Carlyle Group L.P. 10-Q Summary — Third Quarter 2012
Business context and reporting period
The filing covers the quarter and nine months ended September 30, 2012. Carlyle is a global alternative asset manager operating through Corporate Private Equity, Global Market Strategies, Real Assets, and Fund of Funds Solutions. The company completed its reorganization and initial public offering in May 2012; therefore, year-over-year comparisons are affected by changes in ownership, compensation accounting, taxes, consolidation, and the new public-company structure.
- Fee-earning AUM was $115.1 billion, compared with $112.6 billion at September 30, 2011.
- Total AUM was $157.4 billion at September 30, 2012, including $39.4 billion of available capital.
- Management stated that approximately 16% of AUM was represented by consolidated funds, whose assets and liabilities are generally non-recourse to Carlyle.
Financial performance and key metrics
| Metric | Three months ended September 30 | Nine months ended September 30 |
|---|---|---|
| Total revenue | $858.5 million, versus $(59.6) million in 2011 | $2.218 billion, versus $2.014 billion in 2011 |
| Fund management fees | $239.8 million, up 2% | $714.1 million, up 5% |
| Total performance fees | $356.3 million, versus $(483.9) million | $776.7 million, versus $736.5 million |
| Income before taxes | $602.5 million, versus $(619.2) million | $2.294 billion, versus $470.4 million |
| Net income | $597.0 million, versus $(632.1) million | $2.267 billion, versus $444.7 million |
| Net income attributable to Carlyle Group L.P. | $18.6 million; $0.43 basic and $0.40 diluted per unit | $8.3 million for the post-IPO period; pro forma $33.5 million, or $0.91 basic and $0.85 diluted per unit |
| Economic Net Income | $218.5 million, versus $(191.3) million | $553.4 million, versus $578.9 million |
| Fee Related Earnings | $45.5 million, versus $36.6 million | $115.0 million, versus $107.5 million |
| Distributable Earnings | $206.3 million, versus $243.8 million | $500.4 million, versus $617.0 million |
Reported GAAP margins were heavily affected by consolidated funds and non-controlling interests. Income before tax was approximately 70% of revenue in the third quarter and approximately 103% for the nine-month period; these percentages are not representative of underlying operating margins because consolidated-fund gains and losses are included in revenue and other income.
- Third-quarter performance fees benefited from approximately 3% appreciation in underlying fund values, compared with approximately 6% depreciation in the prior-year quarter.
- Corporate Private Equity generated $350.8 million of third-quarter performance fees and $597.7 million for the nine-month period.
- Compensation and benefits increased to $393.6 million in the third quarter and $767.3 million for nine months, including $53.2 million and $147.4 million, respectively, of equity-based compensation following the IPO and reorganization.
- Accrued performance fees were $2.153 billion at September 30, 2012, while accrued giveback obligations were $86.1 million.
Cash flow, debt, and liquidity
- Cash provided by operating activities was $2.052 billion for the nine months, compared with $1.963 billion in 2011. This figure includes substantial consolidated-fund activity and is not equivalent to cash generated by Carlyle’s operating entities alone.
- Cash used in investing activities was $70.6 million; cash used in financing activities was $1.725 billion.
- Cash and cash equivalents attributable to Carlyle were $769.2 million at September 30, 2012, up from $509.6 million at December 31, 2011. The additional $1.425 billion held at consolidated funds was not available for Carlyle’s general liquidity needs.
- Carlyle had $500.0 million of term debt outstanding and no revolving borrowings. The new senior credit facility includes a $750.0 million revolving facility and matures September 30, 2016.
- The facility requires management fee-earning assets of at least $53.0 billion plus 70% of future acquired AUM and a total debt leverage ratio below 3.0 to 1.0. Carlyle reported compliance with all debt covenants.
- The IPO generated $615.8 million of net proceeds, which were used principally to repay revolving debt and the Claren Road acquisition loan. Mubadala subordinated notes were fully redeemed in March 2012.
Material changes versus the prior comparable period
- Third-quarter results reversed the substantial performance-fee and investment losses reported in the third quarter of 2011, primarily because of improved fund valuations.
- Nine-month total revenue increased 10%, but the improvement in GAAP net income was driven disproportionately by consolidated-fund investment gains and changes in fair value.
- Fee Related Earnings improved 7% for nine months, while Distributable Earnings declined 19%, reflecting lower realized performance fees and realized investment income.
- Fee-earning AUM increased modestly overall, but mix changes were material: Corporate Private Equity declined to $36.9 billion, Real Assets declined to $19.6 billion, Global Market Strategies increased to $28.5 billion, and Fund of Funds Solutions was $30.2 billion.
- Compensation accounting changed after the IPO: senior professional compensation is now recorded as expense rather than as distributions from equity. This limits direct comparison with pre-IPO periods.
Guidance, outlook, risks, and unusual items
- No formal earnings guidance was provided in the filing. Management expected compensation and general and administrative expenses to increase as Carlyle expanded staff, infrastructure, and public-company reporting capabilities.
- Management expected future distributions to be based substantially on Distributable Earnings, subject to capital needs, investment opportunities, contractual restrictions, taxes, and the discretion of the general partner.
- Management identified fundraising, investment performance, realizations, deployment of available capital, valuation levels, credit availability, interest rates, foreign exchange, Eurozone conditions, and investor liquidity requirements as important business drivers.
- Carried interest is volatile and may be reversed or subject to giveback obligations. If all fund investments became worthless, previously distributed carried interest potentially subject to giveback was estimated at approximately $1.1 billion after tax.
- Carlyle had $2.064 billion of unfunded commitments to its funds; approximately $1.93 billion was subscribed individually by senior professionals and other personnel, with the balance funded directly by Carlyle.
- CEREP I faced a French tax assessment of approximately €97 million and proposed Italian tax adjustments of approximately €24 million. Carlyle provided credit support for a €45.7 million French assessment and stated that any unrecoverable cost was not estimable.
- Material litigation included CCC-related claims, a Guernsey liquidators’ action seeking $1.0 billion, and an antitrust class action. Management stated that material losses were not probable or estimable, but outcomes remained uncertain.
- Subsequent events included the October 1 acquisition of 55% of Vermillion Asset Management, with approximately $2.2 billion of AUM, an $18.5 million insurance settlement related to CCC litigation, and a declared November distribution of $0.16 per common unit.
Most important facts for investors to verify
- Reconcile GAAP net income with Economic Net Income, Fee Related Earnings, and Distributable Earnings; these measures differ materially because of consolidated funds, non-controlling interests, performance-fee volatility, and IPO-related compensation.
- Assess the sustainability of $2.153 billion of accrued performance fees and the potential for future reversals or givebacks.
- Review the liquidity impact of $2.064 billion of unfunded commitments, tax receivable agreement payments, capital requirements, and distributions.
- Confirm that the company continues to satisfy the senior credit facility’s AUM and leverage covenants.
- Evaluate the effect of fund investment-period expirations and distributions on future fee-earning AUM and management-fee revenue.
- Review valuation assumptions for Level III assets, which represented approximately $20.5 billion of fair-valued consolidated-fund assets and depend significantly on unobservable inputs.
- Monitor the CEREP tax matters, CCC litigation, antitrust proceedings, and the terms and integration of the Vermillion acquisition.