SCBrown Landscape Analysis Carlyle Group UPDATE2

8/2/2019 SCBrown Landscape Analysis Carlyle Group UPDATE2

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Sylvia C. BrownCommunications ResearchMPPR-870-01.Fall201110/18/2011

The Carlyle Group

Landscape Analysis


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T h e C a r l y l e G r o u p L a n d s c a p e A n a l y s i s | 2

EXECUTIVE SUMMARYThe Carlyle Group, like its industry, has always been characterized as cloakedcloaked

in mystery, power, secrets, and money. Being named after the ritzy Upper East Side hotel, theCarlyle, company founders wanted its target markethigh-end investorsto think it was fromold money.

The Carlyle Group based its headquarters in Washington, D.C. unlike other private equityfirms that set up in the financial centers of New York or even Chicago. Setting up in D.C.allowed the Carlyle Group founders to trade in what it had in spadesaccess. The company hadaccess to the upper echelons of business and politics. To really make it big, though, the companyfound it needed more than just political pedigree; they needed a niche. With inside knowledge ofthe United States defense procurement processes matched with political networking thatleveraged intel about defense and military-related policy decisions Carlyle became anchored indefense. In nearly a quarter of a century market conditions, investment interests, and prioritieschange. The Carlyle Group has changed. The firm has broadened its business model frompolitical access to a niche buyout firm to a top-tier multi-product global alternative asset

management firm.

Carlyle has been planning its initial public offering (IPO) for years, in part because itbelieves having public currency will help it better compete with already-public firms Blackstone,Kohlberg KravisRoberts & Companys investment vehicle, KKR, and Apollo. For a successfulIPO, the company needs to address its communications opportunities.

Problem/Opportunity Statements

Turmoil in the domestic and global economies presents the Carlyle Group with an opportunity torebrand itself as an asset management firm managing investments in diverse industries andemergent markets.

Improving transparency about the Carlyle Groups operations can have a beneficial impact on itsinitial public offering and performance of the products.

Private equity investment often slows or halts existing job losses.

L-R: William Conway, Daniel D'Aniello, and David Rubenstein founded the Carlyle Group. The private-equity firm fileddocuments that would turn it into a public company. Overnight, Carlyle's 99 partners will become millionaires and billionaires,with individual stakes valued from $3 million to $2 billion andup.


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IndustryThe financial industry, more specifically the private equity sector, is cloakedcloaked in

mystery, cloaked in power, and cloaked in money. Private equity (PE) is a niche market forfinance. Capital investments in the sector limit communications. PE firms avoid the demandsthat regulators and shareholders make on public companies every quarter. Some of the

communications blackout is regulatory. No mass mailings, advertisements, press releases orinformational seminars are allowed when funds are being raised.

The private equity sector works by using large sums of money to invest in a company.Described ideally, in its most basic terms, private equity allows the seeds of new ideastogerminate and the souls of the withering may be granted rebirth. PE investment can be in oneof two formsventure capital or buyout. In the venture capital investment process the privateequity firm invests funds in business start-ups with the expectations that the nascent companyeventually will be profitable. The venture capital model is prevalent in the technology sector.Increasingly, the renewable energy sector is getting attention from venture capitalists.

In the buyout investment, the private equity firm buys shares in a company, takes thecompany private, restructures thecompany to profitability, and thenexits the company by putting it backon the public equity market (i.e.,stock trading) or selling it throughcorporate acquisitions or selling it toother PE firms through secondarybuyouts. It is believed the firstprivate equity buyout was madebetween the storied money familiesled by J.P. Morgan and AndrewCarnegie with the sale of theCarnegie Steel Company to Morgan

in the 1800s.

Buyout Process and Stakeholders

In private equity investments the purpose of investment is to align the interests of thecompanys managers and shareholdersachieving economic efficiencies for high financialvalue. In the early days of PE, managers and investors were financial experts rather than sectorspecialists. Financial experts had a bottom-line approach and PE firms and managers were

considered cut-throat. The bottom-line approach meant laser focus on operationalimprovements. These operational improvements manifested as massive job losses to cut thefat and squeeze out profitability. The bottom-line approach certainly did little to endear theprospects of a buyout to a companys managers, employees, and investors, even if the companywas struggling.

One of the more notorious steps in the buyout process is the buyout. The private equitybusiness is built on buying companies, often by borrowing large amounts of debt. This gave rise


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to the term leveraged buyouts (LBOs). The companies may be distressed but they are stillvaluable because of their market leadership and stable cash flows. With these characteristics,banks lend significant debt to the PE firm. At the same time the firm fronts a small portion ofthe buyout cost. The buyout usually uses as much as 70 cents of every dollar as debt they invest.The bank and firm get paid first when the PE firm takes control of the company leaving the

company saddled with debt and pushing to make a profit. Adding to the rich get richer narrative,the private equity firm, following the industry standard, charges investors up to a two percentmanagement fee on the total amount of the funds and takes a fifth of any profits it earns.

The industry justifies these operations by noting PE investments are long-term andexpensive commitments on illiquid assets, creating investment risk. Fundraising, or capitalcalls, last about 18 months and minimum investments can be $250,000 but often more.Bringing (in the case of venture capital investment) or returning (in the case of buyoutinvestment) the company to profitability takes time as well, usually six-ten years. The investorswho can play in high-stakes PE, though, are no longer just money families, like Whitney,Rockefeller or Morgan. Now, public and private pension funds and university endowments are

joining the family foundations. The California Public Employees Retirement System(CalPERS) is a major PE investor.

The venture capital PE had its heyday in the 1960s and 1970s with investments ininformation technology and healthcare. Buyout PE rode high in the 1980s though the early2000s.

CompanyThe Carlyle Group was founded in 1987 by Stephen Norris, a veteran businessman

working at the Marriott hotel chain, and David Rubenstein, a veteran of politics and policy whoworked his way up through President Jimmy Carters Administration. Norris spearheaded thepromising beginnings ofthe mens business relationship. Norris was a financial whiz andinitially partnered with Rubenstein to take advantage of a gaping tax loophole by setting updummy companies for Alaskan natives. With Norris tax knowledge and Rubensteins Rolodex,they became quite wealthy because of that loophole and decided to incorporate. They named thenew company after the Carlyle Hotel in Manhattans Upper East Side because they wanted thebusiness to sound of old money. Eventually the U.S. Congress closed the loophole but Carlylewas positioned to become a part of the boom of the private equity sector.

Daniel DAniello was lured from Marriott and William Conway, a formertelecommunications executive, rounded out the Carlyle Group as they moved to become aprivate equity buy-out firm. It cost $5 million to start the firm and financial backing primarilycame from the Mellon family and Ed Mathias, an investment banker at T. Rowe Price who wenton to become a managing director at Carlyle. The Carlyle Group based its headquarters inWashington, D.C. unlike other PE firms that set up in the financial centers of New York or evenChicago. Setting up in D.C. allowed the Carlyle Group to trade in what it had in spadesaccess.The company had access to the upper echelons of business and politics. To really make it big,though, the company found it needed more than just political pedigree; they needed a niche.


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Just as Carlyle realized its weakness a political and business powerbroker was gettinginto hot water. Frederic Malek was a strongman for President Richard Nixon in the Bureau ofLabor and Statistics (BLS). While he was at BLS, Nixon instructed Malek to compile a list ofJewish employees who could be conspiring against him. Maleks role in the matter came to lightin 1988 just as he was taking over chairmanship to the Republican National Committee. Malek

was connected to Norris and Rubenstein through Marriott. Norris took Malek in to the firmwhen the scandal broke. Malek was closely tied to George W. Bush, who had just won thepresidency. Malekbrought the Carlyle Groups defining nichethe defense industry. ThroughMalek Frank Carlucci, a former secretary of defense, former deputy director of the CentralIntelligence Agency, and friend of Congressman and Defense Secretary Donald Rumsfeld,joined Carlyle as vice-chairman. When Carlucci joined Carlyle the company established whathas been called an iron trianglepolitical access, business acumen, and the defense industry.

With Carlucci in the mix, Carlyle gained access to defense companies that becamebuyout targets. Carluccis knowledge of defense procurement processes matched with politicalnetworking anchored Carlyle in defense. In several movies including Fahrenheit 9/11 and The

Manchurian Candidate there were direct accusations and insinuations that Carlyle Group wasnefarious and pushed the military industrial complex. The companys ties to Saudi Arabia royalfamilies and the Middle East has intensified the accusations. After September 11 Carlylebrought out holdings of family members of Osama Bin Ladens families. In 2007 the companysold a 7.5 percent stake to the Abu Dhabi government (the capital of the United Arab Emirates).The Mubadala Development Company paid $1.35 billion for that minority stake of Carlyle.

In nearly a quarter of a century the Carlyle Group has broadened its business model frompolitical access to a niche buyout firm to a top-tier multi-product global alternative asset management firm.According to its SEC filings the Carlyle Group now has$153 billion in assets under management and operates itsbusiness across four segments:

1. Corporate Private Equity: advises buyout andgrowth capital funds; 25 active CorporatePrivate Equity funds are organized andoperated by geography or industry and areadvised by separate teams of localprofessionals

2. Real Assets: U.S. real estate fund, advises 18active real estate, infrastructure and energy andrenewable resources funds

3. Global Market Strategies: high yield fund, advises a group of 43 active funds thatpursue investment opportunities across various types of credit, equities andalternative instruments

4. Fund of Funds Solutions: investors in private equity and advises a global privateequity fund of funds program and related co-investment and secondary activities

Carlyle invests in small, medium and large companies, real estate, infrastructure projectsand financial services firms. These investments are in approximately 80 companies based in the


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United States, 77 percent of which are small or medium-size businesses (fewer than 2,500employees), as well as about 125 real estate projects, which include commercial, residential, andhealth care or data centers. Combined, these companies employ more than 216,000 people in theUnited States in all 50 states.

Issue The Carlyle Group filed with the Securities and Exchange Commission to go publicSeptember 6, 2011. The offering is for $100 million, which is expected to be a placeholder. J.P.Morgan, Citigroup and Credit Suisse are serving as co-lead underwriters.

Carlyle has been planning its initial public offering (IPO) for years, in part because itbelieves having public currency will help it better compete with already-public firms Blackstone,Kohlberg KravisRoberts & Companys investment vehicle, KKR, and Apollo.ExternalEnvironment

According to Ed Mathias, Managing Director at Carlyle, the private equity industry has

gone through four stages:

1. The Stone Age, ran from the mid-70s to mid-80s, when firms and deals were small.2. The Bronze Age from 1985 to 1990 saw the industry mushroom.3. The Silver Age from 1991 through 2001 saw the industry mature with many funds

with billions of dollars to invest, drawn from around the world.4. Then came the Golden Age from 2002 into 2007 where more than 175 funds had at

least $1 billion under management, and some funds were big enough to buy Fortune500 companies

With financial markets reeling, though, private equity firms have turned to the publicequity markets (i.e., stock trading). Listing gives the firm an open opportunity to tap the capitalmarkets instead of raising investment for a particular fund that has a limited lifespan. The listingalso opens a door to investors who are not wealthy enough to invest directly in a private equityfund. The first public listing was completed by The Blackstone Group under its founder SteveSchwarzman on March 22, 2007. The offering raised $4 billion in an initial public offering. OnJune 21, Blackstone sold a 12.3% stake in its ownership to the public for $4.13 billion in thelargest U.S. IPO since 2002.

Problem/Opportunity Statements

Turmoil in the domestic and global economies presents the Carlyle Group with an opportunity torebrand itself as an asset management firm managing investments in diverse industries andemergent markets.

Improving transparency about the Carlyle Groups operations can have a beneficial impact on itsinitial public offering and performance of the products.

Private equity investment often slows or halts existing job losses.

Key Publics


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U.S. CongressCongressional and federal oversight could impose regulatory impedimentsthat could hinder efforts to expand into new investment strategies, markets andbusinesses.

Debt financing markets Most ofCarlyles investment funds invest in illiquid, long-terminvestments that are not marketable securities and such investments may lose significantvalue during an economic downturn. Theres also the potential for poor performance ofthe investment funds. The mortgage bonds that banks had been using to finance privateequity deals collapsed when rating agencies acknowledged these bonds included toomany risky, high-interest home loans that weren't getting paid back; banks suddenlyreluctant to lend at favorable terms, some $100 billion in announced private equityinvestments have been scrapped, and another $100 billion had to be renegotiated underless favorable terms.

Domestic and global economic markets With a greater presence around the globe andin emerging markets than any other alternative asset manager volatility affects the CarlyleGroups business and liquidity position. The credit crunch has also made it harder for PEfirms to borrow. Fundraising hit a wall.

Investors The high finance investor expects annual returns of eight to twenty-fivepercent for alternative investments such as private equity, hedge funds and venturecapital, compared with the traditional, small investor who expects 6 to 8% for stocks and2 to 4% for bonds. However, the law of averages makes it difficult to sustain highperformance year after year. With the market turmoil, all investors have become riskaverse and less money is being put into private equity funds.

Labor unions With its broadened portfolio and the interest in protecting and growingjobs, companies in Carlyles portfolio come under greater scrutiny. It is important tobuild relationships with labor and employees. Ensuring all parties work toward theshared goal of generating good financial performance to keep U.S. businesses morecompetitive and saves jobs.

Media Just like the PE industry Carlyle has operated on a schedule of years when itcomes to its investments and returns and has avoided the demands that regulators andshareholders require from public companies. Becoming more accountable to the public,and thus less private will continue to set the stage for a successful transition to the publicequity markets.


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