategy and operations going forward.
The Counter-Thesis
However, there are notable contrasts to the sell thesis for Goldman Sachs, with several elements of the company’s business model and strategic focus in 2023 presenting a compelling counter-argument. These aspects, ranging from revenue diversification to strategic shifts in client focus and operational efficiency, underscore the company’s resilience and potential for growth despite current market challenges.
Diversified Business Model & Revenue Streams
Goldman Sachs benefits from a multifaceted revenue model, encompassing investment banking, trading, asset management, and lending. This diversification allows for a balanced risk profile and financial stability. The firm excels in advising on complex financial transactions, market making, and managing a wide array of asset classes, earning substantial fees and profits across these segments.
Comprehensive Financial Solutions and Client Diversity
The company’s strength lies in offering tailor-made financial solutions, serving a wide array of clients like corporations, governments, and high-net-worth individuals. This ability to cater to diverse financial needs underlines Goldman Sachs’ value proposition and versatility in service offerings.
Strategic Focus on Core Businesses
The firm’s strategic shift towards core Wall Street businesses and asset management, and away from Marcus, now championed by CEO David Solomon, reflects a commitment to revitalize operations and improve financial performance, focusing on areas of traditional strength.
Efficiency and Cost-Cutting Initiatives
Goldman Sachs is implementing cost-cutting measures aimed at saving $1 billion, targeting smaller expenses, and optimizing staff levels. These efforts are part of a broader strategy to enhance operational efficiency and strengthen the core business.
Commitment to Strategic Growth Goals
The leadership is dedicated to achieving strategic goals set during Investor Day, focusing on growing existing businesses, diversifying products and services, and operating more efficiently. This approach is designed to solidify the company’s market position and improve operational effectiveness.
Emphasis on Ultra-High-Net-Worth Clients
A key strategic decision involves refocusing on ultra-high-net-worth clients, a segment known for generating more stable revenues compared to the volatile nature of investment banking and trading operations. This shift is indicative of Goldman Sachs’ adaptability and foresight in targeting lucrative and resilient market segments.
Valuation
While the firm has strong offshoots from its refocus away from Marcus, they still seem expensive. With FWD GAAP P/E estimate of 14.19x, (note: the Seeking Alpha symbol page uses non-GAAP P/E here -I am using GAAP metrics), Goldman Sachs earns a grade ‘D+’ rating as indicated by the Seeking Alpha. This implies that the stock may be overvalued compared to the sector median P/E of 9.63x (47.36% difference). I believe the company is overvalued after its blemishes with Marcus, meaning the firm should trade at the forward P/E of an investment bank (closer to the sector median).
Similarly, an FWD P/S ratio of 2.53x, which is also higher (albeit slightly) than the sector median of 2.34x, as highlighted by a ‘C’ grade, points to the stock being priced more richly on a sales basis than its peers. The market could be pricing in higher future sales growth, which may or may not materialize especially with the difficulties they are seeing with their Marcus division. I believe underlying fundamentals do not support such growth, leaning into my “sell” argument.
Takeaway
Goldman Sachs’ foray into consumer banking with Marcus reveals a series of strategic missteps and financial challenges that have significantly impacted the company’s performance and market valuation. Despite Goldman Sachs’ historical strengths in investment banking and trading, the difficulties encountered with Marcus, coupled with broader economic downturns and substantial job cuts, reflect deeper organizational and strategic issues. The financial losses, technological hurdles, and management shifts within Marcus, alongside investor pressures and market valuation concerns, highlight the need for caution among investors. These factors, taken together, underpin the rationale for a sell thesis, suggesting that Goldman Sachs’ ambitions in consumer banking may not align with its traditional areas of strength and market expectations. As Charlie Munger would say, the firm is outside its circle of competence. I believe they do not deserve to trade at an above-sector forward GAAP P/E ratio when they are in a space they do not understand as well and have not historically executed well in.
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