Goldman Sachs Claims a Piece of the Net for Its Own

If Wit Capital didn't get any respect from the Wall Street establishment when it hired star banker Bob Lessin last year, or in February when it snared Merrill Lynch (MER) Net analyst Jonathan Cohen, Monday changed everything.

By selling a 22% stake in its online investment bank to Goldman Sachs, Wit showed that the biggest, baddest Wall Street bully is decidedly on the Internet finance bandwagon.

Yet for all the glitter that the investment sprinkles on Wit, it is Goldman that has anted up in a strategic poker game against the rest of Wall Street, betting that it can carve out a niche superior to Merrill, Salomon Smith Barney, and especially Morgan Stanley Dean Witter (MWD).

"It's like buying a call option. If it works, it can be a bonanza. If not, it's probably not that much money," says Mike Holland, a New York money manager and former executive at Salomon Brothers and Oppenheimer. The price of Goldman's investment isn't likely to be disclosed until Wit, which is going public, files an amended S-1 registration statement.

Why Goldman wants a tiny Internet investment bank that has typically grabbed 5% to 10% of an IPO's distribution is determined more by the future than anything Wit has done to distinguish itself since its 1996 launch.

"Goldman has to have a hole card so that if all the business goes that way [on the Net], it's covered," says one former high-ranking brokerage executive in New York. "They don't want to lose out on any deal origination."

Holland takes that idea a step further and thinks having a partial relationship works to Goldman's advantage. "I don't think it's crazy for Goldman to get an early toehold. It's the perfect entree" into the Internet retail client base, he says. Goldman won't have a representative on Wit's board but has the right to have an observer.

On its own, Goldman only has retail distribution that's limited to a few hundred brokers selling to the super-rich.

"I think that Goldman's willingness to pursue e-commerce demonstrates flexibility and open-mindedness for such a large company. Goldman doesn't want to be left behind," says John Payne at Cerulli Associates, a Boston-based research and consulting firm for financial institutions.

All of the firm's key competitors have either strong brokerage networks to reach individual investors or Internet distribution channels (or in the case of Morgan Stanley, both). "This gives Goldman a way to reach those people without building offices for 10,000 brokers," says one Wall Street retail brokerage executive. "It's an important selling point when you're pitching for a deal."

Because Goldman and Wit are in the throes of preparing their own IPOs, there isn't much information forthcoming from the firms. For Goldman, however, the signs of its broadening electronic presence are obvious. Last year, Goldman invested $25 million in Archipelago electronic communications network, an alternative trading system in which E*Trade (EGRP) also is a major investor. Goldman distributes pieces of some IPOs through E*Trade as well. And the firm has a management committee studying ways to develop Internet alternatives.

"Goldman is also planning to go public, and demonstrating a strong foothold in e-commerce in today's Internet-centric environment can only enhance the perceived value of the company, particularly at the retail level," says Payne at Cerulli Associates.

"Business models are being challenged across the board in financial services, from the way information is delivered, to the servicing of products to the brokers' value propositions, and all the way up the chain to investment banking," says Payne. "No one corner or segment appears to be free from the impact of the Internet."

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