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

Thank you for standing by, and welcome to Carlyle Group's First Quarter 2023 Earnings Conference Call. [Operator Instructions]. I would now like to hand the call over to Head of Public Investor Relations, Daniel Harris. Please go ahead.

Thank you, [ Atif ]. Good morning, and welcome to Carlyle's First Quarter 2023 Earnings Call. With me on the call this morning is our Chief Executive Officer, Harvey Schwartz; and our Chief Financial Officer, Curtis Buser. Earlier this morning, we issued a press release and a detailed earnings presentation, which is also available on our Investor Relations website. This call is being webcast, and a replay will be available on our website. We will refer to certain non-GAAP financial measures during today's call. These measures should not be considered in isolation from or as a substitute for, measures prepared in accordance with generally accepted accounting principles. We have provided a reconciliation of these measures to GAAP in our earnings release to the extent reasonably available. Any forward-looking statements made today do not guarantee future performance, and undue reliance should not be placed on them. These statements are based on current management expectations and involve inherent risks and uncertainties, including those identified in the Risk Factors section of our annual report on Form 10-K that could cause actual results to differ materially from those indicated. Carlyle assumes no obligation to update any forward-looking statements at any time. I'm going to begin with a quick discussion of our results and then hand the call over to Harvey. For the first quarter, we generated $193 million in fee-related earnings and $272 million in distributable earnings, with DE per common share of $0.63. We raised $6.8 billion of new capital and deployed $3.8 billion in capital across our carry funds. Our accrued carry balance remains at a robust $4 billion. We declared a quarterly dividend of $0.35 per common share. We know it's a busy morning, and as we already have a long queue, please limit yourself to 1 question and move back into the queue for any additional follow-ups. And with that, let me turn the call over to our Chief Executive Officer, Harvey Schwartz.

Thanks, Dan. Good morning, and thank you for joining us today. It's great to be here with all of you. Some of you I've worked with in the past and others, it would be great to meet you soon. There are 3 things I plan to review today. Our first quarter performance, the macro environment and our general outlook. And lastly, I'll end with some initial thoughts on my first 80 days here at Carlyle. First, with regards to our performance, let me be clear, we're not pleased with our first quarter results. Curt will walk you through the details, but our activity levels and investments, realizations and fundraising were more muted than our prior expectations. We continue to navigate one of the most complex financial markets in recent memory, which is clouding the near-term outlook and impacting market sentiment. It's our expectation these effects will last throughout the remainder of the year and impact both FRE and distributable earnings. That said, importantly, we are confident that Carlyle is well positioned for when markets stabilize and activity levels ultimately pick up. We don't invest and we don't run the firm quarter-to-quarter. The firm had the long history of successfully investing through all cycles. We have a leading private equity business with a long-term track record, a fast-growing global credit business and a high-performing investment solutions business. We have $381 billion in assets under management and $73 billion in capital available to [indiscernible] across strategies and geographies. And we have long-standing, very deep relationships with the largest and most sophisticated global investors. There is substantial and very attractive white space for Carlyle to continue to grow our platform, which alongside a disciplined approach joining the firm, will ultimately expand margins, expand FRE and grow distributable earnings. Shifting now to the macro environment. For the past 30 to 40 years, there were several mega trends at play. These mega trends underpinned economic activity, a long-term downtrend in interest rates, supporting an upward trend in equity markets and asset prices broadly, markets benefited from historically low inflation and increased globalization and technological innovation allowed global economies to thrive. Today, for the first time in many investors' lifetimes, some of those trends are slowing or even reversing. Cost of capital has gone up. Discount rates and cap rates have increased and are pressuring valuations as well as expected returns. Of course, this shift in trends will take time to work through global markets and asset prices. Adding even more complexity, while the banking system in the U.S. and abroad generally have healthy balance sheets from years of capital building, they're now tightening underwriting standards. And regional banks, following recent stress, are likely to face increased regulation and capital requirements. In my experience, this will almost certainly lead to a further tightening of lending standards, dampening the pace of economic activity. While companies are not raising capital the same frequency as prior years, their core needs haven't changed. They need capital to grow and capital to refinance liabilities. This is where our Global Credit business is taking share from traditional lenders. And just this week, you will have seen Fortitude announce a major reinsurance transaction that will accelerate the growth of their business. For our LPs who require help managing their portfolios in this complex environment, our Global Investment Solutions business is well positioned to meet this demand and continue to grow the platform. The important point to remember is that Carlyle has operated through significant market dislocations before. We remain actively engaged with sellers, buyers and capital providers around the world. We're very front-footed. We certainly don't invest for a single quarter or a year. We raised capital and we invest for the long term. The opportunities across asset classes, regions and sectors are growing increasingly more attractive as markets remain volatile and uncertain. While we remain cautious on the near-term environment, we also are beginning to see opportunities to put a huge amount of capital to work that will help drive long-term performance and asset growth. This is an exciting time to be an investor in global private markets. I'll close with some thoughts regarding start in my new role. I spent the past few months meeting our people and getting to know our investors around the world. Carlyle is an iconic brand, one I've admired my entire career. We have an experienced and talented team of professionals who are up for any challenge, and that team is a big part of why I'm here. Our culture is strong. It reflects the 35-year history of the firm, and it's made up of a group of talented, smart, hard-working, world-class professionals who care deeply about our firm and we are committed to being a fiduciary for our clients. We are in an industry that is growing and there is a massive long-term potential for Carlyle. Everything starts with investment performance and our firm was built to provide the highest level of care to our investors and to capture the significant opportunities that continue to emerge. Throughout my career, I've been a believer in disciplined growth. As we grow, we are also working to identify areas where we can instill more discipline around our operations. This approach will deliver returns for our shareholders and fund investors alike. It's an exciting time for the industry and for Carlyle and I'm very excited to be here and be part of it. With that, I'll hand things over to Curt to provide a more detailed breakdown of the quarter.

Thank you, Harvey, and good morning, everyone. I want to start with an outlook on 3 particular areas that complement Harvey's comments and put our financial results in context with the current macro environment. First, with respect to fundraising. We continue to expect to raise more capital this year than we did last year. Though the composition of that fundraising has skewed further towards global credit and investment solutions and less from corporate private equity. Over the balance of this year, we expect to see CLO issuance resume in addition to incremental fundraising for a number of credit products as well as raising capital in our secondaries and co-investment strategies and investment solutions. While we believe that we will attract a significant amount of capital for our next vintage of buyout funds, we no longer expect these funds in the aggregate to be the same size as their predecessors and now expect to see a decline in buyout fund sizes across most geographies. Second, as you heard Harvey indicate, we expect that the slowdown in capital markets activity will result in a muted level of near-term realizations, pressure on capital markets transaction fees and lower performance-related earnings. That said, we continue to have $4 billion in net accrued carry and believe the firm's ability to monetize that carry will be strong over the next few years. And third, our 2023 FRE outlook. Given uncertainty in current market conditions, including the impact from a slower transactional environment and a lower buyout fundraising outlook, our 2023 FRE is likely to be modestly below last year. While we expect to see top line fee growth this year, we also expect to see continued investments into our teams and businesses. We will be disciplined in managing our expenses while at the same time, ensuring the firm is well positioned to grow over time, notably across our global credit platform, extending the capabilities of our capital markets team and supporting continued growth at Fortitude. Now let me dig a bit deeper into the major drivers of our results. Fee-related earnings of $193 million increased 6% over the first quarter of 2022. Top line management fees of $506 million were up 11% year-over-year, with the strongest growth in our global credit platform through a combination of organic growth and the impact from strategic transactions last year. Fee-earning assets under management of $271 billion increased 29% from the first quarter last year, driven by $28 billion of fundraising over that same time period, alongside strategic transactions completed last year. 2 days ago, on May 2, Fortitude announced an agreement to reinsure $28 billion of life and fixed annuity products. This Fortitude transaction is a great example of its strategy to become a preferred solutions provider to large global insurers as it leverages its strong balance sheet and broad capabilities to pursue growth. Fortitude expects to close this transaction in mid-2023, pending customary regulatory approvals. When the transaction closes, Carlyle's fee earning assets under management will increase by the amount of the reinsurance transaction as part of our strategic advisory services agreement with Fortitude. And over time, we expect about 20% of the general account assets related to this transaction to be directly invested into Carlyle investment strategies. The impact of this transaction was included in our updated fee-related earnings outlook for the year. Fee-related performance revenue of $29 million in the first quarter was down from $45 million last year as the contribution from Core Plus real estate was muted in the first quarter, while global credit fee-related performance revenue was up more than 30%. Looking forward to the second quarter, we expect to benefit from a substantially higher level of fee-related performance revenue in global private equity. This is because we expect a significant step-up in the crystallizing of gains next quarter in Core Plus Real Estate, which will then moderate in the following quarters. As we have previously noted, we expect to generate significant revenues in this line item every year, though certain quarters throughout the year will be higher than others. Also keep in mind that fee-related performance revenues compensation expense which is captured in our FRE compensation line will vary directly at about 45% of revenue. FRE margin was 35% this quarter, down modestly from 36% in the first quarter of last year. While total fee revenues were up 7% compared to last year, FRE expenses increased 8%, leading to the margin compression. For the full year, we expect FRE margin to be modestly lower compared to 2022. Longer term, scaling the firm and operating effectively remains a key priority, and we expect to see FRE margins resume their upward trend in 2024. Moving on, our portfolio continues to perform well relative to choppy public markets with overall portfolio appreciation of 2% in the first quarter across our carry funds and appreciation of 7% over the past 12 months. This is well higher relative to a 9% decline in the MSCI, All country World Index over that same time period. Our Global Credit Carry Fund portfolio rose 3% in the quarter and is also up 7% over the last 12 months. While our corporate private equity portfolio was up 1% in the quarter and 3% over the past year. Appreciation in our infrastructure and natural resources portfolio was flat in the quarter amidst volatile but range-bound energy prices, but this portfolio is still up 24% over the last 12 months and appreciation in our Global Investment Solutions funds was up 5% in the quarter and 7% over the past year. A few other quick points. Equity-based compensation expense of $57 million increased from $41 million in the first quarter last year as an elevated level of equity grants to employees, and our new CEO grants in February began to impact results. We expect to see this expense tick higher in the second quarter and then remain at an elevated level. We repurchased $100 million in shares in the first quarter. And as of March 31, our Board of Directors reset and increased our repurchase authorization to $500 million. Our balance sheet remains solid, over $1 billion in cash and nothing drawn against our $1 billion revolver. We have the flexibility to remain opportunistic if prospects arise to deploy our valuable capital. And as we have said before, our DE effective tax rate is likely to be volatile on a quarterly basis, and this quarter, it was lower than normal, and we still expect it to average around 20% on an annualized basis. In sum, while there are some short-term challenges, we are optimistic long term and see opportunities for growth and value creation. With that, let me turn the call back over to Harvey who would like to make a few closing remarks.

Thanks, Curt. Before we move on to Q&A, I wanted to reiterate that while there are near-term challenges, there is tremendous long-term opportunity for the firm. The overall positive trends in the industry and the strength of our brand and our people, well, these are the reasons why I'm here. It really is quite a privilege to be part of this team and part of this firm. Let me turn the call over to the operator so we can take your questions. Again, great to be here with you.

[Operator Instructions] Our first question comes from the line of Glenn Schorr of Evercore.

Good to talk to you again.

Brian, you're just breaking up a little bit.

Good to talk to you again. I'm curious, it's a little bit of a unique situation, but new CEO, I heard some of your previous comments. I'm curious how you described maybe in layman terms, what are you here to do? I saw the quote in the beginning of the slide deck of continuing to expand and diversify the platform. I heard your comment about substantial and very active white space for Carlyle. So I was wondering if you could expand on that a little bit.

Okay. Well, Glenn, it's good to hear your voice, even a little garbled, but nice to chat with you again. I hope you've been well. Well, maybe I should back up for a second and before I get directly to your question. Maybe I should just talk a little bit about why I'm here and how I got here and that decision-making process. And so as I said in my remarks, I've known about Carlyle for my entire career. It's an amazing brand. I know the power of an amazing brand. Since I met with the founders, we clicked immediately. And as I got to know the people, I knew the talent in the organization and the investing prowess and then when I -- really, when I looked at the valuation gap between our firm and other firms, it just didn't make any sense to me. And so the decision to be here actually ended up being quite easy. And as I said, really quite a privilege for me to be part of this team and part of this firm. Now I've been here, I don't know, give or take, 80 days, the team reminded me. And I sort of jokingly, I referred to it sort of in my own Carlyle emerging course, I've just been spending time with our LPs, spending time with the teams, getting to know everyone and probably more importantly, giving them a chance to get to know me. In terms of the white space, there's just a lot of opportunity for us. We have businesses like Global Credit, which has been growing very quickly. We'll continue to grow those. There's the private wealth space, real estate, one of the highest performing real estate teams. There's a lot of interest there. Our solutions business, when you go around the firm, there's a lot of energy to grow these businesses. Now it's early days for me, but I can tell you the enthusiasm and the energy is real.

Our next question comes from the line of Bill Katz of Credit Suisse.

So first of all, Harvey, congratulations, and welcome. So maybe just to build on your last set of responses to Glenn's question. Can you sort of tie together, maybe as you look at some of these bigger picture opportunities maybe the top 1 or 2 things you'll be most focused on as you look out over the next year or two. And then relative to your discussion of sort of disciplined growth, can you tie that into Curt's comments about FRE guide down on expenses and where that expense growth may focus?

So well, the disciplined growth, that's just always the way I've approached businesses that I've been part of, it's the way the team here approaches things. And so that, again, I would say, is more philosophically my approach, but it's also been the philosophy of the firm. I don't think it's -- how do I say it, I don't really have any favorite children. So I mean, I like growth for growth sake. And so we have a lot of resources here. And so if there's demand for our solutions business, we'll respond to that. If there's demand for growing the private wealth footprint, there's a lot of people in the world that want access to Carlyle and Carlyle's investing capability. Some things will take longer, some things will be more immediate. But I don't think it's a question of prioritizing 1 or 2 things. I think it's a question of, as a team, we mobilize against all these things, but we do it quite thoughtfully. We're not going to rush. I'm certainly not in a rush and it's really going to be about excellence of execution. And -- however long that takes, I think it's more about excellence of execution, but the opportunities are clear.

Why don't I take the part -- the second part of Bill's question really on FRE and the revised guidance. Look, we've been focused on growing FRE. It remains a key priority and those white space opportunities that Harvey alluded to are going to propel us forward. Now let's just kind of level set and remind everybody kind of where we've been. We grew FRE 40% in 2022. And over the past 5 years, it's up about fourfold. And I think we are in great position to continue to do that over the next several years. But this year is not one of those growth years, this year is going to be -- this growth trend is not even every year, and this year is a bit of a catch up and get things in the right place. Now let me level set that a little bit for you. It's a complicated complex market environment, as Harvey said in his opening remarks. M&A volumes are about half of what they were just last year. IPO activity is sluggish. U.S. leveraged loans are much smaller, smaller than they have been in many, many years. And so all that activity level is depressed and it impacts our earnings, our ability to generate transaction fees, impacts performance revenues, the lower level that you see is going to impact realizations. And even at Fortitude, it affects kind of our fees, there are a variable rate. And so as Fortitude does well, we make more money, but mark-to-market types of adjustments impact some of those returns. And so right now, it's at a lower level. And so that's also impacted our thinking with respect to the current year, but again, we're in great shape for the long term. We see lots of opportunities for long-term growth here and things that will be set up. And we're going to be very disciplined in terms of how we approach the balance of this year, and we're going to work really hard to outperform kind of where we are.

Our next question comes from the line of Alexander Blostein of Goldman Sachs.

So sticking with maybe some of the bigger picture kind of initiatives. As you look at areas of growth for Carlyle over the next couple of years. The firm has a really healthy balance sheet to your point, generating substantial amount of cash flow. How are you approaching the capital return framework for the firm, how are you thinking about inorganic opportunities within the context of sort of the white space that you've talked about?

Yes. So the white space list that I went through -- obviously, that's not inclusive, right? I mean that's not in total, right? So you saw us announce the Fortitude transaction, there's a lot of room for that business to grow -- the capital markets business. And so our approach to all of this, as I said before, is going to be about patients and excellence of execution. You're right to point out the balance sheet strength. I think Curt and the team have done an extraordinary job of structuring the balance sheet. It was 1 of the things I diligence before I came to the firm, and there's a lot of cash flow generation. And so I think that all these things, I think, in some respects, Alex, all these things kind of come down to math, right? So we have a cost of capital. We have very strong cash flow, and we have a very significant opportunity set. And so you're going to see us be quite disciplined about how we think about utilizing our capital, but we're going to invest in growth. And we're going to be very thoughtful about how we deploy that capital. We're always going to be thoughtful about it. I think in this market environment, you should expect us to be exceptionally disciplined.

Our next question comes from the line Brian Bedell of Deutsche Bank.

Just your comment about the valuation gap that you see at Carlyle and the enormous opportunity to close that valuation gap. I realized there's a lot of things to invest in and a lot of white space, and that will create a sort of a longer-term pressure on expenses. But if you think longer term about the franchise, in closing that valuation gap, how do you think about potentially changing the compensation structure to align more with some of the peers that have a higher FRE margin? And then how do you think about whether that is one way to do that as opposed to just scaling various businesses?

Brian, Its Curt. Let me start and Harvey can add in. So look, our compensation structures, we use the combination, obviously, of cash carry, equity. And you got to be very careful when you move the cheese. And so we think very carefully about how all of this is set up and how we incentivize our people. The alignment that we have in place does a couple of things. First, it aligns with FRE growth, and we've had very good growth over the past 4 or 5 years in FRE. Second, it aligns with carry generation in performance for our LP investors. Very important that we drive LP performance. And the carry that we've thrown off $1.5 billion net realized carry in '21, $1 billion last year that provides a lot of capital as well for the balance sheet. So that alignment is important and keeping people kind of focused on the long-term trajectory of shareholder value, the equity awards, obviously kind of play into that. And so all of those things matter, but you're right. We continue to evaluate how it could be better and drive further things. And when we have something to announce in terms of a change, we'll be sure to make sure everybody is aware of that, but nothing to announce it today.

The only thing I would say is you mentioned the valuation gap -- when I look at the valuation gap, when I was doing my diligence, I didn't look at it and say, "Oh, we want to be this firm or that firm" I just knew that it screamed opportunity, because I know the power of the brand. And so what we're going to do is, I think, what you hope we'll do. We're going to listen quite carefully to our LPs. We're going to evaluate our strength internally. And we're going to marry those efforts together to make sure we deliver to LPs. We drive growth and we use our capital along the way. In terms of incentives, I think Curt captured it perfectly, we want our people to be incented. We have fantastic talent here, we want to attract the best talent. We want to retain the best talent. And so all these things are the way that we'll think through the compensation. And listen, we want to make sure people get paid for performance. That's how I'm thinking about it philosophically. Too early to comment on any specific changes, but I like Curt's language about the cheese. I don't think that was prepared remarks by the way. But we probably wouldn't have put that in the script, but I think he captured it well.

Our next question comes from the line of Brian Mckenna of JMP Securities.

So it's great to see the Fortitude deal get announced a couple of deals ago -- a couple of days ago. But Curt, could you just remind us about the fee arrangement with Fortitude and then how that evolves over time with underlying performance of that business? And then related, how does the pipeline look for these larger deals looking out over the next 12- to 18 months? And does Fortitude have kind of incremental excess capital for some more deals moving forward? Or will they have to look to raise some additional capital?