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

Good afternoon, everyone, and welcome back to the BofA Securities Future of Financials Virtual Conference. I'm Mike Carrier, the research analyst covering the brokers, asset managers and exchanges at BofA, and I hope you're all doing well. Our next company up is The Carlyle Group. And with us today is Curt Buser, Carlyle's Chief Financial Officer. Curt, thanks for being with us today.

Hey, Mike. Really appreciate you having me on. Thank you.

[Operator Instructions] Curt, maybe just to kick it off, given your unique perspective across different economies, different markets and a fairly dynamic macro backdrop that we're in right now, I just wanted to get your perspective on some of the nuances that we're seeing in terms of valuations in the public markets and the private markets and whether that makes sense just given what you're seeing in the real economy. And obviously, the news today on a vaccine, maybe it makes a little more sense in terms of what all the parts are doing.

It's a great day, isn't it? Let's just hope this can stay that way. So again, thanks for having me, and thanks for having Carlyle represented. I really appreciate everything you're doing and Bank of America's doing. Let me just maybe just first start with a quick comment on our portfolio. I'm very pleased with how our portfolio is set up. I think the construction of it, generally speaking, has been very good. It's diversified, and I think you're seeing that in our results and our performance. I would also say, before getting into the specifics of your question, as you think about our portfolio, roughly 14% is publicly traded. So -- and I'm talking here in the traditional carry funds. And that 14% is the portion that's truly p times q, whereas most of the portfolio is not valued at exactly today's price; it’s best. And I think it's appropriately valued given how it's set up. I think when you think about what's happening in the public markets, generally speaking, and that's really emphasized today, it's a forward view of the real economy, not the current point in time. And so it really bakes in expectations. And we all know that. And I think those valuations today generally reflect optimism for a post-COVID environment. But how reality has played out and how it will play out is going to be a huge variety. I mean, which -- the aggregate trends here are very favorable. What we have seen is the whole kinds of difference of results by asset class, by industry sector and by region. So I think as everybody knows, energy has had some headwinds against it, as has true retail or commercial real estate. With respect to those, I think we're generally pretty well positioned with the one place there in energy where we have ring-fenced our exposure to energy into certain funds. But overall, we feel really good about kind of how the portfolio is set up and how to operate in these volatile times. And I do think that the recovery will continue to be varied across asset class and region.

Right. That's helpful color. And then maybe just based on some of the -- and I know this is very early, but based on some of the current policies from Biden, whether it's on the tax front or the regulatory front, despite odds of the split Congress, do you see any areas of concern or opportunities for Carlyle or for the broader industry?

Mike, it's -- just as we said on our earnings call, it's really too early to talk about specifics without really knowing what the real proposals are going to be and how they're going to be presented. Still got to figure out who's controlling the Senate and how all that will play. Clearly not the strong mandate that may have been anticipated by some. But regardless of all that, look, we're continuing to run a variety of scenarios and planning appropriately. And we have experience operating in high-tax environments, different administrations, different regulatory regimes. And so we're confident that we can perform well. And sometimes actually, change does create opportunities for players such as us. And the other thing I would just simply say as we think about change, just as Kew emphasized on our call, is we made the switch to being a full C corp, 1 share, 1 vote, all set up the same way. We don't need to really worry about the private side different than the public side because it's all the same.

Right. Okay. And then just shifting more to Carlyle, specifically, you guys have made significant progress in your level of FRE and the margin over the past few years. And I just wanted to get your take on how you see that trending over the coming years.

Look, it's something that we have really focused on. So we want to continue to grow FRE in terms of total dollars and continue to improve the margin. That will occur over time. We've had very good success, as you observed. We were roughly $190 million of FRE in 2017, grew that to $450 million in 2019, and we're on track to exceed our target of $475 million for this year. We've expanded our margins 1,000 basis points over the last 3 years. If you look at our Global Credit business and our Investment Solutions business the year-to-date activity through September compared to a year ago, both of those businesses have about doubled their FRE. And look, for going forward, we'll give a whole lot more detail in the new year. But I really think that we'll be -- you'll continue to see growth. It will be a little bit modest in 2021. And then I think that will really pick up thereafter, especially as we raise our next generation of our flagship funds.

Great. Okay. And then maybe shifting to the level of net accrued performance fees. You guys stand out as having a very, I'd say, impressive level given the market backdrop and some of the fund seasoning. We haven't seen a ton of performance fees for you guys or the industry this year. But how do you think about that, the future level, like playing out, particularly if markets remain fairly constructive? And how does that compare to, say, like prior cycles?

Right. So just to level set for everybody, we have about $2 billion of net realized performance fees on our balance sheet at September 30. It's up about 14% year-to-date. So real nice increase in that balance. That's about $5.50 pretax per share, so just as you point out, well set up from where we are from an accrual perspective. We're very thoughtful about when we turn on carry and how we take carry. And so one of the things that happened here in the third quarter was Carlyle Partner VI, our large U.S. buyout fund. We actually turned carry on, on that, not at the full 20% rate but a discount to that. We'll increase that over time. Over time, we will, of course, realize the full 20%. But we've been thoughtful about when we turn it on because when we turned it on, we want to have a high degree of confidence that it will remain on through the balance of its life. And while no one's perfect in terms of their crystal ball, I think we're in good shape there. Just to remind everybody, from 2012 to 2017, we averaged about $600 million a year in net realized performance revenue. We obviously in the last couple of years have been well below that. But before we entered into that cycle of $600 million, we were roughly just shy of that $2 billion mark. We're obviously higher than that now. We're feeling really good about what the future will hold. We won't be at that $600 million number in 2021, but we'll be stairstepping up to it. And I fully expect us to be at that or higher levels going forward, certainly when markets and everything else continue to be in our favor.

Right. Okay. That makes sense. And then just on that point, we just talked about the net accrued. Maybe if you can put in context the opportunity to realize those investments right now, so whether it's across the different segments or the avenues to exit, whether it's through secondaries, IPOs, strategic sales. How is that, like backdrop, like setting up?

Well, hopefully, people saw the announcement this morning. We did announce a large exit realization this morning with Supreme, so very pleased with that. Obviously, it's not closed yet, but the announcement's out. And yes, that's a nice transaction that's proved out well. The market recovery really throughout 2020 has improved. Our ability to complete transactions, whether it's through the IPO market, we've had very good success early part of this year through a number of exits already. Whether it was what I just talked about or through Exocad and Golden Goose and Eggplant, we've had a number of transactions already this year at very nice returns, and the public markets have helped us. But the portfolio is nicely set up. We have about $156 billion of remaining assets in the portfolio, about $85 billion remaining fair value in what people will think of as our traditional carry funds. A large percentage of that is 4 years or older and is well set up for us to realize it. And so feeling pretty good about backdrop, feeling pretty good about macro environment, and more importantly, we've been -- announced an exit. So I mean, that's all good.

Okay. That's good color. And then just with the news this morning on progress on vaccines. On one hand, it seems like this has been dragging on probably longer than most people thought, maybe companies thought that we're trying to manage and navigate through this environment. So curious of what you're seeing in terms of some of these challenges, how that's impacting private companies. And are you starting to see more opportunities to deploy capital?

So first and foremost, in terms of our portfolio, again, it's -- we've been well positioned. And unfortunate that this has taken much longer than many would thought, and we've been thankful, both the firm has operated really well in a remote environment, and our portfolio companies have generally performed well. But in terms of activity, our pipelines are filling up. Our activity level is picking up. And so not all of that's obviously going to transact and be consummated, but I'm seeing a lot of people that are really working hard and busy chasing various things. We're long-term investors. We're busy evaluating opportunities, and we think we're focused on building long-term value. We generally buy good companies. And I'll say we generally focus on -- we're not buying low and selling high. We're buying in situations that have the right tailwinds and, more importantly, businesses that we think we can make better. We make our money by improving revenues, improving earnings and making the assets that we invest in better assets as opposed to buying low, selling high, turning something around. Occasionally that happens, but not always. And you saw not too long ago, we just announced a big deal with Siemens to buy Flender, a EUR 2 billion transaction. And so you see that activity really kind of coming through. Our pipeline, we've got nice things signed up. Probably just in the private equity space, north of $3 billion, and a good part of that's in Asia, which is a place where our strength and our global reach has enabled us to continue to remain active and really proud of our teams over there.

Right. Okay. Just shifting to fundraising. This year, for Carlyle, without like the flagships, most of the growth has been coming from Global Credit and Solutions. So what is the outlook for fundraising? And then when could we see the flagships come back into the mix?

Right. So even without one of the big flagship funds in the market, we've had a good fundraising year, about $18 billion year-to-date compared to about $16 billion same time period last year. As you pointed out, a lot of that is in our credit business and in our Investment Solutions business, which has driven growth and FRE improvement in both of those. The nice thing about what's happening in our credit business is I think that, that can be continued. And so it's not going to be periodic. And so I expect the credit business to continue to grow at comparable rates going forward. As you think about the flagship funds, a key element to obviously watch is deployment. Generally speaking in terms of the big flagship funds, they're not going to be fundraising until they're 75% invested and/or committed. And we give the data on invested. We don't give the data on committed, and you can see that some of the funds are essentially about halfway invested. And so starting to get closer, but I think it'll probably be not early '21, but you could see, depending upon how deployment works, tail end of '21 and then into '22 for some of that coming back. We'll come back and give real good granular detail from a forecast perspective on fundraising, FRE and growth trajectories in the beginning of next year and provide good clarity to people once we've wrapped up all of our planning for the current year and for next year.

Okay. Great. And maybe on that point, just in terms of institutional allocations, we've seen an increasing allocation towards alternatives in private markets just given the return backdrop. How do you think about the growth opportunity ahead as [ for Carlyle ], like broaden the strategies that you're offering to those clients?

So look, we're fortunate to have one of the leading distribution teams. So our investment relations professionals as it relates to our limited partners, I think, have done a really nice job. Generally, we have very good relationships with our LPs. They're generally looking to consolidate more investment across fewer large firms. So as such, us and a lot of our public peers are benefiting from those macro trends. Performance in Carlyle funds is remaining strong. And this asset class is a good asset class for investors to invest in relative to other opportunities that they have to invest. Our private equity, private credit, private real estate are all growing. And it's really appealing to -- and we have roughly 2,600 fund investors from around the world. Like, close to 100 different countries are represented. And 74% of our investor capital is invested in 6 or more of our funds. And that's up from like 50% in 2006. So the -- a, the growth; b, the concentration across our funds has really played out nicely. So I think we're well set up from -- to take advantage of what's there. Of course, we have to have the right product in the market, and that product has to be performing well.

Okay. Great. And then just on the LP side, have you seen any shifts just given the rate and return environment in terms of return expectations or any pricing pushback by investors just given the low rate backdrop?

So investor -- so from a -- what we're seeing from the low rate perspective is our targeted returns really haven't moved. I think there's one really important data point to look at. If you look at -- in our U.S. buyout funds, Fund IV, V and VI, they've all had pretty similar net IRRs, kind of in that mid-teens range. And that just really kind of speaks to the strength of the platform and what investors are looking for. They continue to overall want returns better than they can get elsewhere. This asset class continues to deliver that, and we continue to perform well. I think in terms of shifts and expectations, they understand that a lot of it also comes down to, a, having returns better than what they can get elsewhere; and b, having appropriately diversified portfolios so that they're not overly exposed to one thing or another. And so in any given fund, you'll have maybe a higher risk and, therefore, a higher return type investment for part of it. And you'll have more stable lower risk for the rest of it. And you'll have overall a mix of returns but still blending out to that mid- to high-teen net. And it really all comes down to net. I mean gross is always interesting. But in the end, it's net that gets returned to the investors, and that's what they're focused on. So feeling pretty good about that. In terms of shifts, really not anything major that we're seeing. Again, they're seeking good performance and consolidation. And from a rate perspective, really no change in rates that I've noticed.

Okay. That's helpful. And then you mentioned upfront that you're happy with how the portfolio is performing. If we just look at private equity in this COVID backdrop, when you think about areas that either have exposure -- more exposure to COVID, where it's been more challenging; or areas that you guys have been pretty -- technology, where you maybe have had some tailwinds, I just wanted to get some context on, when you look through the portfolio, how that's positioned for areas that are seeing tailwinds versus headwinds in this environment.

Right. So well, first, across corporate private equity, it was up like 5% here in the third quarter. On a last 12-month basis, it's up 11%. It had very strong performance in Q2 in addition to Q3. Q1 was obviously down just as everybody was because of the pandemic. But overall, that portfolio has done well. Very limited exposure in the portfolio to areas of concern. Generally, what's driven the portfolio is our strong industry sectors, particularly in health care and technology. We have big teams in both. They've done really nicely, and that's really helped us through this environment. One of the things that you'll know about Carlyle is we do also have a number of investments in the energy sector, generally ring-fenced to energy-specific funds. And so the exposure in the traditional flagship funds is relatively low to energy. So all -- again, portfolio construction has helped Carlyle well during this time period. Same is true in real estate. Rob Stuckey, who runs our real estate platform, has really thought -- been very thoughtful in terms of how to structure his portfolio, very much focused on demographic trends as opposed to GDP trends. And so therefore, from a demographic standpoint, he has not invested in commercial real estate. He's not invested really in retail and very little exposure to leisure or travel or -- which is most of it would show up in hotels, a couple of hotels but very modest within the portfolio.

Great. You mentioned technology. I'm just curious in the private equity business given that it's been disruptive to many sectors and companies. What has Carlyle done to kind of incorporate some of the technology thinking across the different industries that you participate or invest in to avoid areas that can be disrupted?