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

All right. For important disclosures, please see the Morgan Stanley research disclosure website at morganstanley.com/researchdisclosures. Note that taking your photographs and use of recording devices is not allowed. If you have any questions, please reach out to your Morgan Stanley sales representative. All right. With that out of the way. Good morning, thanks for staying with us here on day 2 of the Morgan Stanley Financials Conference. I'm Mike Cyprys, Equity Analyst covering brokers, asset managers and exchanges for Morgan Stanley Research. And for our next session, we have the Carlyle Group, and we're excited to have with us John Redett, the Chief Financial Officer. As many of you know, Carlyle is a global alternative asset manager with over $450 billion of assets under management across private equity, real assets, credit and solutions. John, welcome. Thank you for joining us.

Thank you. Thanks for having us. Appreciate it. Hopefully, by the time we're done, we'll move you from a neutral to a buy.

All right. I look forward to that.

So let's set the scene with the macro backdrop through the lens of your portfolio companies globally. What are you seeing just in terms of the state of the economy, health of the consumer, path of inflation, just given a lot of the uncertainty and volatility that is out there? And how is your portfolio holding up through this?

Yes. I think it's interesting. I think the market is telling you that the level of uncertainty has diminished dramatically from early April. I think it was incredibly elevated right after Liberation Day. If you look at the S&P, it's up 5% or 6%. If you look at where the S&P is trading, it's near record highs. If you look at spreads, spreads are actually tighter today. than they were pre-Liberation. So the markets are not too troubled. And when I look at our portfolio across kind of credit, secondaries, corporate private equity, it's very healthy. We came into the year with a very strong portfolio. First quarter looked very good. And we haven't seen any noticeable deterioration in the last couple of months in our portfolio. So we feel very good about the portfolio. I think the consumer is a little bit of a kind of a mixed bag, if you will. I always tell CEOs, if you can tell me how well your consumer customer is doing, I can tell you exactly who your consumer is. I think it depends on income levels. I think at the lower end of the income spectrum, it's more of a challenge. And at the upper end, it seems to be smooth sailing. But generally speaking, we haven't seen any deterioration in our portfolio in the last couple of months.

That's quite encouraging. So maybe with that backdrop and over $80 billion of dry powder you have today, just maybe you could talk a little bit about how you're thinking about deploying capital here, where you're seeing some of the most interesting opportunities to put capital to work? And what's changed now versus a year ago as you're sort of putting that capital to work as you think about that? Any areas you're avoiding?

Yes. I mean, look, I would say our investment teams across kind of credit, private equity in our solutions business, which is a secondaries as a co-investment and a portfolio finance business are very busy. Our deployment was up roughly 50% the last 12 months over the previous 12 months. So the teams are very busy. You referenced we have $80 billion of dry powder, which is plenty of capital to support the investments our teams are looking at. I would say within the investment businesses, our Japan buyout team is incredibly busy. That is a very, very attractive market. Within the U.S., our corporate private equity team sees a lot of good opportunity in health care, aerospace, defense, business services. Credit is pretty busy, I'd say, across the business. We've priced 4 CLOs since the end of first quarter. So that team has been very busy. Our asset-backed finance business, which I think is going to be the biggest driver of growth in our credit business, that team is super busy. That's an area where we're investing a lot of money. And I think the investments are starting to show. And then in terms of our secondaries business, that team has been busy for the last 3 years, and it really hasn't slowed. We're raising a secondaries -- our current vintage of our secondaries fund, and we should have the final close in the second or third quarter. That's already 60% committed. So I'd say the activity level is pretty evenly spread out across the platform. The teams are leaning in. We're certainly not risk-off. If we find a great company, we're leaning in and we're going to buy it.

And turning to the exit activity. How much of the portfolio would you say is exit ready today? Has this changed at all just given some of the recent market volatility uncertainty? And how do you see the backdrop for realizations as you look out over the next 12 months? Do you need to see IPOs come back in order for this to pick up?

Well, that would be helpful. Investment bankers, including some in the room, keep telling me IPO market is open. I'm not sure it's open. But anyhow...

I have seen a number of deals though over the past couple of...

Mainly crypto, but we don't invest in a lot of crypto. I'd say in terms of realizations, that's probably where I'm most proud about our investment teams. I think we are an outlier in a good way. If you look at -- you can't pick up a newspaper where they don't talk about how private equity is not returning capital. And generally speaking, from an industry perspective, that is true. That's a fact. The industry is returning roughly 30% to 35% of the invested capital based on historical standards. We are probably double the industry. So we are actually returning more capital to our LPs than we're investing. In the U.S. alone, in our corporate private equity business, we returned $8 billion or $9 billion last year to our LPs. So our teams are actually, I think, a little bit of an outlier in a good way. We are returning capital. In the fourth and first quarter, we had some very high-profile IPOs, StandardAero, which I think was one of the more successful IPOs done in the last couple of years. I think it really opened up the IPO market. That was obviously a big success for us. We had Rigaku which was the largest ever sponsor-backed IPO in Japan, and we had Hexaware. So the teams are busy. In fact, I think if you look at IPO market the last couple of quarters among large-cap sponsors, we had 70% of the market. So I think we're a bit of an outlier in terms of realizations. It slowed down a little bit kind of post-Liberation Day, but it's picked back up. We did another secondary sale of StandardAero a couple of weeks ago. We just sold a block of a company we own in India, a very successful investment. So it's picking up. I think the teams are optimistic that activity levels will resume. The one area that I think is a little bit more uncertain is just the IPO market. And we have a couple of companies that I think I would characterize as IPO ready. They're fantastic companies. But we're going to kind of sit tight and watch the IPO markets until we feel like they're open. But I would say realization activity is an area where I am incredibly proud of our investment teams.

Maybe shifting gears to fundraising. You've laid out plans to target $40 billion of flows for this year, including from [ Fortitude ]. It's a similar level to last year, which was nearly $41 billion, which was, I think, the third best year that you have ever raised. So I guess what gives you confidence in your ability to achieve a similar level of success this year, just given this backdrop we were talking about with the DPI challenges for the industry, although be you guys may be doing a little bit better. What does the progress look like so far on the fundraising front?

Yes. So last year, we put out a $40 billion target. And of all the targets we put out, I was probably most nervous about that one. But we surpassed it. So I think this is very much a bright spot for us. This year, we put out a similar target. And look, I realize when we put these 1-year financial targets out there, unlike, say, a fundraising, you guys go through all these super in-depth analytics and then you actually take the number and divide it by 4. So it's not linear like that. We have quarters where we raise a lot of money. We have quarters that we raise less money. So it's very hard for me to say quarter-to-quarter. But we put a target out of $40 billion again for this year of inflows. We had $14 billion in the first quarter. We're very much on track to hit our target for 2025. We have another $4 billion in insurance that we've announced that we should close in the second quarter. And quite -- we have some of our biggest strategies in the market. So we have our secondary strategy in the market. That is a very, very attractive area for LPs. We have our co-investment strategy in the market. We have our real estate strategy in the market. I think we're a bit of an outlier in terms of real estate in the sense we have a very strong performance in that product, and there's a lot of demand for that product. And then we should be in the market. We've talked about on previous earnings calls for our latest vintage of our U.S. buyout fund at some point late this year. So I feel -- the fundraising target, I feel very good about it.

How are you thinking about the sizing of that U.S. buyout fund?

Too early to tell.

Do you think it could grow?

We're optimistic it could grow.

Staying with the fundraising side, maybe just on the institutional side, we are hearing about some pressures across the institutional LP community, whether it's from China LPs to large endowments and just overall distributions weighing on LPs. So to what extent do you see this impacting fundraising? And more broadly, how do you think about the growth outlook across the institutional community? Some would suggest that they're largely full up on allocation. So where do you see some of the biggest opportunities on the institutional side?

Yes. So I would just say just kind of taking a step back, Harvey and I have done a lot of travel around the globe the last, last month. I was in Asia a couple of weeks ago. I was in Europe last week. And I know in the media, there is this certain narrative that institutional clients are allocating away from the U.S. We are not hearing that from our institutional client base. They still very much want access to the U.S. Look, it's -- if you are an investor, it's a very hard market to avoid. It's the largest market. It's the most liquid market. Monetizations in our market are the easiest. So we're just not hearing that narrative around LPs wanting to allocate outside the U.S. away from the U.S. I do think there's -- I do think China at the moment is a little bit of a challenge in terms of fundraising. I think that's for the industry. That's certainly not specific to Carlyle. I do think a successful resolution of this trade deal with China, and it looks like they made some progress the last couple of days should alleviate some of that. So we do feel better about China long term. And for us, China is a very small amount. It's immaterial. So it doesn't impact our fundraising targets at all. And in terms of the endowments, that's also an area that has been getting a lot of press. And it's very hard for me to comment on the endowment channel in the sense. We just -- it's just a channel we've never tapped into. We focused more on family offices for endowments, but -- so I can't really comment on the endowment channel.

And where would you say you see some of the biggest growth opportunities across the institutional community...

I think there's pockets in Europe where there's good growth opportunities. The Middle East, -- we're seeing good demand coming out of the Middle East. We're seeing good demand coming out of parts of Asia, I would say, kind of non-China. So we feel very good about the institutional market.

What about in the U.S.? Some would say U.S. is over their skis a little bit, some would say.

Yes. I mean, look, I think the U.S. is a little slower to make a decision, but we have some of the largest institutional investors in the U.S., and they're very much allocating money to the products we have in the market, and we expect them to allocate money to corporate private equities [indiscernible] that's the market. So...

And you mentioned just in terms of your travels, Harvey travels around the world, not hearing about investors overseas looking to necessarily reduce allocations to the U.S. What are you hearing just in terms of demand for non-U.S. exposures for which you have a leading Japanese platform and franchise there. I guess what are you seeing around the globe in terms of appetite for non-U.S. assets? And is there an opportunity for you guys to lean into that a bit more aggressively?

Yes. I mean, look, we're as global as any of the [ ED Alt ] managers out there. I mean we've been in Japan for 25 years. Harvey and I were in Tokyo a couple of weeks ago celebrating our 25th anniversary. Japan is -- the Japan we've all been waiting for. I mean it is hot. And we're probably the biggest name in Japan. So there is tremendous demand for anything Japan today. Our current Japan buyout fund, I think it was 60%, 70% bigger than the predecessor. So Japan is a very, very attractive market. I would say most spots in Asia are very attractive ex-Japan. I mean we've been in India for 20 years. That has a tremendous amount of interest. And Europe is an area where we've been in Europe probably 30 years. We are really starting to hear a lot of interest in Europe. And I think Europe is going to be a very good place for corporate private equity in the next 5 to 10 years. And we're leaning into areas where we see opportunity.

Why don't we shift gears and talk about the private wealth channel, major focus for the industry, significant opportunity. You have a number of products in the market from CTAC to CAPM. Can you talk about the traction that you're seeing, the steps you're taking to broaden out distribution? And maybe touch upon how flows have fared through the volatility in April and into May?

Yes. So look, obviously, I think everyone in this room knows that the wealth channel is -- it's an enormous opportunity for our industry. It's obviously an enormous opportunity for Carlyle. It's a massive market. It's largely untapped for our businesses, and it has really good, really good tailwinds, which there's not a lot of things in financial services that have such strong tailwinds. So obviously, very attractive for us. This has been a real focus area for the management team. When Harvey joined about 2.5 years ago, we really, really started to focus on wealth, invested a lot of money in wealth, and we're incredibly happy with the progress. I do think this is such an enormous opportunity, and it is such a large market that this is going to take years to play out. It will still be playing out long after I'm CFO. I don't really buy into the narrative that it's going to play out quickly. It's just too big of a market, and it's going to take time for people to change their asset allocation into these products. So I think it plays out over a long period of time. I'm probably investing more money in wealth than any other area of the firm. How do you do well in wealth? You have to have a brand. We clearly have a brand. You have to have good performance. You don't have to have the best performance, but you have to have good performance. And you have to be willing to invest a lot of money. When you go on these platforms, you need to have the resources to educate the FAs about the products that they're selling. So it requires a fair amount of investment, and we're making great progress. I think we've doubled the flows in our evergreen wealth product over the last 12 months. I think our evergreen wealth AUM is up 70%. And as you said, we only have 2 products in the market. We have a credit product, which we call CTAC, which has been around for a few years. That continues to scale. And we launched CAPM, which is our solutions, largely secondaries product, I want to say, 18 months ago, and that is scaling really rapidly, much faster than I think we anticipated. It's a fantastic product for the wealth channel. If you think about it, it's private equity exposure diversified and there is no J curve. And the returns on that product are phenomenal. So we think that will continue to scale quickly. And then we hope to have a corporate private equity product in the market in the fourth quarter. I'm spending a lot of time on that. And that will really reflect our global corporate private equity footprint. So Japan, Asia, Europe and the United States, and we should have that up and running in the fourth quarter. And we do think that will ramp quickly. Our strategy is probably a bit different than some of our peers in the sense we're going to have 3 products. I know a lot of our peers have flooded the markets with multiple products. We're going to make sure those products are performing well. And then over time, you can -- it's likely to see us add additional products. But we're going to initially focus on these 3 products, which really reflect the 3 businesses we have at Carlyle.

Maybe just digging in on the private equity product that you mentioned is coming in the fourth quarter of this year. Maybe you could speak to what this product is going to look like, how it's going to differ from, say, CAPM that you've introduced? And what role can it play in client portfolios relative to a client buying CAPM?

Yes. So I think when you think about the wealth space and the products we're selling into the wealth space, I think a corporate private equity product is probably the most complicated. The nature of corporate private equity is it's episodic. Deals don't happen every day. You can go a period of time where deal activity is more benign. You can go through a period where there's a tremendous amount of deal activity. that's not necessarily correlated to the flows you're getting into the product. So the biggest challenge is how do you manage the flows into the product given the episodic nature of the deals you're putting into that retail portfolio. I think our product will be a little different to the industry in the sense it will have a secondary sleeve to help us kind of manage the fluctuation of capital coming in and capital being put to work by our corporate private equity deal teams. And I kind of view it as more of a relief valve that will enable us to kind of manage the episodic nature. So it will be a different product.

And is that liquidity sleeve a stake in CAPM? Or is it a stake in sort of similar types of investments...

Similar type of investments.

That they're making?

Yes, similar type investments.

Got it. Okay. And maybe just you could speak to broadly how you see your presence in the wealth channel evolving over the next couple of years, whether it's from a distribution standpoint. It sounds like maybe not that many new incremental products beyond the 3. But when you look out, like what other types of strategies could make sense given the platform that you have.

Yes. I mean, look, 2 years ago, we were really behind. We've made tremendous progress. We've really focused on the brand, making sure the 2 products we have in the market are performing well. We don't really have a problem getting on the wirehouses, but you should expect to see more of those kind of partnerships going forward with the wirehouses, the RIA channel and other kind of large banks, you should expect to see some partnerships on the distribution front. It is a tremendous focus area. Harvey spends a lot of his time in the wealth channel. I probably spend less than Harvey, but it is a massive focus area for the firm. And I think we -- 2 years ago, we had maybe 30 individuals in our wealth business, and it's well north of 100 today. And I would expect that type of growth to continue.

And you mentioned partnerships. One of the things we're seeing is alternative managers partnering with traditional money managers on the product side. Just curious your thoughts around hybrid public private solutions. How are you thinking about that? And to what extent could we see some of that?

Yes, you're seeing a lot of partnerships, not a lot of products yet, but a lot of partnerships. And look, we understand why some of those partnerships are being created. And you should assume we're having similar type of conversations, very focused on anything that's very much a partnership. And look, I think it's very much an evolving area. I think it's going to change. It's going to be very different in 5 years than what it looks like today. And I don't think you're going to see situations where they're just going to have one all partner. I think they're going to have multiple partners.

Got it. So we'll stay tuned on that. Why don't we shift and talk about margins, fee-related earnings margins. You guys have made significant progress in recent years. You achieved 46% FRE margin in 2024 and note that you expect this year's margin to be similar with about 6% or so fee-related earnings growth. Can you talk about some of the underlying contributors to get there between whether it's fundraising, fee activations, of expense growth? And where might there be any sort of scope for upside?

Yes. So I think it's important to put the FRE margin in context at Carlyle. The margin we had last year of 46% was 1,000 basis points higher than it was 2 or 3 years earlier. It was 2,000 basis points higher than it was 5 years ago. So we made tremendous progress on the margin front. And I've been very clear with shareholders and the investment community that when we put our first guidance out for 2024, we said, we want to get the FRE in the kind of the FRE margin in the 40%, 50% range. Last year, it was 46%. I think in the first quarter, it was 47%, 48%. So we're already at the upper end of that range. Can we drive our FRE margin outside that range? Yes, we can. But we've also been very clear that the way we're going to get that margin higher is going to be through growth and scale. We're not going to cut our way to a higher margin. And quite frankly, we didn't even really cut that many expenses to get the margin to where it was. We just -- I would say, we're a little more prudent in terms of how we thought about expenses. But our single focus is on growth going forward. And the way you will see that margin expand beyond that range we outlined will be from growth and additional scale. And you're already seeing that in some of our businesses. If you look at the FRE margin in our AlpInvest business, which is our secondaries co-investment and portfolio finance business, it was in the mid-50s in the first quarter, and that business is really starting to scale. So the margin should improve over time with growth and scale. In terms of the absolute FRE, last year, we had a really good year on FRE. We had $1.1 billion. Our guidance this year was 6% FRE growth. And the way we outlined it to our investors on the call was, I know FRE is important. But to me, 2025 FRE, the absolute FRE level is a lot less important than the growth rate this firm and this platform can continue to generate consistently in a couple of years down the road. And Harvey and I are completely focused on growth -- sustainable long-term growth. And that 6% FRE growth, if we were not investing in the businesses, that number would have been a lot higher. But we are investing heavily in our businesses to generate growth down the road. And in our opinion, most of our shareholders would very much prefer us to be taking that strategy. So I think we'll -- let me put it this way. I don't know if we'll beat it. I feel very good about the 6%.

Okay. Fair enough.

Want to make sure as Carlyle, we were at $310 million, $311 million of FRE. So I feel very good about the number.

Great. Why don't we shift and talk about private credit. We saw fee-related earnings in your global credit business grow by 50% year-on-year, surpassing $100 million for the first time. So significant growth there. I guess how do you see the pace of growth in your credit platform trajecting going forward, you look out the next 3 to 5 years? And where do you see some of the incremental opportunities to further expand the platform and the capabilities?

Yes. Look, growth has been a very good business for us. It's been a large contributor to our growth rate. I think over the last 4 years, I think FRE is up 40%. I think the AUM is up 40% as well. So it's been a big driver of growth. We have our insurance business inside our credit business. Look, the business, I think, had some headwinds the last couple of years, given how large we are in the CLO space. We're the largest CLO manager in the world or maybe today, we're #2. I always get these e-mails that we're #1. But -- and the industry that had headwinds. I think those headwinds have abated. As I said earlier, we priced 4 CLOs since the end of the first quarter. So fantastic activity. If you actually -- if you look at the credit business ex-CLOs, the credit management fee business has been growing 15%, 16%. So it's been growing at a very healthy clip. It just had some headwinds with the CLOs. And again, we think that's largely abated. So I feel very good about credit kind of looking forward as being one of our big, big growth drivers of our platform looking forward. Where I think we're going to see outsized growth in that business is insurance. We have a balance sheet-light strategy in insurance. As you know, via Fortitude, we had an unbelievably active year in 2023. We added $25 billion of assets to Fortitude. We had a deliberately quiet year last year as we made sure that the Lincoln acquisition we did was properly integrated and the assets were properly rotated. We've already announced $8 billion of transactions this year, 4 of which we've closed. We hope to close the other 4 in the second quarter. So I would say insurance conversations are more elevated than I've ever seen, and I expect that to continue. I think the other area of credit where we're a major player is the asset-backed finance space. That is a massive market. It is multiples of direct lending. And that's a business similar to wealth, we're investing a lot. We've added a lot of headcount. We had almost no AUM a couple of years ago, and that's already a $10 billion business. I like that business a lot. I think it's going to be a big growth driver. It throws off a lot of capital market fees, which has been a big initiative for us. The other component of credit that's been a big driver. We put our capital market fees inside our credit business. And look, for 2 years, that's been a big focus area for Harvey and myself. And I think we've made tremendous progress. Last year was a record year. If you look at just the last 2 quarters in capital markets, it's better than any 1-year we've had. So clearly, it's working. I think the quality of those capital market earnings revenue streams, Mike, are high quality in the sense that we're not using our balance sheet. We're not levering our balance sheet, taking down debt. And also, it's just focused on Carlyle. We're not underwriting non-Carlyle deals.

Why don't we double-click on the ABF platform? Can you talk about how it's contributing today? How you see it scaling as you look out over the next couple of years? And where might there be opportunities for expanded origination?

Yes. So again, this is a business that we've really organically built over the last couple of years. I think if you look at the headcount in that business, the growth is probably -- the growth rate is probably similar to what we've seen in our wealth space. I think this business will be largely played out among the large global players. You have to be able to write big checks. We did a student loan deal, I want to say last fall, closed it last fall. That was in aggregate, a $10 billion deal. So it requires a lot of checks. I think in terms of originations, it's really going to come from 3 different areas. I think banks are going to have multiple relationships with credit providers. So that will be a channel. I think there will be one-off bidding situations where we'll get flow from. And then we have ownership stakes in, I want to say, 4, 5 origination platforms. And I would assume over time, that expands into other asset classes. But where we've been pretty active would be manufactured housing, student loans, C-PACE loans. Look, I think the headwinds facing the banks, maybe they get a little better from a regulatory perspective. I don't think they get to a point to where it impacts that business. I think the tailwinds for that business are long-term sustainable. And I think the asset classes that make sense in banking stay in the banking system and a lot of the other assets come into the ABF ecosystem. Again, the market is multiples of the direct lending business, and we really feel like we have a good position in that market.

Great. We have just a few minutes left. I do want to get a question in on AI, advances in technology, data reshaping many sectors. So I was hoping you could talk about how you see AI impacting the asset management industry, how you're experimenting with that today? What use cases you've identified and how many you might put into production over the next 12, 24 months?

Yes. So AI is an area where we are investing a lot of money, a lot of time and a lot of resources. And I would say it's kind of -- some of the use cases are pretty obvious, right? It should help automate a lot of different processes. We have at Carlyle, like the digestion of data. You think about our businesses on the credit side of the business, you're digesting a tremendous amount of data with credit agreements. When you think about what we do on the secondary side of the business, when we buy a portfolio, there's a tremendous amount of data. So AI will definitely help us automate a lot of that. It will help us become very efficient. In our back office, we can do similar things, whether that's in legal, using AI to look at contracts. So I think it's going to help streamline our back office. I also think we can help our portfolio companies in our secondaries business, our credit business or our private equity business. We can let them leverage the money we're spending in AI. And you think about what AI is really powerful is any type of rules-based decision, AI is super powerful. So if you own a business that processes insurance claims, any claim that fits in a predefined box probably doesn't need a human. AI can make that decision. And anything that doesn't fit in that predefined box, you probably need a human to adjudicate that claim. But I think it's going to be incredibly powerful on the efficiency productivity front. And then I think some of the other kind of newer frontiers are just the massive amount of data we have at Carlyle across our platform. How do we better leverage that data to help us in the diligence process to help us make better investment decisions. It's not quite there yet, but it will evolve. But I would say AI is an area where we spend a lot of time.

On the diligence process, what's the timing do you think for something like that coming across to your team?

It's not as far away as you think.

So maybe sometime next year?

Yes, we're spending a lot of money. And look, when you have a lot of data, it's a huge advantage.

How do you think about the impact of what that does it increase the velocity of capital from a deployment standpoint because you're making decisions more quickly? How do you think...

Yes. I think you can have -- if you become more efficient, you can have your people spending time more wisely.

And when you think about the magnitude of efficiency saves, you were mentioning the back office, just how might you sort of quantify?

I haven't really quantified it yet. I think it's early. We are doing very specific test cases. And I would say we are very pleased with those test cases. Look, I don't think anyone can deny the massive impact AI is going to have on any company. And if you don't think it will, you're already behind and maybe you've lost. But it's just going to take time. The narrative is too much it's going to happen overnight. We are all spending a lot of money, very focused on AI, but it's just going to take time to play out.

Great. Why don't we leave it there. Thank you very much.

Thank you.