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

All right. Good morning, everyone. Let's get started. This is Craig Siegenthaler from Crédit Suisse, and it's my pleasure to introduce Kewsong Lee from the Carlyle Group.

Thanks for having me here, Craig.

Kew is the firm's Co-CEO and also chairs Carlyle's Executive Committee. He joined Carlyle back in 2013 as Deputy CIO. And in 2016, he was promoted to lead Carlyle's credit business. Carlyle is one of the largest alternative asset managers in the world with $224 billion in assets under management. And while many know the firm from its very strong reputation in private equity, Carlyle has been focused on building out its credit business, its real assets business and its investment solutions business. So Kew, thank you again for coming.

So maybe starting now with what many down here are thinking is the elephant in the room, the coronavirus. Maybe you can discuss for a moment what you think the impact on your business will be of the coronavirus.

Sure. Okay. Well, obviously, this is the topic of the day and I suspect will continue to be for a while. First and foremost, there is a real human element to this. And so I've got to, as CEO, take good care of our people. And so we are very focused every day multiple times with folks looking at the right policies and protocols to make sure that our people, their families and really, broadly speaking, our portfolio companies are taken care of and we're trying to do the best that we can. So we're doing that. Short term, first, I'll say, environmentally, but then I'll get to the different layers involved in your question. There's definitely going to be a short-term financial hit. You can't have half of the world's second largest economy be dormant and not have an impact to global economy. You can't have 55% of global manufacturing output go through China in some shape or form without there being a short-term hit. And I think people underestimate the disruption to the supply chain. We've got estimates of close to 60,000 containers that are in the wrong places, wrong ports, wrong railway stations because everything is disrupted. To get that all moving and going in sequence in the right way, it's going to take a long time. So monitoring our portfolio at the ground level, without a doubt, lack of travel, retail traffic down, people not making decisions, it's going to have a short-term financial impact on our portfolio. We're on top of it. We've got plenty of capital. We've got great financial partners, and we're going to work our way through it. It's just too early to tell, to understand the magnitude of some of this because the situation is evolving. But if you take a bigger step back, I think we're built to deal with crises and issues like these. We're a well-diversified company, multiple asset classes, and there are parts of our business, like our credit business, where volatility in the world starts to present financing opportunities for them because the banks may be more risk off. We're seeing with our $70 billion of dry powder an ability that over time as the investment environment shakes out, that we feel well positioned to navigate through the environment. But the first and foremost issue has got to be for us to focus on our people, then to focus on our portfolio of companies, and then to take a step back and say how will this play out and how are we positioned in this environment. It's too early to tell. Craig, I don't think there are any experts who really can predict what's going to happen here as to the severity and the duration of this, but I feel like we're well positioned to push through this and navigate it as the circumstances evolve.

Kew, a topic we've talked about with each executive of your peers this week has been the secular migration to private markets, private capital. Do you think the industry can continue to grow at this pace?

The short answer is yes. I mean it's a $6.7 trillion, close to $7 trillion of assets growing at about 10%. And it's growing across all asset classes, not just private equity, but credit, real estate, infrastructure, et cetera. I just came back from SuperReturn in Berlin, which is the industry's largest conference. And I can tell you, despite the environment and some of the market correction that is happening, there is no shortage of appetite to continue to invest and to seek allocation into this asset class. In fact, I keep making the comment, it's really not alternative anymore. It's more mainstream. It's such a main part of every single institution's investment portfolio to help drive returns. You didn't ask, but I'm going to go right there, which is there's a Bain & Company report, which pointed out that, hey, over a 10-year period of time, public markets have outperformed private equity, at least that's the assertion. Yet when you look at it, I think the report does a better job of framing the really important question, which is public markets delivered 15%, which is an outperformance of 2x over their historical levels of return. Do we really think public markets can keep continuing to outperform in that way? Or do you suspect a reversion to the mean, whereas private capital has been consistently generating the types of returns that are being published? And so to me, the question is, how do you drive these types of returns moving forward? And it's interesting that in that report, 60% multiple expansion occurred to get the public returns to deliver what they did. Whereas if you take a look at what Carlyle does, 2/3 of our returns are driven by operating earnings and growth and fundamental changes that we're putting into the business with less than 20% based on multiple expansion. So I guess where I'm going with all this is, I think our asset class is performing. It's going to get harder and harder to perform, but we have the platform built to continue to drive change, create value to deliver that type of performance. If that continues, I suspect you're going to continue to see secular tailwinds to support continued growth in our asset class because, quite frankly, it is the best-performing asset class that all of our customers have to help them meet their investment objectives. So I think this is going to keep continuing for a bit longer.

Okay. Maybe coming to investing for a second. Especially given the coronavirus issue and large inflows you've experienced over the last few years, how do you think about prudently deploying capital? And could the coronavirus actually provide opportunity to invest across asset classes at low valuations?

Sure. Well, look, it's not appropriate for me to say that we're going to be opportunistic about something which has got such human consequences, right? So again, we're carefully trying to manage this to make sure our people are well taken care of. I can tell you, deal flow right now is about as high as it's ever been. And people talk about all this money, all this dry powder. But you can't talk about dry powder without talking about the other side of the equation, which is the opportunity set for deals. And in every single asset class, you're just seeing the demand for private capital expand significantly. To soak up that dry powder, you're seeing companies wanting to stay private for longer. The number of private companies versus public companies, private companies exceed public companies by a factor of 2x. Banks are retreating from certain types of loans and you're seeing private capital go in and make direct loans. In every single asset class, you see regions opening up like Japan. So the opportunity set is growing. And I think that's what will absorb all this dry powder that is being raised. And you have to keep in mind, it's not necessarily the lack of an ability to put the money to work because there are plenty of ways to put the money to work. The real question is, are you putting the money to work in good deals? Valuations are high, no doubt. And so the key is, how do you drive returns? And I like our model because we drive returns with a long-term perspective based on creating this fundamental operational improvement and changes to a company's profile that improves earnings. And if you have that mindset, I feel very good about our ability to continue to consistently deliver the types of returns we've always done to properly deploy that dry powder that you're referring to.

Yes. And maybe just starting right there. If I look at the historical returns in some of your larger funds, I'm thinking Carlyle Partners IV, V, VI, very solid double-digit zone. What is your confidence that future funds could actually generate similar growth?

So what I can comment on is the following. The current funds, the big flagship funds that we're deploying on a multiple of invested capital basis, they are tracking more or less in line with exactly those predecessor funds that you're mentioning. So my crystal ball is -- can get a little bit cloudy. But as of right here, right now, despite the challenging environment, despite the factors you're talking about, our current large funds are more or less tracking in line with what our historical predecessor funds have been able to do. So if that were to continue, I feel very confident that we'll be able to drive performance revenues and the level of earnings that we have been able to do in the past.

Got it. Coming to one of my favorite topics, C-corp conversion. You had a differentiated C-corp conversion. It was actually completed almost 2 months ago, January 1. How do you think your shareholder base will change when I look at both the active side and the passive side?

Okay. Great question. So yes, we did do a C-corp change. It was a true C-corp change. As folks know, we went -- it's best-in-class. It's 1 share of -- 1 class of common stock. It's 1 share, 1 vote. It's the best governance, the simplest, the most transparent. And we feel very good about it. And it opens us up to the maximum possible amount of index inclusion vis-à-vis our peers. If you take a step back and look at what is likely to happen and for some indices, it's formulaic, and for others, there's some judgment. But starting in March and in the spring and throughout the year, you will see Carlyle be added to a bunch of indices. And that, for sure, will drive a technical demand or a need for our stock as we get included in a lot of these passive indices. S&P 500 or the S&P is something that we are also eligible for. Obviously, there is a committee there that has judgment as to whether or not we should be included. But best to our knowledge and based on conversations, we fulfill all the criteria. So it's just a matter of do they want us in that index or not. But we are, from an index-inclusion perspective, probably the best positioned across our peers given the simplicity, transparency and the ultimate structure of how we converted. And as a result, I suspect you're going to see that type of technical demand for our stock starting in the not-too-distant future, and that should continue to go throughout the year and into next.

Great. And this topic is kind of linked to that topic, valuation. Despite a really nice run you've had over the last 12 months, the Carlyle stock still remains at a lower multiple than peers. So how do you think about that discount? And how do you think you can close that?

Yes. It is -- thank you for pointing this out. It is something that we look at all the time. And it's either annoying or an intellectual curiosity as to why this is the case. I can appreciate some of it. If you go back to the very first question you asked about the virus and the impact, I was remiss in not mentioning, our capital is locked in. 98% -- let's call it, virtually 100% of our capital is locked in for many, many, many years. And as a result, our fee base is, in essence, locked in. So I feel really good about our ability to continue to drive on FRE and the ability to continue to scale that up, as our CFO talked about on the last earnings call. That gives us a level of solidity, which -- and a base, which regardless of the volatility in the world and regardless of events in the short term gives us huge confidence in our ability to provide that base level of earnings. And that's a huge focus of the firm that we went into a few years ago to say, we will establish a solid base of FRE and continue to grow it. By the way, as that happens, it would be our intent to move our dividend up in line -- maybe lagging, but in line with that type of FRE base. Off of that, you then have our carry income, which is much harder to predict. But as I just told you, our funds are more or less performing in line. And you also have to keep in mind, 5, 6, 7 years ago, we were investing at a pace of about $10 billion, $11 billion a year, which, when we look at it through a cycle, created about on a normalized basis $600 million of performance fees. Over the past 3, 4 years, we've been investing at over $20 billion a year. Okay. So I just want folks to appreciate the back-of-the-envelope math. We've doubled the ability to have money in the ground. Our performance right now is more or less on track with historical. Yes, we have product mix. Yes, you have events like coronavirus. Yes, you have events like Phase 1 U.S.-China tension. Yes, does that mean that exits could get pushed out, et cetera? Of course. But the pace has been doubled. So if our performance is anywhere near as what it used to be, you guys can do the math to say, well, where should the $600 million go up to? You add that to the FRE baseline that we feel very comfortable is -- last year, it was $450-ish million. This year, our CFO guided you all to about $475 million and the number with a 5 on it and, call it, a 10% type of growth rate over the cycle. You can kind of start the back of the envelope to say, wow, the earnings power of what we built is pretty good. It's visible. We can see it. We can see how we get there. Maybe I can't predict it by this quarter or that quarter, but you can start seeing the building blocks for kind of a back-of-the-envelope model that kind of makes sense. Now people out there have to decide what multiple they want to put on that. Should we be at the level of multiple? Should we be at a slight discount because of the fact that our growth profile was X or our product mix is Y? Those are judgments that the market can make. Do we deserve the level of discount that we have now based on what I just described? I would say, maybe not. But that's my opinion, that the market is going to make their own judgment, but that's the way I look at it. Now in terms of what could drive future growth, people have to appreciate we have a powerful private equity business, and it is not getting less powerful. And I hope that we can -- our last $100 billion fundraising program, the PE portion of that, the biggest funds grew 20%, 30%, 40% over previous funds. I would hope that, that type of step-up is what we have in line on the PE side. Credit has basically gone from, on an apples-to-apples basis, $25 billion to well over $50 billion currently and is on a track to grow even more. And I would be disappointed if we weren't growing well above the 10% rate that the industry is growing at and is starting to already add significantly to our FRE on a contribution basis. We have a very strong real estate business, a really strong energy business. You add all of this up, you're seeing a more diversified business model where we have real growth happening out of credit. You see sustained organic growth coming out of PE. And then our solutions business for the first time is starting to move the needle if we can get a couple of funds raised. So you're starting to see all the elements in place that we're going to deliver growth on an organic basis. You're seeing a real concentration of getting that FRE up, and you're seeing the earnings power of the carry that I just back of the envelope for you. And then finally, you add to that, we made some strong strategic moves on a very selective basis with acquisitions in things like Fortitude and our aviation finance business, both of which are on plan, if not, doing better than we thought, which is external. So you wrap that all in, and you have to make the judgment, well, can this management team execute? And that's what I asked at investment committee meetings all the time, on the PE side, when you're doing a deal. Can this management team execute? Are they delivering credibility and earning the credibility of the market to be able to earn higher and higher valuation and multiple because of your belief that we can actually get this done and deliver? I'd humbly submit over the past 2, 3 years, we've done a pretty darn good job. We'll see where that goes in the future as we keep navigating through some of the tough environment. But my really long-winded answer to your very simple question of, do you think we're undervalued? And do you think we can grow to command a higher valuation? You can tell from my answer, I believe so, and I'm pretty confident we can get there.