While other large private equity companies like Blackstone (BX, Financial) and Apollo Global (APO, Financial) have crushed it over the last five years with their stocks up more than 100%, The Carlyle Group Inc.'s (CG, Financial) share price has not followed suit. In fact, the company has lagged the S&P 500 over that time period, producing just a 38% return. I think the next five years will be different.
Founded in 1987, Carlyle has grown to become one of the largest private equity companies in the world. It operates in four business segments: Corporate Private Equity, Real Assets, Global Credit and Investment Solutions. Today, assets under management are over $381 billion through a broad range of investments across industries such as aerospace, defense, telecommunications, media, healthcare, financial services, transportation, consumer and retail.
Business model breakdown
Like most private equity companies, Carlyle makes money by investing in companies, typically via a leveraged buyout, then trying to improve operations and profitability, and finally selling them for a profit back in the public markets. This means doing a variety of pretty difficult things.
First is fundraising. Carlyle raises funds from a variety of sources, including pension funds, endowment funds, sovereign wealth funds, high net-worth individuals and other financial institutions. These investors are known as limited partners. Without a high level of trust and performance, the company would not have been able to amass the AUM it did.
Using the pooled capital, Carlyle also invests in private companies or public companies it takes private, typically one it believes are undervalued or have significant growth potential.
Next, Carlyle uses its expertise to improve the company's operations and profitability. This might involve restructuring the company, making strategic acquisitions, improving supply chains or implementing new technologies.
Once the company's operations and profitability have improved, the Carlyle Group seeks to sell it for a profit. This is often done through an initial public offering or a sale to another company. The profits from the sale are then returned to investors.
Carlyle charges its limited partners two types of fees. The first is a management fee, which is usually 1 to 2% of the total assets under management. The second is a performance fee (or carried interest), which is a percentage of the profits made from the investments after a hurdle rate is achieved. That means, while the company may get $20 million on a $2 billion fund, it likely pays out 8% a year in hurdle on the tail end.
While private equity companies like Carlyle Group gobble up plenty of money in fees, they have also returned a lot of value to shareholders, and more importantly, they play several important roles in the economy.
For one, private equity companies provide capital to companies that might otherwise struggle to raise it. This can lead to job creation, innovation and economic growth. They often target companies with high capital gains potential, providing them with the necessary resources to survive and grow.
Second, private equity players often aim to improve the operations of the companies they invest in, helping them become more efficient and profitable. This can lead to better products and services for consumers. There is a reason pension funds, endowments and other institutional investors often invest in private equity firms like Carlyle. It is to diversify their portfolios and seek high returns.
Finally, there is a lot of debate on the value private equity companies bring to the marketplace, but there is a lot of capital floating around and it needs to be allocated somewhere. At least most private equity companies generally have pretty long-term time horizons, unlike many hedge funds. This allows them to undertake strategic initiatives that may take several years to bear fruit, such as business transformation, market expansion or research and development.
Carlyle has several competitive advantages
As one of the largest and most established private equity companies in the world, Carlyle has developed several durable competitive advantages.
Carlyle has a wide range of investment vehicles and manages a diverse set of assets. This diversification helps it reduce risk and allows it to take advantage of opportunities across different sectors and regions. It has built a strong reputation in the industry that gives the company an edge in attracting investors and sourcing deals.
Carlyle's team has deep industry expertise and extensive experience in managing investments. It also has offices around the world, allowing it to source and manage investments in a variety of markets. Moreover, based in Washington D.C., Carlyle is known for its connections to political figures and its investment in military and defense companies. This network can give it access to unique investment opportunities and insights.
In a statement, director and CEO Harvey M. Schwartz said:
"In 2022, we deployed a record $35 billion across our equity, credit, and solutions strategies. Looking forward, Carlyle remains well-positioned with $72 billion in dry powder to deploy opportunistically across diversified markets. Our record deployment will continue to deliver earnings growth.
It is worth repeating, we delivered record Fee Related Earnings of $834 million in 2022, an increase of 40% over 2021. This is illustrative of our strategic focus on growing FRE and diversifying our earnings mix. We have now grown our FRE at a 34% average annual rate over the past five years. Our AUM grew 24% year-over-year to a record $373 billion, as investors continue to entrust us with an increasing amount of their capital."
Thoughts on valuation
This is not the type of steady growth story that could be analyzed the same way most stocks can. Carlyle makes deals and manages money. That inherently means in order to get better than market returns, it has to only deploy capital as deals are available.
Revenue growth is anticipated as the company continues to raise funds. Carlyle is starting to put money to work with $35 billion deployed in 2022 and more expected this year. This will result in increased management fees in the short term and, if successful, higher performance fees over the long term. Earnings are expected to be around $4.80 per share in 2024 and reach $6.50 per share between 2026 and 2028.
What matters is that its pool of capital continues to grow. In 2015, assets under management was $194 billion. As of May 4, AUM was approaching $400 billion. In another decade, funds could be upwards of $900 billion. That is where it makes sense to compare Carlyle with industry leader Blackstone. Blackstone is valued at 11.2% of its AUM while Carlyle is valued at just 2.9%. Even other big private equity firms like Apollo and KKR (KKR, Financial) carry higher valuations based on AUM at 7.3% and 9.7% respectively. This is utterly ridiculous.
Blackstone has performed better, but its financials are just as erratic as Carlyle. Both companies have seen wide fluctuations in sales, profit and book value and carry plenty of long-term debt. At most, Blackstone should carry a market value twice that of Carlyle, not 10 times the capitalization. In the meantime, collecting $1.40 in annual dividends while waiting for the long-term capital gains seems more than reasonable.
