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

Okay. Great. So we're going to get started with our next session here. It is my pleasure to welcome Harvey Schwartz, CEO of Carlyle.

Hi, everybody. Great to be here.

With over $380 billion in asset under management, Carlyle Group is one of the largest global alternative asset managers with presence across private equity, real assets, credit and solutions. Prior to joining Carlyle Group, Harvey spent over 20 years at Goldman Sachs in a number of leadership positions, including being President and Co-Chief Operating Officer, the firm's CFO prior to that and of course, many other roles before that. So we're obviously very happy to welcome you back, and good to talk to you.

It's fantastic to be here. A lot of familiar faces in the room. So it's great to see everybody. I missed all of you -- not all of you. I'd say like 99% of you, it's really good to see all of you.

There you go. So look, before we begin, Carlyle had a number of pretty big wins recently. You guys sold McDonald's China over 6x earnings. That's been 6x capital, which has been great. Closing the Lincoln deal, the stock was added to the S&P 500. So momentum is building, which is great. I would love to start off with just kind of your perspective on your first 10 months as the CEO of the company, what you've learned and where you're spending your time?

Great. Well, I won't spend any time why I am at Carlyle, most of you've heard that. It was really just too good an opportunity to pass up in terms of the brand. I'm sure we'll talk a little bit about the industry, the industry trajectory, the people, the team, the founders. And obviously, I'd have some degree of confidence that could have an impact and help mobilize the team. In terms of the first 10 months, it's very cognizant in the fact that I was a new CEO and a new company. And the overly simplified playbook had three parts to it: one, spend a lot of time with my teams internally. And that was about me getting to know them but really as much them getting to know me, right, new to the company. Two, a lot of time with LPs. I've -- we stopped counting. I think I met with close to 300 LPs around the world. They've been to the Middle East twice, Asia twice, [ Europe ] twice, so a lot of road time, obviously, all over the U.S. and North America. And the third part of the playbook was really identifying. I've referred to them externally is work stream and internally, really a couple of areas of strategic focus where it would basically bring us all together as an organization where we can identify areas of growth and opportunity. And that's the oversimplified three-part playbook.

Yes. Well, let's build on that a little bit. In one of the earlier calls earlier this year, you talked about some of the key strategic priority. I think you narrowed it down to 5. Insurance, capital markets, private wealth, tech AI and expense management. It's a lot to cover, so we're probably not going to get to all of that today, but I would do.

No, let us do all of it.

Here you go. Well, we only have 31 minutes not too sure if we'll be able to. But look, I would love to hear a little bit more about where you see the most significant opportunity? Where you're spending most of your time related to these issues?

There are no favorite kids in that list. Yes. I love all my kids. I would say, look, the thing that -- which was sort of the thing we updated on the most detail would have been on the expense initiatives. I would say that's the lowest priority in terms of how we're thinking about Carlyle. When I traveled around the world, the opportunity sits pretty significant. And so if you think about what I fortunately had the privilege to participate in when I showed up, the platform itself across the $380 billion of assets, you have basically roughly $150 billion what we call private equity, but of course, that includes real estate. We have one of the, I think, best real estate investors in the world to an enormous -- it's an extraordinary team. Just to give some people some insight into that, that team basically decided they wouldn't invest in office space or retail in 2013. It's a pretty bold call, by the way, back in 2013. And it speaks to sort of the quality of the investing culture, which we'll talk a little bit about, I think I'll touch on some of the things -- some of the recent wins. So the investing platform itself is quite diversified across what I'd call traditional private equity, real estate, real assets, infrastructure, renewables and energy. And then, of course, you have the credit business, $150 billion. And then the Solutions business, our secondaries business, which I think maybe one of the greatest acquisitions of all time that the firm made long before I showed up. And then, of course, you have the insurance business, right? And so all of these things have opportunities for growth and again, the reason I detailed out the work streams because I was bringing the teams together to make sure we maximize that. So I'd use capital markets as kind of the simplest to be effective in the capital markets business, you can either be best in the world at as a Goldman Sachs or you can position the way we position, which is less about committing capital and more about the raw material and the pieces. And to be successful, you need a really world-class private equity franchise, you need a great capital markets team and you need basically the cross-section of event diagram of insurance clients, people you can distribute and share risk with, partners that we can share risk with that basically are peers of ours. And so bringing all these pieces together, in some cases, it was really just about prioritizing a bit of reorganizational design and incentives. It's hard to go through any of those areas and not feel optimistic about the long term growth trajectory. I think that's a lot about Carlyle, the brand, the people and what I've been fortunate to join, but I think a lot of it is about the industry trajectory, right? If you take wealth for just an example of one of the work streams. And I guess I am going to manage to go through each of them quickly. If you take wealth, for example, we raised $45 billion through that channel. And when you think about wealth, if you think about it as sort of basically feeder funds and then the evolving interval product, where some of our peers have had great success, it is, in my opinion, maybe pick your sports analogy, I'm not a very good athlete. I think our sports analogy, like top of the first inning in wealth. This is a 10-, 20-year trajectory and what you need is excellent investors, an understanding of the clients, and a brand. And I've spent a lot of time now in the wealth space. I think this is enormous opportunity, 3 years, 5 years and sooner, obviously. But we've made some resource additions in this space. I feel really, really good about the momentum across all the work streams.

Great. Well, we're going to unpack a lot of this. But before we go in, I would love to get your macro perspective as well. You've been through multiple market cycles, obviously been in finance for a long time. You have the benefit of having a pretty diverse set of portfolio companies in private equity. What do you hear in the ground? What's your outlook for the economy for '24?

Okay. That's definitely not a 27 minute, 15-second answer but I'll simplify it. So I would talk just macro, I'll give you my perspective. I think in my career, I'm 59. I was born in 1964, good time to be born by the way. I think this is one of the most complex market environments we've seen in 30, 40 years. And I say that because a lot of the mega trends of deflation, globalization, geopolitics, monetary policy, regulatory trend. A lot of that is in the process of reversing to some degree or at a minimum slowing for sure. And I think it's very hard to unpack the tailwinds associated with that. And the other thing I'll say is I know we all talk about the significance of a 500-plus basis point rate increase, but if you -- if we were sitting here in June 2021, and we just took well because in Goldman Sachs, market implied volatilities, if you took market implied volatilities, it's a 4 or 5 sigma event that we'd have a 500-basis point rise. And I was trying to frame that. So I asked my data scientists the other day and said, "Hey, how much is that?" and he said, "Well, that's one in a million. I said okay, it's one in a million. He said, "Well, that's -- if we put the quarter 20 times in a row, you always get heads, but I thought this was better. Then he said, one of the next 24 babies born in the United States is [present] in the United States. Like that's how extraordinary what we've been through. And I think this recalibration of rates, sure, we've seen the issues the U.K. had. We've seen Silicon Valley Bank and other bank issues. I think this recalibration of rates and what it means for forward rates. And I think people can become victims of recency bias. And because the vast majority of the people that are in markets today have experienced basically easy monetary conditions and extreme monetary conditions. I think there's a sense that rates will revert back to some very, very low level. And my personal view is that's not the case. I think these headwinds, combined with a normalization of the rate curve just means the cost of capital will normalize in a way that maybe should have been the case for a while. And I think that when we look at now our proprietary data, so we have close to 900,000 employees, 30 countries. We have a huge proprietary data set. And when you look at that, you can see that inflation peaked very specifically in June of '22, and you can see it roll off. And when I say inflation, I'm not talking about the headline inflation that you all read about, we're talking about like input prices that went from $1 to like $1.70 and you can see, as portfolio companies start to adjust external prices. And they didn't even know they had price elasticity. And now we're seeing that sort of feedback. And so we're definitely past this inflationary peak. My base case is, yes, we'll see a rate cut or two, but the notion that we'll see 5, I think that's not anything we should be rooting for. I think if we see 5, 6 or 7 rate cuts in the near term, it means we've got a market disruption of pretty significant recession of both. And so when I take the framing of kind of the mega trends, the local data that we have to sort of my own personal view, I think higher for longer than the market is expecting, and I think there's some degree of uncertainty in there. So I would say, short term, cautious. I think long term, now putting on my Carlyle hat, I think the opportunities are pretty extraordinary because some of the other data under the hood, I was just talking to Richard Ramsden before, and I said I was looking at this data set, which I know is going to have an opinion on this, okay? The data set -- basically, we have all the public companies in the United States, last 12 months, greater than $100 million, public companies, how many are last 12 months operating cash flow negative -- free cash flow negative. And the number is about 1/3. There's a lot of reasons for that. The primary reason is not because revenues are stuff growing, and the primary reason is not because they have too much debt, primary reasons because back in 2021, when they were getting financed, nobody expected rates to be 500 basis points higher. So interest rates are consuming a lot of cash flow and some of these are great companies, and they're going to need capital from firms like ours, whether it's debt, preferred, equity capital, they're going to need to restructure themselves. They're going to need to do carve-outs. A lot of this won't happen tomorrow. But when you think about that framing over the next couple of years and what we do at Carlyle as fiduciaries and micro investors, we're providers of that capital and I think the trend is very powerful. But I think near term, cautiously optimistic. The consumer seems really strong in our portfolio companies. And -- but I don't think this is a debate about soft landing, hard landing, I think, is a little extreme. I'll try more than you wanted.

No, that was actually perfect.

Okay. Great.

So look, I know you said you don't have sort of favorite kids in your -- in the set of your priorities, but I do want to talk about a couple of things you mentioned. So solutions. You're in the middle of several fundraises in the solution business. Let's talk a little bit about deployment and fundraising feels like in this market. That's #1. And then #2, you also talk about adjacencies that you're looking to build around the solutions business. Can you talk a little bit more about that as well?

Sure. So primary from the solutions business, the easiest way to think about this is the secondary business, the firm bought it several years ago that help invest Carlyle. We own 100% of it. And basically, the fundamental nature of the business or you don't know is they invest in primary, so they invest in primary [indiscernible] but they have a very large secondary business. They also have an adjacent financing business. And I think this is like the perfect if you were designing -- not designed this way, but if you're designing for diversification, this is the perfect diversification [ ballast ], because if primary is slower because capital is not cycling back quickly through private equity conventionally than LPs need liquidity, so you'll see the secondary business is very, very strong. So it's a very big growth area right now. There's a lot of appetite. I would say I don't like sort of absolute statements, but I'll make one, I would say, in general, more opportunity than one can deploy into, which you would expect given the nature of the markets right now. And the financing business is -- it's a fantastic team. The financing business, I think, is a huge opportunity, but this is all in the nature of things like NAV financing other things that we can do off that part of the platform.

Got it. And in terms of fundraising itself, how things going there?

Pretty good. Yes.

All right. Let's shift to insurance. It's another one on your priority list, and you guys obviously have an important partnership with Fortitude. You recently closed the Lincoln deal. So that was a nice win as well. Can you walk us through what that partnership with Fortitude means to Carlyle, how do other opportunities through that partnership stackup? What else could come out of it?

So for those of you who don't know Fortitude, again I walked into this, I had nothing to do with this creation. I'm just the beneficiary of being there. Fortitude is our partnership. It's a reinsurance business, what he's referring to for those who didn't see, there was a transaction actually that took a couple of years to bring together with Lincoln National, that will add on a longer-term run rate basis, about $40 million to the FRE of the enterprise. The -- so we just for extra disclosure. We just did a 6-hour strategy session with senior leadership in the firm of the Fortitude team yesterday. And I think the optionality around this franchise is very powerful. Within Fortitude, we have 170 actuaries. It's a very significantly built out enterprise. I like the capital-light model. There's a lot of things strategically we can do with the platform. That's my personal bias. I come from a heavier capital committee world, but I like the capital-light model. But there's a lot of flexibility around this in terms of the what I'll call the core business, where the pipeline is quite good in terms of global transactions. It's a global business. But also the ability to do partnerships strategic things around it. There's a lot of ways for this franchise to grow. And I think it gives us a really good base to continue to build up. But what I love about it is the optionality.

Yes. How do you think about opportunities outside of the Fortitude partnership, right? So insurance is a space, how meaningful of an opportunity is it for Carlyle?

So there's a couple of very, I think, powerful long-term trends that are -- that you can -- in my opinion, I think you can kind of anchor yourself to. It doesn't mean they're going to play out. There's a lot of discussion, obviously, about bank regulation and what it means for the banking sector and the banking sector's ability to commit capital to certain asset classes. There's also a lot happening in the regulatory space in insurance and some of these trends will continue for a long period of time, where if you're an insurer and you're capital constrained, but you want to grow, you obviously can enter into a partnership with us. But I think the dynamic nature of the flywheel effect of deployment of capital between what's happening with the banking system. This is a global event, by the way, but the banking system and capital the banking system won't provide going forward to market participants the growth in insurance companies and the ability to either absorb assets or be partners with us, I think this is a flywheel effect when you fit in with the capital markets business that has very, very long-term legs. I think these are 3, 5, 10-year trends.

Yes. That makes sense. Let's talk a little bit about private credit. It's been coming up, obviously, in every conversation over the last couple of days. It's not a new topic and a lot of folks excited about private credit for many other right reasons. You talked about that as being a big opportunity for the firm as well. You already have a sizable credit business, a lot of it as CLOs, but you also have a lot of product.

Don't get it download. What did Mike say? I just want to know what Mike said. So I don't completely contradict.

I think he's bullish. Yes, I thought he was.

I could have assumed that.

Also kind of bullish, but I would love to hear your perspective on kind of how you're thinking about building out private credit for Carlyle.

Yes, so at this stage, for those again, not familiar, it's $150 billion across the credit platform, we're the largest CLO manager in the world. Again, I think this is -- if you unpack it in terms of a fiduciary and a micro investor, the opportunity to continue to commit capital in this space is huge. And I know there's -- again, I've only been at Carlyle for 10 months, but this notion of private credit and public credit. I actually just think of it as credit. And I don't even really -- you didn't go there, but I don't even understand why it's called shadow versus not. There's more light on this sector. Everybody talks about it. And I think that I'll go back to what I said about public companies before -- the need for capital for public companies that we and others in our space can provide. I just think the demand will be very, very high over the next couple of years and so I feel really good about [indiscernible]. So when you -- when I say what do I see sort of like natural growth, just natural tailwinds, the insurance base, the credit space, secondary, like you're hitting all the good growth stuff.

Yes. Let's talk about the wealth channel for...

Almost like I still pay you -- when I used to pay you and I used to ask all the questions, it was great, but now you're answering -- asking the good question.

I got my like this, though. I don't know.

Yes, I'm going to get a bad feedback on my team for saying that.

Well, let's talk about the wealth channel. So again, one of the bigger priorities and the thing I want to zone into particularly is the democratized products. You guys do have a product in the space already. What's the vision there? What's the competitive edge? How are you thinking about going after this opportunity?

So, I love this child. I love this child. A lot of this is about brand recognition and Carlyle can get a lot of brand attention. And the team has done a great job building out. We have one product in credit called CTAC, it's growing very steadily. Just recently, we announced the product in the secondary business. And I think -- when I think about the wealth channel, I think what you need to have is great investing performance the right product fit for the client, extraordinarily important because this is going to be a 10- or 20-year growth space for the industry. And you have to have brand recognition. And the diversified product that we have in credit or the diversified product that we have in secondary is the perfect kind of diversified product for the client base. And this is a space where -- when I first showed up, I probably didn't think I would spend as much time in, but I spent a very significant amount of time in the space, really trying to unpack it and understand it and how to bring the resources together at the firm. So this is a very powerful long-term growth area for us and I feel really good about it.

Got it. Okay. Let's talk about one of the kids that is not on the priority list, but it's a big one, and it's an important one. And I don't want to diminish the importance of private equity, but we should obviously talk about it. It is still the largest contributor to management fee for the firm today. We know the cyclical issues in the marketplace with difficulty in fundraising, LPs are [indiscernible] again cashback, denominated. In fact, there's a lot of issues. So help us kind of break this down a little bit what it means for Carlyle? How much of this is simply cyclical in terms of slower fundraising versus anything Carlyle-specific that you see in your private equity business that could be a bigger challenge. And how do you see the broader corporate equity opportunity set evolving over the next several years?

So only make one -- I'm not big on long-term predictions for those of you who used to work for me here just because there's a lot of uncertainty in the world. I'll make one long-term prediction. Private equity asset class, asset class will be much, much bigger over time. It may hesitate here, it may pause here. It may not grow for a little bit because it grew so quickly. It will grow, I think, very powerfully over the next 3, 5, 10 years. In terms of Carlyle, hard not to love the kid that's kind of the soul of the place. And the footings, I really like the design because it's geographically focused. I think there'll be a lot of unique opportunities from an idiosyncratic perspective whether you're in Europe or you're in the U.S. or you're in Asia. We're in the process of -- when I first started traveling one of my early observations, I hadn't been to Japan since before the pandemic. And for those of you have been to Japan, it's pretty extraordinary what's happening there. I'm just looking from a macro perspective. And we have a great Japan fund there raising money. I have to be careful what I say about the specific fundraises obviously, but there's a lot of appetite. But I think you're right. I think the industry is we go through this period for a little bit of indigestion. Now I'll go back to where you started because you talked about -- for those who didn't see he referenced that we monetize an asset that our team in Asia had invested back in 2017. McDonald's. We went into partnership in China. And that transaction kind of really illustrates as a fiduciary and as a micro investor, [ white ] Carlyle is special. And I'll walk you through it for a second because we just did a global town hall this morning and XD, who runs our business has been in the firm for over 20 years. When you look at the impact they had on that franchise in McDonald's in China from 2017 to 2023 where we just sold it to McDonald's and increasing value 6.7x. He went through a staircase build of value creation. And if I said to you, I won't do this, but if I said to you, "Hey, how much of that was about leverage"? My guess is most people in the audience would say, well, a lot of it was about leverage because money was cheap and [indiscernible]. It's like 1.6x of the 6.7x. It's all about operational improvement, working with a great partner, picking a fantastic brand like McDonald's, being in a good demographic. I mean, they added thousands of restaurants. And even that, when I say leverage is really about leveraging cash flow, some even overstating the leverage factor. So I think, again, when you look out over the next couple of years, I could be wrong because my crystal ball is no better than anyone else's. And I can give you my view on rates, but I'll just tell you my opinion, nobody knows where rates are going. And if they tell you they do and they get it right, I think they're lucky and they're more likely to get it wrong. But I'll always give you my base case. But I think that when you look out over the future, the demand for capital and the value proposition for our teams because they've been doing it a long time, and they have the expertise. So will 1 or 2 funds be smaller, sure. Will some be larger? Yes. I don't spend a lot of time stressing about it.

Got you. Let's talk about expenses and margins. You mentioned that's a priority, you kind of named it, I think, in one of your earlier earnings calls that you think the operating margins of the company have more room to go. You've outlined $40 million, I think, of run rate expense savings already and working on more. But clearly, Carlyle is a growth firm. And you guys have a number of initiatives at play that will require investing. So how do you sort of balance these two dynamics, well, trying to improve fee-related margins and cutting costs and investing at the same time.

So I think the data is really important around margins. I think for me, it's just an output, right? And strategy fee. It's like a first principles thing. I think if you do any business, by the way, I think in terms of portfolio company, we wouldn't drive the portfolio company to a margin, we would drive the company around a plan. And so for me, it's not a question of, well, the margin has to be a certain place. It's a question of what is the most disciplined, thoughtful way to run the company in a way that allows us to invest in the secondaries business or the wealth business or grow the insurance business or the credit platform. And if other parts of the firm or a real estate platform, where we need to invest in a moment and have other areas, but I do think it's really about creating absolutely as much operating flexibility as we can and I just think that's good business. So John and the team and before John, Kurt started a process earlier this year, I'm pretty impressed with everything they did. They actually were able to be. I didn't give any time lines. But the progress just came together a lot faster than I thought it would.

I got you. Let's spend a couple of minutes on capital management and your priorities. They are both with respect to M&A and potential return of capital. I know back when you were CFO at Goldman, share buybacks is something you did a lot and you enjoyed doing and ...

I think I set a record by the way. I'm just kind of saying wrong, but I think I -- not at Goldman. I just mean across all regulated banks.

Well, the price was right. So if you really think about the amount of balance sheet flexibility you guys have, the amount of accrued care you have that is eventually going to turn into cash. That gives you a lot of firepower. So how do you think about strategic M&A versus buybacks at this multiple?

I think -- let's back up, let's, first of all, discuss how I think about the flexibility of strategic M&A. If I had a whole -- I had -- or I felt whole not maybe the right language, but if I had a part of the business, like I didn't have a secondaries business, I was really desirous of the secondaries business and I might say, okay, look, I think there's a lot of value in a secondaries business, but I have one. If I didn't have Fortitude and I thought, I really needed an insurance platform. I might say, okay, that could be accretive over an extended period of time relative to returning capital. But a lot of the footings are in place. And so I've never really been in a habit of someone was saying like, we think that's about our stock or not, but you said it. I think that -- I think the valuation is pretty modest by any standards. And so I would -- the short answer, I would say because I've given you a long one, the short answer, I'd say is open to anything because I don't think it'd be wise not to. And I think the team and my Board feel that way. But narrowly in terms of how -- if you want to know my thinking about this, and I know John, after being 16 years as a [indiscernible] investor, it's just math for me and for the team. And so in some respects, it's really just about relative value and where we think we can get the maximum return for the enterprise, for our LPs, for our shareholders, and that's how we'll think about the marginal capital deployment.

Is there anything that's more glaring and with respect to inorganic initiatives that you feel like you still needed to pursue. I know you said you feel good about insurance, you feel good about solutions. But is there anything else out there on the map there like we really need to get bigger here faster and inorganic is kind of the way to go.

No, I'm not feeling that. There's no shortage. This is as much as I'm going to give you, okay because I know you really want to go here. And I say that with all the greatest fondness, and I'm saying that because we worked together a long time ago. There are no shortage of partnerships out there and people wanting to partner with Carlyle. But that's -- but no, I'm not thinking that way at all.

Great. All right. Well, before we wrap up, I just have a question around the stock itself. And that kind of goes back to the first conversation we had when you took on the CEO role. You talked about a lot of value that you see in the shares. Your compensation structure is actually very much aligned with that, and it's very public.

I think 100%.

So talk to us a little bit about the catalyst that you see on the horizon to unlock that value for shareholders, not next quarter, not maybe next 6 months, 9 months, but over the next several years.

Well, what -- I think I spoke about pretty openly when I accepted the responsibility was that because someone asked me and maybe -- and certainly did it in investor meetings, I might have even talked about on the call, was that when I was approached and I looked at the enterprise, and I just sort of broke it out on a piece of paper. At the time, it was like $3.5 billion of accrued carry. There was $1 billion of cash, $2 billion of debt has got an extraordinary debt structure. And like I think there's some 5-year piece of paper that they issued at like 5%. And the founders of the time on something like 30% or 27%. So it's very closely held. And when you start to break down all that math, the market cap of the company, I think, was something like $10 billion. It's very hard not to look at that the Carlyle brand. And I think there's a huge value opportunity there. That was sort of me as I entered discussions with the Board and the founders about joining the company. And so now that I'm here and I'm inside, and I've spent 10 months talking to LPs and working with my team, yes, I feel good. I feel good.

All right. Well, we'll leave it there. Harvey, great to have you back here. Thank you for doing that.

Everyone. It's really nice to see everybody and happy new year, enjoy the holidays. Alex doesn't treat me any specialty, that's for sure because unfortunately, I don't pay him anymore. But anyway [indiscernible]. Everybody, thanks very much. Great to see everybody.

Thank you.