The Carlyle Group Inc. (CG) Earnings Call Transcript & Summary

Next up, it's my pleasure to welcome John Redett, Co-President and Head of Private Equity at Carlyle. John assumed his newly created role in January after serving as CFO and Head of Corporate Strategy. John's tenure as CFO was at a key moment for Carlyle. Harvey Schwartz has just taken over as CEO. And during John's tenure, FRE at Carlyle grew by more than 50%, FRE margins improved from the mid- to high 30s to the high 40s. So please help me welcome John Redett. Thank you. So let's start out with the mark-to-market on private equity, if you don't mind, John. So Carlyle's private equity business is its largest. It's a big part of the firm's heritage. So it'd be great to hear your updated thoughts on the state of the private equity business, what you've achieved in taking the helm of that business and what are the big things that are on your to-do list. And of course, we would be remiss in not talking about monetization given how important that is.

All right. Well, Brennan, thanks for having us. It's great to be here. We have a bird in the room.

There's a few. Yes. It's the hawk idea. It's dramatically central.

So look, I think that is a question that probably is a very, very long answer, so I'll try to be reasonably brief. In terms of realizations, I think our teams have done an outstanding job. If you look at the industry, the industry is returning roughly 12% of NAV, which is meaningfully below historical levels. We, as a firm, globally are closer to 18% of NAV in the U.S., we're north of 20%. So I think the teams have done an exceptional job of returning capital. And look, we're in a time period where a lot of LPs have not returned capital or a lot of competitors have not returned capital to LPs. And that has created some problems for LPs allocating money to private equity, but our team has done an exceptional job. And I think some of that is just really a reflection of how we run the business. We always build a a very diversified portfolio. We don't like over concentrations. And I think you've seen the industry really struggle with monetizations because of the overall concentration in software. I mean in 2020, 2021, 50% of private equity deals are software. So it's going to take some time for the industry to get unclogged on the software front. We never got overexposed to software. So our teams are not spending time with portfolio companies that have upside on capital structures because they paid a huge price for back in 2021. So I think that's enabled our teams to realized more than the industry. In terms of the -- what gets me really excited is just the investment environment. When I was a CFO, I got heavily criticized because we were not all in on software. And needless to say, today, we don't get criticized. People are quite happy about that. But if you think about where the opportunities are today, -- it's right in Carlyle sweet spot, so defense. You can't go anywhere in the globe without an LP wanting to talk about defense, more broadly, national security. What does that mean? Energy independence, supply chain resilience, cybersecurity, actual defense. Those are really important topics, and we're seeing tremendous opportunity in defense energy. We're 1 of the few firms that has an energy effort. We do Brown Energy. And if you would have told me Five years ago, that'd be running around Europe and LPs wanted to talk about Brown Energy. I would not have believed you, but they want to talk about Brown Energy. So we're raising money for a global energy fund health care, financial services, industrials, we've done 90 -- more than 90 industrial carve-outs, and we're seeing an acceleration in carve-out activity in Europe, in the U.S. And we're really seeing a big acceleration in Japan. We've announced, I think, 2 carve-outs in Japan just this year. So look, I think the -- there's a view among LPs that the current funds that are being raised will have some of the best returns LPs have seen in a long time. So I'm pretty excited about the opportunity. And I think our teams have just done an amazing job positioning the business for growth going forward.

Right. Some of the recent vintages with no doubt, everybody is really excited about what's getting raised today, performance in CP7, you've described it publicly is not what you guys expect to be your finest moment. The public portion of the portfolio moves around, and that held back some of the performance recently rebounded quarter-to-date, right? We can all track the big ones Medline and Standard Aero. So what are your updated expectations for that fund -- and what are you thinking about for the likelihood of that getting into carry. And it's early days for CPA, but that performance has been more encouraging. How do we think about those 2 vintages.

Yes. So CP7 when you've been doing private equity for 40 years, you will have a fund that doesn't meet your expectations. And that for us is 7. I think the leadership in our U.S. buyout business has done a fantastic job getting CP7 to where it is. And I think we have a very clear path that we've explained, walked our LP through where we think it will get to and it seems absolutely doable. And I think the LPs recognize that occasionally, you're going to have a fund that's not your best and that for us is CP7. So I feel good about where CD7is heading. Again, it's not our finest piece of art our work, whatever you want to call it. But I think most LPs really focused more on 8 and 8 is 75% invested CP8 is going to be a fantastic fund. . Typically, when you're 75% invested into a fund, you have 1 or 2 companies where you're like, oh, geez, I don't know about that. We don't have that in CPA. So I think it's going to be a great fund. So when I talk to the large LPs, they get 7, they understand the path, the glide path we're on. But more importantly, they're really laser-like focus on 8 and it looks like a great fund. So I think we've done an exceptionally good job positioning the business for the current fundraise, which we've launched. And I think you couple that with where the opportunities are in the world it's kind of the old economy opportunity, and that's just where Carlyle go for 40 years. So I think the environment is reasonably attractive.

It's certainly -- you guys are halo heavy, so it certainly speaks to our strings. Now you can't talk about 7 and 8 without then talking about 9. You guys are out fundraising now. How has that experience been -- and I believe you guys indicated that you expect a close around year-end or early 2027, -- any sense for the sizing of that?

Yes, I have to be careful what I can say on that is we're actually in the market fundraising, but we do -- we will have a first close sometime this quarter or next quarter. It's really hard to nail down the exact date because it really is dictated by a couple of large LPs coming in than other LPs come in, but I feel very good about the fundraise prospects. I think the environment for private equity fundraising has gotten marginally more positive as LP see the enormous opportunity that we're seeing. But it's still not -- it's not as easy as it was, say, 5 years ago.

Right. And that segues perfectly into AlpInvest because the solutions businesses are there, and they're facilitating some of this DPI. You guys had a structured solution for 9. You got earlier this year, the SPV was announced Pitomic, I believe it's called utilized the CFO structure to cement $5 billion of commitments for 9 and liquidity, provides some LPs and 7 and 8 some of our DPI. What's been response to that from LPs? And how significant do you expect that's going to be as a feature for the future?

Yes. So the structured solution, it's been very positive from the LP community. It's one of those few situations where it's a win-win. It was a win for Carlyle. We earmarked $5 billion for our current U.S. buyout vintage. And it also enabled some LPs to get liquidity in their portfolio. So it was really a win-win. The response has been incredibly positive. I do think the technology will have some applicability to other situations, and we're thinking about that. But -- this wouldn't have been possible for Carlyle to do this transaction if we did not own AlpInvest. And I think Harvey has done an exceptional job integrating AlpInvest into the fabric of Carlyle. And the connectivity between private equity and AlpInvest has become seamless. And I run the private equity business, but I spent a lot of time with the AlpInvest team -- and their data and their market insights are immensely valuable, and they tuck a lead role in driving that structure, and it was a fantastic outcome. It had never been done before very unique. I got a lot of calls from competitors asking how we did it, how does it work? And I think it's generated a lot of interest in the market.

All right. I would love to drill into part of that. So you talked about AlpInvest. It's definitely a unique business for Carlyle. I think it's 1 of the most interesting. I'd love to hear how Alpinvest in the integration of AlpInvest has changed in your time in being involved in private equity and what the level of engagement is between those 2 teams.

Yes. I mean if you think about what AlpInvest does, they're really at the center of the private equity industry and how the private equity industry is evolving. And when I was on the private equity side of the business, right are wrongly, there was just no connectivity with AlpInvest. And until I became CFO, I didn't really fully understand how AlpInvest what their products were, what their capabilities were, and I was just blown away by just the data insights this business has and global private equity. So there's tremendous connectivity across the globe between AlpInvest and global private equity. They're immensely helpful as we think about a new fundraise. They are immensely helpful as we think about how we want to position the new fund in terms of how we're going to raise it. So -- it is a it was a wonderful acquisition for us. The organic growth in that business is amazing. And they have -- they continue to have immense tailwinds. And you look at in most of it, most people talk about the equity side of the secondaries business. No 1 really talks about the credit side of the business. The credit side of the business is it's not even batting practice. I mean it is early days. It roughly represents 1% of direct lending. So I think the credit side of the business is going to have phenomenal growth over the next 5 to 10 years. It was a great acquisition. And integrating it into Carlyle was a very smart thing for us to do for the firm.

Yes. And it feels like that's really changed in the last few years when you think about the organization. Are there any examples that you can give about how that has manifested within Carlyle. The business is working together. When we came in and we had -- you guys had your Investor Day, earlier this year, getting a chance to sit down and have lunch and talk with some of the different businesses, they all echoed that idea. So I'm sure the examples are extensive, but maybe give a little sense of that.

Well, I think that structure we did for the private equity business that would not have happened 2 years ago, 3 years ago. We just didn't have that kind -- but it's -- there's connectivity across the entire firm. So you think about like direct lending, it's very much GP relationships. What does Alpinvest have, tremendous GP relationships. So -- it's all over the firm. And I think there is still a material amount more we can do together with AlpInvest. But it's -- I mean it's really just a solutions business and the market insight and data that business has is just phenomenal. I mean they have data on over 30,000 companies. It's just -- it's really valuable.

Yes. Fundraising. So you guys have talked about $200 billion fundraising target over the next 3 years. And I don't believe this is your term, but Harvey has called it a super cycle for fundraising.

Not my turn.

Now your turn. Fair enough. From the 3Q coal, it sounded like it's about to get kicked off. You spoke to LP appetite I assume that's around large-cap buyout, but it'd be great to hear you confirm that. And how are you thinking about how the different geographies can contribute to that target?

So I don't think -- I've been at Carlyle for 20 years. I'm not sure over that 20-year period, I've seen a 2-year period where we have this many material funds in the market. So I guess it is a super fundraising cycle. So in the U.S., we'll have our current vintage of U.S. buyout. We're raising a defense industrial fund, which is the first for us. I think that will resonate with LPs. I mean we -- we've been doing defense for 40 years. That's what we started in. And I don't think there's an LP in the U.S. that doesn't want exposure to defense. Our track record in defense is fantastic. So -- that will be in the market. We're raising a global energy fund. Again, we're one of the few large global firms that does brown energy, whether you like it or not, Brown Energy is necessary, particularly in today's energy-consumptive environment we're in. We are raising a new secondaries fund, which is in the market. We're raising an opportunistic credit fund, which we've had to first close on our Japan buyout business will be in the market at some point in the next 12 to 18 months. So it's really -- when you look at Carlyle and you look at all of our material funds, funds of size and scale, -- they're all in the market in the next -- some of them are already in and others will be in '27. So '17, '28 is going to be a very busy fundraising cycle for Carlyle. I feel very good about it. It's very diversified, which I like. And wealth is a component of that as well. We just launched a private equity wealth product about 12 months ago, 18 months ago, and it's really just starting to scale as we get on some of the wire houses. So wealth will be a contributor to that as well.

That was a piece that I was going to drill into next, that's $40 billion of the $200 million. You talked about CPAP, could you talk about -- a little bit more about wealth, what your expectations are? Where is CPAP on the journey? How many wires is it on? What -- where are you thinking about that?

I think for whatever reason, when people were talking about wealth 9 months ago, it was just up and to the right. And -- nothing in our business is up into the right. But for some reason, that sell people had it pictured in their mind. We always knew it's going to be a journey with some bumps in the road. And we're at a point in that journey where there are some bumps in the road, particularly on the credit side. It will work itself out because when you look at the underlying quality credit quality of these funds, it's still quite exceptional. So we now it's going to be up into the right. We'll get there. It's going to be an enormous source of growth for the industry. I mean the penetration of private market assets into individual accounts is de minimis. But again, we never thought it was going to play out overnight. I think this is a 15-year journey, and it's going to take time, but it's going to be an immensely important source of growth for us. So we really have 3 businesses. We have AlpInvest, which is our Solutions business. We have a private equity business and we have a credit business. We launched our secondaries product a couple of years ago. It's scaled really nicely. We launched our credit product 7 years ago. That scaled, and we just recently launched our private equity product, which we call CPAP, and we just crossed $1 billion on that fund. And it really just went live on the first wire house a couple of months ago. And when you look at the calendar, we go on more and more wirehouses in '27 and '28. So I expect to see that scale nicely over the next couple of years. And it's just more kind of a sequencing calendar issue with the wirehouses. The RIA channel also is going to be a big growth driver for CPAP and we're starting to get on some of the bigger RIAs as well.

Yes. That makes sense. When we think about the FRE margin expansion, when Harvey arrived, the margin was in the 3, 7, I want to say...

A couple of years before that was 22.

Here you go. The team has expanded. Now you guys were at a record 47%. Your 2028 target, I believe, is 50 plus. Can you speak to the sustainability of current levels and the big drivers of operating leverage as we move forward to '28.

Yes. I've always thought the firm should be able to operate at an FRE margin in kind of 50 plus. But I never really wanted to get there through efficiencies, but rather through growth. I think you're going to see as we move through this fundraising super cycle and we gather assets, you're going to see that margin just naturally expand as we raise more money. Because in our business, you don't -- if you raise previous fund was $5 billion and the next funds, $8 billion. You don't need more people. So you're just going to see naturally the operating leverage in the business with growth. And I think I think getting to a better margin through more scale and more growth makes a lot of sense. But it's not an efficiency exercise. I do think there are things as a firm -- and as an industry, you're going to see over the next 5 years in terms of automation that should, on the margin, enhance the FRE margin, but it's not going to be a meaningful driver. The real driver is going to be just growth.

Right. Europe. So you guys have been pretty upfront in the issues in your -- that your bio business base is in Europe. Could you give us an update on that? It sounds like there's been a lot of change -- and I think that is something that might not be fully appreciated by investors. Like where are you in that journey? And what's recently been some of the accomplishments.

Yes. So Europe, we've had some challenges in Europe. When I became CFO, we may were focused on making some changes to our U.S. business. And then we moved on to Europe. We changed the leadership. The guy running that business is probably one of our best private equity investors. And he's restacked the team to where we have some newer talent coming in. Some actually used to work at Carlyle, I came back, some other people from competitors. I feel incredibly good about that business. I think we're probably way through that transition. And we just announced our first deal for our latest fund in Europe. And I think the opportunity in Europe is very attractive. I know a lot of people say, "Oh, Europe doesn't grow -- but the pricing is attractive. And quite frankly, if you back out the AI CapEx in the United States, I'm not sure the growth rates of the 2 geographies are all that different. But we see great opportunities in Europe. And this defense fund, we're raising this industrial fund we're raising will be focused on the U.S. and Europe. So you're going to see a lot of ability of that fund in our European business to work together. And just I think it just really is going to leverage areas where we have a proven rate to win. But I feel very good with where the European business is. I've been very upfront when I was CFO that we will be investing out of a fund that is substantially smaller than the predecessor.

Right. Right. And you touched on the defense fund that you guys are now, I believe this is going to be a new series of funds for you potentially. Could you talk about that? Could you talk about where you think that opportunity set looks like? I think the idea that fence is a theme here resonates a lot. So I'd love to hear you just drill down a little bit on that.

Yes. I just national security is top of mind everywhere. Some of it's top of mind for reasons that are rather unpleasant, but it is what it is. It is a topic that is critically important to all nations. And that includes cybersecurity, I think cybersecurity risk is getting elevated with AI. A lot of CEOs are incredibly concerned. I think energy independence is critically important. And Europe is very focused on energy independence I think actual defense, kinetic defense is incredibly important. Supply chain resilience is top of mind for everyone. I mean these are -- this is an enormous opportunity. And I think it's probably one of the more attractive opportunities I've seen in my career. And the United States has an amazing defense capability but it has to change for the times we live in. And you're going to see a big transformation in the U.S. in terms of how we go about defense. You're going to see a lot of the business being generated by the nonprime, newer companies that are coming online, in Europe really has to build defense capabilities. They're going to require a tremendous amount of private capital. The governments don't have the capital to do it themselves. They're all heavily indebted. So it's going to be an enormous opportunity for private capital. We've been doing defense for 40 years. We have an amazing track record. We're the only global private equity firm that has a defense capability. So we're really competing against middle market firms that don't have the global footprint, the resources the technology that Carlyle has. So I think it's one of the most attractive opportunities I've seen. Historically, we haven't really captured this defense capability outside of our large U.S. buyout fund. That is a large cap focused fund. This is going to do more middle market which is where we see the opportunity in the next 5 to 10 years. And again, it's just taking a step back and looking at ways we can grow a business where we have an amazing track record and a right to win. And any time we have a business with a track record like this, and we have a right to win, we'll figure out a way to leverage it. And that's what we're doing with this defense fund.

You guys have a tremendous heritage in Washington. It speaks to some our defense capabilities. Can you talk about how that translates and how you think about the opportunity set, which I think some of which sits in Europe that is it inherent through just being -- having your connectivity in Washington, where that, therefore, gives you the insights. Like how does that -- how does that evolve.