Business Context and Reporting Period
The filing is The Carlyle Group L.P.’s Form 10-K for the fiscal year ended December 31, 2017, filed February 15, 2018. Carlyle is a global alternative asset manager operating through Corporate Private Equity, Real Assets, Global Credit and Investment Solutions. It reported more than $195.1 billion of assets under management, $124.6 billion of fee-earning AUM, 317 investment vehicles and more than 1,600 employees at year-end.
The registrant identified in the filing is The Carlyle Group L.P., not “Carlyle Group Inc.”
Key Financial Metrics
| Metric | 2017 | 2016 | Change |
|---|---|---|---|
| Total revenue | $3,676.2 million | $2,274.3 million | +62% |
| Fund management fees | $1,026.9 million | $1,076.1 million | -5% |
| Performance fees | $2,093.9 million | $751.8 million | +179% |
| Investment income | $232.0 million | $160.5 million | +45% |
| Total expenses | $2,632.3 million | $2,242.1 million | +17% |
| Income before taxes | $1,132.3 million | $45.3 million | Material increase |
| Net income | $1,007.4 million | $15.3 million | Material increase |
| Net income attributable to common unitholders | $238.1 million | $6.4 million | Material increase |
| Basic earnings per common unit | $2.58 | $0.08 | Material increase |
| Distributable Earnings | $670.0 million | $651.7 million | +3% |
| Fee Related Earnings | $192.0 million | $32.6 million | Material increase |
Consolidated cash flow from operating activities was negative $7.1 million, compared with negative $300.6 million in 2016. Cash and cash equivalents were $1,000.1 million, and corporate treasury investments were $376.3 million, for approximately $1.2 billion of remaining cash and treasury liquidity after amounts allocated to specific purposes.
Total debt obligations were $1,573.6 million, including $25.0 million outstanding under the senior credit facility, $1.1 billion of senior notes, $294.5 million of CLO term loans and $156.0 million of promissory notes. The senior credit facility had $750.0 million of revolving capacity available and matures May 5, 2020. Carlyle reported compliance with its financial and non-financial debt covenants.
Common-unit distributions declared for 2017 totaled approximately $137.5 million, or $1.41 per common unit. The preferred-unit distribution for 2017 totaled approximately $6.0 million. Preferred distributions are discretionary and non-cumulative.
Material Changes Versus the Prior Comparable Period
- Performance fees increased sharply as carry-fund valuations appreciated; overall carry-fund appreciation was 20% in 2017 versus 12% in 2016. Corporate Private Equity performance fees rose to $1,629.6 million from $289.6 million.
- Fund management fees declined despite fundraising because older funds continued to harvest investments, fee bases shifted from commitments to invested capital, and fee activation for newly raised capital had not yet occurred.
- Fee-earning AUM increased to $124.6 billion from $115.0 billion, while total AUM increased to $195.1 billion from $157.6 billion. The increase in total AUM reflected $42.8 billion of new commitments, $17.1 billion of market appreciation and $6.5 billion of foreign-exchange gains.
- Pending AUM on which fees had not yet been activated was approximately $22 billion at year-end, creating potential future fee growth but also reflecting near-term fundraising costs before revenue activation.
- Distributable Earnings rose only modestly because realized net performance fees declined to $552.6 million from $625.3 million, particularly in Corporate Private Equity, despite the large increase in accrued and unrealized performance fees.
- Global Credit improved substantially after the wind-down or transfer of hedge-fund and commodities businesses. Segment Distributable Earnings increased to $126.9 million from a loss of $157.4 million.
- Carlyle issued 16 million 5.875% Series A Preferred Units for $387.5 million of net proceeds and began quarterly preferred distributions.
- Urbplan was deconsolidated following a transfer of control, resulting in a pre-tax loss of approximately $65 million. The business is not expected to contribute comparable losses going forward.
- The Tax Cuts and Jobs Act produced a $113.0 million additional income-tax provision from remeasurement of deferred taxes and reduced the tax receivable agreement liability by approximately $71.5 million.
- Carlyle completed settlements related to misappropriated petroleum investments, paid $165 million during 2017, issued approximately $54 million of promissory notes, and recognized $177 million of net insurance proceeds.
Guidance, Outlook, Risks and Contingencies
Management expected to raise approximately $25 billion of new capital during 2018 and stated that it had raised 57% of its $100 billion fundraising target by year-end 2017. Management expected fee activation on several large buyout funds in the second half of 2018, which it anticipated would increase fee-earning AUM and Fee Related Earnings.
Management expected net realized performance fees to decline in 2018 because newer funds were accruing carry but were not yet generating substantial realized carry. It also cautioned that high asset valuations, rising interest rates and greater market volatility could make it difficult to replicate 2017 portfolio appreciation.
Carlyle planned to expand its Global Credit platform and expected that successful execution could increase AUM and improve financial results over the following several years. The February 2018 market sell-off was identified as a potential warning sign for valuations, financing markets and future realizations.
- Performance fees are highly volatile and depend on realized exits, fund return hurdles, fair-value marks and potential giveback obligations.
- Accrued performance fees were $3.7 billion, but net accrued performance fees attributable to Carlyle Holdings were $1.7 billion and are not equivalent to immediately realizable cash.
- Accrued giveback obligations were $66.8 million. If all fund investments were deemed worthless, previously realized and distributed performance fees subject to potential giveback were approximately $0.7 billion after tax, although management viewed that scenario as remote.
- Approximately 93% of Corporate Private Equity, 86% of Real Assets, 98% of Global Credit and 97% of Investment Solutions remaining fair value was classified as Level III, involving significant valuation judgment.
- Carlyle had $3.8 billion of unfunded commitments to its funds, although approximately $3.4 billion was subscribed individually by senior professionals and other personnel.
- Legal and regulatory matters include an appeal in the CCC litigation, the Foy matter, Cobalt-related securities litigation, SEC inquiries concerning monitoring-fee acceleration and other practices, and $35 million of recorded litigation and regulatory liabilities.
- The French tax appellate court awarded a refund of approximately €105 million plus estimated interest of €12.5 million, but Carlyle had not recognized the refund pending any further appeal and receipt of funds.
- Key risks include market downturns, higher financing costs, leverage at portfolio companies, fundraising and fee pressure, personnel departures, regulatory changes, tax uncertainty, cybersecurity, conflicts of interest, litigation, foreign-exchange movements and the illiquidity of private investments.
Most Important Facts for Investors to Verify
- Reconcile GAAP net income with Distributable Earnings and determine how much 2017 earnings came from unrealized performance fees, tax remeasurement and insurance proceeds.
- Assess the cash-conversion gap between $3.7 billion of accrued performance fees and actual realized carry, including the timing of future exits and potential givebacks.
- Verify the activation schedule and fee rates for the approximately $22 billion of pending fee-earning AUM.
- Review liquidity after excluding restricted or earmarked cash, and evaluate the $3.8 billion of unfunded commitments, preferred distributions, debt maturities and tax receivable agreement payments.
- Evaluate the sustainability of 2017 valuation gains given high market multiples, rising rates and the concentration of assets in Level III valuations.
- Monitor the transition to Co-CEOs Kewsong Lee and Glenn Youngkin, founder roles, related compensation arrangements and key-person provisions in fund agreements.
- Follow the outcomes of SEC inquiries, CCC and Cobalt litigation, the French tax refund appeal and the commodities-related settlements.
- Review the impact of the 2018 adoption of revenue-recognition guidance, including the expected reclassification of carried interest from performance-fee revenue to investment income.