A State Street-Goldman Sachs Deal?

by Will Ashworth | June 12, 2012 9:59 am

A State Street-Goldman Sachs Deal?

Hedge funds are big business. Globally, assets under management could reach $2.3 trillion in 2012 as investors continue to seek investment returns. As a result, hedge fund administrators have also become big business.

Rumors of a potential deal[1] between Goldman Sachs (NYSE:GS[2]) and State Street (NYSE:STT[3]) hit the newswires Monday. If true, this linkup could completely alter the competitive landscape in hedge fund administration. Here’s why a deal makes sense for both parties.

According to the eVestment|HFN Q4 2011 Hedge Fund Administrator Survey, the largest hedge fund administrator globally is Citco Fund Services, with $594 million in assets under administration. State Street (NYSE:STT[3]) is second, with $487 million.

That would change if State Street is able to buy Goldman Sachs‘ (NYSE:GS[2]) hedge fund administration unit. The combined assets of the two firms would be close to $700 million, making it the largest administrator in the world.

According to Christopher Wheeler, an analyst at London-based Mediobanca, the sale makes sense for Goldman Sachs given the recent increased regulation and oversight by the SEC. Frankly, I think it’s a win-win situation for both companies.

Goldman Sachs is an investment bank. It is not in the business of long-term ownership of corporate assets. Rather, it helps others acquire corporate assets, using its expertise to generate lucrative management and performance fees.

Hedge fund administration, while useful because of the clients it provides access to, is an unglamorous business that likely generates fewer investment banking opportunities than one would think. In addition, it’s a low-margin business, which is the opposite of most of Goldman’s other operating units.

In other words, you need size to make it work, and Goldman was either going to have to get out its checkbook and start taking out its larger peers or put the unit up for sale. I think the firm is making the right move.

Consolidation is the name of the game in fund administration right now, whether it be hedge funds, other alternative investments or plain old mutual funds.

SS&C Technologies (NASDAQ:SSNC[4]) recently made a deal to acquire GlobeOp Financial Services, for $885 million, or 0.52% of assets under administration. Goldman’s assets under administration are about $200 billion, which suggests a potential deal of slightly more than $1 billion.

So, along with the GlobeOp buyout, if State Street closes its deal, there will be two fewer competitors in the top 20, with State Street as the biggest. Investment servicing is a global business, and State Street provides its clients with a worldwide presence. In its 2011 annual slide presentation, the firm mentioned that hedge fund servicing is growing at a compound annual growth rate of 12% and currently is a $2 trillion market, which gives State Street a 35% market share and rising.

As it gathers more assets to service, State Street’s margins should rise exponentially. As Gordon Gekko (Michael Douglas) said to Bud Fox (Charlie Sheen) in Wall Street, “He’s right, I had to sell. The key to the game is capital reserves. If you don’t have enough, you can’t piss in the tall weeds with the big dogs.” In this instance, State Street is the big dog and Goldman Sachs is Gordon Gekko.

Both parties are choosing to stick to their knitting, and by doing so, they’re exhibiting a rare moment of common sense. The best deals are those where both sides get what they want. The shareholders of both companies should be happy.

As of this writing, Will Ashworth did not own a position in any of the stocks named here. 

Endnotes:
  1. Rumors of a potential deal: http://www.hfmweek.com/news/1717998/report-goldman-sachs-nears-agreement-over-admin-unit-sale.thtml
  2. GS: http://studio-5.financialcontent.com/investplace/quote?Symbol=GS
  3. STT: http://studio-5.financialcontent.com/investplace/quote?Symbol=STT
  4. SSNC: http://studio-5.financialcontent.com/investplace/quote?Symbol=SSNC

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