Monday, January 3, 2011

Why Facebook is such a crucial friend for Goldman

Goldman Sachs sent Facebook a friend request, and Facebook accepted.

The news that Goldman has taken a stake in Facebook, the white-hot social networking giant, has tongues wagging from Wall Street to Silicon Valley. As first reported by DealBook, Goldman has invested $450 million in a deal that values Facebook at $50 billion. As part of the deal, Goldman is looking to raise as much as $1.5 billion from its wealthy clients to invest in Facebook alongside the firm.

The move is straight out of Goldman’s playbook. The firm has a long history of “friending” America’s hottest companies and chief executives. By collecting so many important friends, Goldman generates big fees.

The ancillary benefits of buying a stake in Facebook are several. First, it has likely established itself as the leading candidate to win the very lucrative and prestigious assignment of Facebook’s initial public offering, whenever that day comes. Then, of course, there are secondary share offerings, mergers-and-acquisitions business and other banking fees that would inure to Goldman.

Second, Goldman’s private wealth management clients — handled by the firm’s money management unit for rich families — can boast to their friends on the golf course that they own a pre-I.P.O. stake in Facebook.

There is also the huge paper wealth being accumulated by the Facebook co-founder, Mark Zuckerberg, and his fellow executives that will some day be monetized and have to be managed. Goldman would likely have a leg up there, too.

There is plenty of precedent here. In 1956, Goldman advised a prominent Detroit family named Ford on the I.P.O. of its car company. As a result of the deal, the Fords then became Goldman’s first private wealth management clients, and the car company remains an important banking client of the firm. Goldman’s former president, John Thornton, sits on Ford’s board.

In 1994, a New York clothing merchant named Ralph Lauren was looking for money to expand his business. Goldman invested $135 million for a 28 percent stake ithat valued the preppy clothing company at about $480 million. Ralph Lauren went public in 1997, a deal underwritten by Goldman. Today, Ralph Lauren the business is worth about $8 billion. When Ralph Lauren sold $1 billion of stock last year to cash out a quarter of his stake in his company, Goldman sold it for him.

Then there is Meg Whitman and eBay, the online auction site. Goldman put the bear hug on eBay as it was becoming one of the hottest Internet companies during the dot-com boom of the late 1990s and handled its I.P.O. Goldman named Ms. Whitman to its board of directors, eBay has steered millions of dollars in fees to the firm and Goldman manages much of Ms. Whitman’s fortune. (Her close ties to Goldman hurt her during her gubernatorial campaign last year.)

Goldman surely hopes that things turn out much the same way with Facebook and Mr. Zuckerberg, a 26-year-old billionaire, as it did with Ford and Mr. Ford; and Ralph Lauren and Mr. Lauren; and eBay and Ms. Whitman.

That, of course, remains to be seen. Although the Facebook investment could not look more promising at the moment, Goldman and its investors could be buying into a social networking bubble that is poised to eventually burst. It would not be the first time that the investment bank has gotten caught up in what the business writer Roger Lowenstein described as “the sudsy effluvium of Silicon Valley.”

About a decade ago, at the peak of the dot-com bubble, Goldman invested hundreds of millions of dollars in Webvan, the revolutionary online grocer that never got off the ground.

The Facebook investment, made from Goldman’s balance sheet, also sheds light on the firm’s private equity strategy post Dodd-Frank regulatory reform.

Although the Facebook investment represents a negligible percentage of the firm’s roughly $900 billion balance sheet, it is symbolically significant because it had been unclear whether Goldman would, in the wake of the financial crisis, be using its balance sheet to make these types of investments.