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

Okay. So for important disclosures, please see the Morgan Stanley Research Disclosure website at morganstanley.com/researchdisclosures. If you have any questions, feel free to reach out to your Morgan Stanley sell representative. And with that, good morning, everyone. I'm Mike Cyprys, Morgan Stanley's brokers and asset managers analyst. And for our next session, I'm pleased to welcome Curt Buser, the Chief Financial Officer at The Carlyle Group. Curt has been with the company for over 16 years, serves as the -- on the firm's Management Committee and Executive Group. Carlyle is one of the leading global asset managers with over $230 billion of client assets under management across private equity, credit, real estate, real assets and investment solutions. Curt, thanks for being here today.

Mike, thanks for having us. Really want to thank both NASDAQ and Morgan Stanley for sponsoring this. It's a great conference, and really appreciate all that you do. So thank you.

Great. So let's kick off here, and I'll save some time for some audience Q&A towards the end. So investors, feel free to submit any questions you have through the webcast here at any time during this webcast here. So Curt, given this is a bit more of a generalist conference here, and while many people are familiar with the name Carlyle, they may not be as close to the story, so maybe you could just talk a little bit about what is differentiated about your business and how you generate earnings.

Sure. So let me just start with a few overall comments on our firm, and then I'll dive into kind of how we generate earnings and the like. First, we've generated great performance over a long time. Our investment returns for our fund investors across various asset classes over 3-plus decades have really generally outperformed all comparable public indices by pretty much wide margins. Fundamentally, that's why we're a $230 billion AUM firm. Second, we're truly global. We have experienced teams, deep teams around the world, 30-plus offices, 1,800 employees. In fact, more of -- more than half of our investment professionals operate outside the U.S. That global presence, that's truly global, that allows us to do some things that not everybody. Only a few firms can do the types of global transactions, especially of a complex nature that we can do. Third thing I would just say that often gets overlooked when thinking about our business is how sticky our revenue really is. So roughly 98% of our assets under management is in long term, locked up fee structures. So the fee revenues are very secure. And then fourth overall point, I'd just simply say that we're -- while not unique from a corporate America perspective, we're very unique in our asset class, is the only truly full C-corp, meaning there's no longer a private portion. We're not an up-C. It's 1 share, 1 vote, 1 class of stock, very transparent, very normal, very simple in terms of understanding kind of how our structure is. I think that gives us a lot of advantages that investors appreciate, and it just is a common feel. Just driving into kind of the other part of your question in terms of how we make business, just to remind people, we operate in 4 businesses. First, our most known business is our Corporate Private Equity business. It's the biggest. It's $85 billion of assets under management. It's generated mid -- low to mid net IRRs for a long, long time, very consistent performance. These are big buyout and growth capital funds within U.S., Asia, Europe, Japan, et cetera. And it's really what -- when people think about our brand, that's what they think about. Second is our credit business. It's really quickly growing. It's really a lot of white space in front of it still, $53 billion of AUM, various investment, risk and liquidity strategies. It's got -- it's done really well, and I'm excited about what it can continue to do. Third is our Investment Solutions business. It too is about a $52 billion assets under management. That business invests in primary funds on a fund to fund basis, secondaries and also co-investments, and it's grown also real nicely over the past year or so. And then finally is our Real Asset business. It's a $40 billion AUM business with an exceptionally strong U.S. real estate platform. And then in terms of how we generate earnings and, more specifically, fees, our fee-related earnings, what everyone likes to focus on, it's really the management fees and the transaction fees, net of all of our expenses. And so it's really kind of management fees, less all the operating costs in the firm, gets your fee-related earnings. You then have net realized performance revenues, also known as carry, portion that's retained by the firm. That number is -- it has been running roughly $600 million per year from 2012 to 2018. It's been lower than that here in 2019 and '20. But given our -- the strength of the portfolio, I fully see that getting back to those levels in the not-too-distant future. And then you have Investment Income. We have $1.5 billion of assets on our balance sheet that generates investment income. Those 3 things, FRE, which we're focused on really growing as well as net realized performance fees, net -- our realized investment income and net interest expense, all adds up to distributable earnings. And that's how we make money for our investors.

Great. Thanks for that intro. A lot to dig in there. We also have with us Dan Harris, Head of Investor Relations as well. So Dan, feel free to jump in, too, on some of the questions here. So Curt, maybe you could also talk a little bit about the alternative asset management industry. Curious to hear your perspective on how you see that growing. What areas would you say are most attractive and are likely to grow the fastest in the coming years? And also what do you expect from competition over the next several years as well?

So look, we are really fortunate to be in an asset class, in an industry with very favorable macro trends, very different. The alternative asset class is very different from the traditional asset managers. So within the alternatives, real -- I'm calling that private equity, private credit, private real estate. This asset class has been growing roughly 10% per year for a long time, and we see that growth continuing. Why has that growth been so great? And why is it macro trends so well? Well, the performance across the industry, I mentioned talking about Carlyle, but across the whole industry, it has been really spectacular, generally outperforming public markets by wide margins. And you can kind of see the ramifications of that. There are now more private equity-backed companies than ever before, and that trend is growing. And it mirrors the fact that publicly listed companies are actually falling. So this space is incredibly important. And again, macro trends are really good. So when people think about our space, they often think about Carlyle and a lot of our large public peers. But the reality is this, there are thousands of private equity managers in various asset classes, regions, et cetera. And so the competition is real, and we expect that competition to remain significant and high. And for all the obvious reasons, this is the sector to play in. The -- as we think about what to do, it's really kind of doing what we do well. Further scale, growing our big businesses, really being able to drive performance returns for our limited partners, and that's really about creating value, how do we drive revenue, how do we drive earnings and create more value? It's not the days of being able to buy low and sell high or being able to financially engineer doesn't really distinguish you. And so that deep scale of investment professionals with broad and deep industry experience really helps us drive returns. And then having the -- really the infrastructure to support your LPs from a regulatory tax as well as probably the most important is transparency. It's been able to report to them frequently, give them good information so that they can rely upon you and trust and generally provide them with those safe pair of hands to invest a lot of capital, and that's how we play in this space. And our track record speaks for itself in terms of returns. So very competitive, and we're well positioned to handle it.

Great. Now Carlyle has a broad lens here on the macro environment. You have over 200 portfolio companies across the globe. Just curious to hear what you're seeing in terms of how the global economy is reopening here. What's your take on the macro outlook just given some of the recent vaccine developments as well?

Well, first, I am a whole lot more optimistic and happy about where things are now than at the beginning of the pandemic. I mean, I would say going into the pandemic, there was reasons for concern across many fronts just purely out of not knowing and also thinking back on the great financial crisis back in 2008. Well, that's not the way this has played out, and our portfolio has done really well, and you can see that in kind of our appreciation. So the -- how we have structured it. So our portfolio construction from the diversity perspective has really helped to position us well in this pandemic, so very pleased with how we're set up. Second, in terms of the -- more specific to your question, good news here is we're really seeing continued economic recovery, but it's not the same. It's different by asset class. It's different by region. It's just -- and it's not linear. And so now good news that I think you're seeing, the public markets having a great deal of optimism around kind of a post-COVID world. Once we get the vaccine, great improvement. And I think that's really being reflected. I think underlying trends are good, but not as maybe as robust as some of that -- what the public may be seeing or expecting or hoping. And I think there are still some places where, as we all know, that there are some weaknesses in soft spots. Energy remains challenged. Commercial real estate remains challenged. Travel, tourism, big question marks around those areas. Fortunately, we've constructed our portfolios in a way to either ring-fence or not have great exposure to some of those more difficult areas. And so we're well set up. The places of obvious growth, Asia has been a great place for us to invest. We've invested like $1.5 billion to $2 billion year-to-date in Asia, China, India, and really around the rest of the whole Asia perimeter. And then health care and technology also remain very strong. And some spots in consumer where it's more -- where you can kind of take advantage of brand and not be dependent upon retail storefronts, there's some places there. And we're starting to really even see recoveries in pockets of industrial. We just did a great deal of -- a carve-out out of Siemens in Europe for Flender. And so lots of good things are happening, and the pipeline is looking pretty good right now.

Great. And Carlyle also has a large global diverse client base, so just curious in your conversations with LPs in recent days. How are they navigating through the environment here? What are they looking to Carlyle for? And also curious if you have -- if you could share your perspective on what unmet needs that you see from your client base or underserved needs that stand out.

Right. So we have about 2,600 investors in our funds. About 75% of the capital that they've put and entrusted in our funds is in 6 or more funds, and that's up from about 50% in 2006. So I'm feeling pretty good that we're doing something right in terms of serving our LP base. The thing that we continue to hear from LPs is they really want a safe pair of hands, as I talked about before. They're looking to understand, a, how are you delivering better-than-average returns with Quantum. So they're looking to deploy a large amount of capital, and they want to have some transparency around it. They want to know how you're doing it. They want some idea of time lines in terms of -- so when can I expect the capital call, when can I expect cash back, because they've got to manage their overall return and not just the portion that we're doing for them. And they want transparency. They want to be able to -- they want efficiency in their own office and back office costs. And so to the extent that we can make some of those things easier for them in terms of better reporting and the like, that is also all helpful. What else are they looking for in addition to great returns and great communication and the like? Look, they like co-investment. Why? Because it helps them manage down the cost. And so again, that comes from places where there are big deals, where you've got to be able to fund those other -- those needs and you want to be able to manage the diversification within any given fund structure. So they not only offer co-investment. They like that because usually the fee rates are much less on co-investment. So that's generally what we're hearing. And again, a lot of it is always -- comes back to communication, communication, communication.

Okay. Great. And when we think about investment returns, I guess, how are you expecting that to trend as we kind of look forward from here, the hold periods as well? How do you think they're going to compare versus history? And what are LPs expecting as they're investing in Carlyle's funds? And could we have a scenario where maybe hold periods are maybe a little bit shorter here today and the IRRs actually could be higher, but the MOICs could be meaningfully lower in terms of capital you're putting to work today? How do you see that being different from what was done in the past?

So first, I'd just say, look, low interest rates, we believe, are likely to persist, which generally should mean that valuations overall should remain high. Now in answering this question, I've got to be really careful about generalizing too much because your questions around expectations for returns really vary by what's the asset strategy, what's the fund dynamics, where is it located, are we talking about a private equity fund, are we talking about a long-dated fund in private equity, are we talking about growth capital, are we talking about credit, where it's really more focused on yield. And so you really have to kind of make sure that the answer in terms of returns and MOIC and duration, all of which vary to the specific product type. And look, we're a big firm like a lot of our peers, and so we have different products in each of these areas focused on different things. The -- what I would say is, again, in our big funds, so when you think Carlyle, you think big buyout. And if you look at our U.S. buyout funds in particular, so our fourth U.S. buyout fund, our fifth U.S. buyout fund, our sixth U.S. buyout fund, we're now investing our seventh. Those 3 funds spanned a long period of time. The fourth fund is pretty much done. The fifth fund has just a little bit left. Then in the sixth fund, we're harvesting from currently, and it recently went into carry. The spectacular point is that the net IRRs in those 3 funds, all roughly 13% to 15% net IRR. So very consistent performance over a long period of time, and that's over very different kinds of market and different administrations, different tax rules, different -- and so it really gets down to that core knitting, sticking to it and kind of really doing what we do, which is driving underlying value in revenue creation and the like. Same thing -- I can give you the same examples with Rob Stuckey in U.S. real estate. He's just done a fabulous job in terms of his returns for his investors, and so that's really what we're seeing as we think about investment returns. And so you will -- and again, it really comes back down to linking the product to what the expectation is for the investor in managing the risk return profile. Hopefully, that helps you, Mike.

Great. Maybe just diving out a little bit deeper here. To your point on strong returns, I think, year-to-date, the portfolio in private equity is up about 8%. As of the third quarter, up around, I think, 11% over the last 12 months. Maybe you just talk a little bit about the attribution of this performance. How broad based is it across the portfolio? Are you seeing certain performance driven by select geographies or portfolio of companies? How are you seeing that play out?

Right. So first, I would tell everybody that if you go into any of our public disclosures, whether it's in the earnings release or in the 10-Q and the quarterly filings, you'll see very robust detailed disclosure by fund. And so you can get the actual results there pretty clearly. And Mike, you're right, in our corporate private equity business, it's had very good performance here in the quarter as well as over the last 12 months, up about 11% over the last 12 months, and that's also taking into account kind of the challenges that everybody had. I'll say, in Q1 when the pandemic first hit. So it's all very good. Now -- and you're right, it's not consistent everywhere. I would say our -- both in U.S. and Asia, we've had just very good returns. Our Credit business continues to motor along. And Investment Solutions, those performance has also been strong. And what's the key to that? It's really been portfolio construction. So where are there challenges? Well, there's obviously challenges in commercial travel. There's challenges in commercial real estate. There's challenges in energy. And we have some of that, but mostly -- you take energy, for example, most of our energy exposure is in energy funds, and so it's ring-fenced off into those funds and not embedded within our buyout funds, by and large. And then Rob Stuckey within U.S. real estate has really avoided investing in big office buildings and has avoided retail and has very little in the hotel space. And so the U.S. real estate portfolio has performed also really well. And again, it's by portfolio construction. That's about kind of knowing kind of where to put your dollars and where not to put your dollars.

And with $74 billion in dry powder today, can you just talk about where you're seeing some of the most compelling opportunities to put capital to work and where we could see a pickup maybe in some of the traditional large LBOs? What are your expectations there? What sort of sectors or geographic regions you're looking the most attractive today?

Well, one thing I will tell you is the teams right now are incredibly busy. And even with largely everyone working remotely, I'll say the amount of deal activity and pipelines is as high as it's been in a long, long time. Now keep in mind, it takes a while to actually put things together and perform all the close and come together. But this -- there's been a lot of good learnings, I think, through this pandemic. We're operating far more efficient in terms of how to diligence and assess investment opportunities simply because everyone's been forced to do so. So using technology far better, using remote technology and then figuring out kind of when and how to have meetings and how to do that in obviously an efficient way to keep everybody safe. And so that all has been really exciting to kind of see. I will say one thing that is different about right now that is different from when we had our last crisis, and I would say, in the last crisis, there was a shortage of liquidity. And so a lot of the opportunity was -- there was good -- many good companies that had liquidity challenges, which created great opportunities to invest for firms such as us. Today, there has been ample liquidity that's been made available. And so you generally -- which has generally been good. It's protected a lot of things, but it's also maybe protected some companies that are also challenged in some ways that would not have succeeded in the past financial crisis. And so one does need to be really careful in terms of making sure you're buying a good asset, as opposed to investing in something that fundamentally still have some real challenges. Look, given how we've done things and how our focus has been, I feel comfortable that we'll be able to continue to execute like we have and really invest over the long term.

Great. And I'll just remind investors, you could submit a question via the webcast, feel free to do that, and I'm happy to read out any questions that come through. Maybe shifting gears over to fee-related earnings. Curt, you have mentioned this was a priority here of the firm, and you recently provided some upward revisions to guidance here on 2020 FRE of $475 million or above. And I know in the past, you have commented that we could see a step-function growth in FRE, but once you kind of get to that next raising of the flagship fund. So I guess the question here is, before raising the next flagship fundraising cycle, how would you describe the outlook for FRE growth from here? And then what sort of growth could we see once the next set of flagship funds come into the run rate? Any thoughts there as well on timing, too?

Thanks, Mike. And look, I mean, you've summarized it real nicely. I mean, we have made growing FRE as well as growing distributable earnings a priority because growth matters. And so we're really looking on how to grow the firm, focused on and growing FRE. We've had good success already. So $190 million, $192 million of FRE in 2017. $450 million, $453 million in 2019 and we'll do $475 million or maybe even a little better this year. And as we look forward, feeling real good about kind of how we can continue to grow our Global Credit business and our Investment Solutions business, both of them have been very strong from a fundraising perspective and kind of see that continuing, at least over -- as far as I can kind of see over the next year. Our private equity business, whether in Corporate Private Equity or in Real Assets, I think when they come back to market with their flagship funds, my full expectation is those funds will be substantially up in scale from the prior generation of funds, which will allow for a nice uplift in FRE. The exact timing on all of that and scale, et cetera, look, I think overall, again, we'll see some growth here in the 2 segments I called out. And we'll probably have a little bit of runoff in the PE business until those next funds come into play? So we'll be flattish to modest up, and then when the flagship funds come back, coupled with what we have in Credit and Solutions, I think we'll be hitting on all cylinders, and we should see some nice growth at that time. We'll give you -- as we wrap up this year and move into next year, we'll give you a lot more color at the beginning of next year once we've got this year fully buttoned up.

Okay. Fair enough. We're getting some questions in here on the webcast here. So the first one that's come through is, can you talk about the reinsurance opportunity now that Fortitude has been stood up as standalone? And is the rate environment here more or less favorable, would you say, for deals right now?

So on Fortitude, it's our -- so, a, look, we've always viewed insurance as a good area for us to work with. So a number of LPs in our funds have been insurance companies over the years, and so providing good solutions to that industry has always been a great thing for us to grow and focus on. Fortitude is the company that we bought together with our partners from AIG carve-out. It's largely a reinsurance platform, $40 billion, Bermuda based, very diverse portfolio, primarily business to business. We have -- our own stake is about a little less than 20%, but with our partners own 97% of that business. We do not want to be an insurance company. We want to provide investment solutions to the insurance industry. Fortitude happens to be in a fund that we manage and otherwise control, and so that does provide permanent-like capital. We've already rolled in about $4 billion of investments from Fortitude into Carlyle funds, and that's at rack rate fees. So all that is really good business for us. It gives the ability to earn fee revenues as well as carry when that happens. We also have the fund that I talked about that owns Fortitude, it has about $2 billion exclusive of our capital, which we also fee on. And then Fortitude itself is doing really nicely, and so the returns on it, low to mid-teens thus far. Its capital is in great shape. We are very mindful of doing what's right for that business as well as our partners in terms of owning that. And so I do think that, that's an investment that will do well for us. And in terms of the broader space, there's clearly opportunities for Fortitude to grow by acquisition or for us to do other things to add on to that. And obviously, we're focused on that. But we want to, again, remain an investment manager as opposed to an insurance company, but do see the opportunity for growth there. Nothing to announce today with respect to that, but I do see that as a real nice kind of underpinning in a way to further grow the firm in the future.

Great. And I just want to be conscious of time. I think we have about a minute or 2 left here. So maybe with that, just quick round here, maybe just on fee-paying AUM. You guys are up about 5% or so year-on-year driven by some of the growth in Solutions and Credit. Maybe just really quickly, just talk about your strategy to accelerate the growth in those businesses. And looking out, which would you expect to be the largest contributor over the next couple of years?

I think the runway in credit is great. So we have a $50 billion, $53 billion business. I think that -- it raised $7 billion, $8 billion year-to-date or something like that. It will continue to be able to raise capital, the nature of the products, we have a lot of white space there. Investment Solutions has also raised a similar kind of sized number this year, and it remains in active fundraising. And so it too will see some real growth. And we'll provide you more color on total fundraising plans. But I'll just remind people, this macro environment is -- we're saying that 10% compounded growth. We've -- if you look at kind of where we've been, if you strip out some of the legacy businesses, we too have been running about 10% growth when you carve out the effects of the hedge funds and the like, which we're no longer in. You can see that $167 billion of fee-earning AUM today. It's up from about $115 billion in 2016. So really nice growth across the platform.

Great. I'm afraid we'll have to leave it there. We're out of time. Curt and Dan, thanks so much for joining us today.

Mike, thank you, and thanks to Morgan Stanley and NASDAQ for hosting this conference.

Thanks, Mike.

Great. Thanks. Have a good day, everyone.