Business context and reporting period
The filing is The Carlyle Group L.P.’s unaudited Form 10-Q for the quarter and six months ended June 30, 2016. Carlyle is a global alternative asset manager operating through Corporate Private Equity, Global Market Strategies, Real Assets and Investment Solutions. The filing identifies the registrant as The Carlyle Group L.P., although the request metadata refers to Carlyle Group Inc.
Effective January 1, 2016, Carlyle adopted revised consolidation guidance and deconsolidated most previously consolidated funds. This materially reduced reported assets, liabilities and fund-level income and expenses, but did not affect net income attributable to Carlyle.
Key financial metrics
| Metric | Q2 2016 | Q2 2015 | Six months 2016 | Six months 2015 |
|---|---|---|---|---|
| Total revenue | $608.0 million | $856.1 million | $1,091.1 million | $1,992.9 million |
| Fund management fees | $272.5 million | $282.3 million | $562.0 million | $551.8 million |
| Total performance fees | $210.9 million | $294.9 million | $356.1 million | $867.9 million |
| Investment income | $65.3 million | $9.2 million | $55.7 million | $16.0 million |
| Income before taxes | $67.8 million | $474.1 million | $83.1 million | $1,089.4 million |
| Net income attributable to Carlyle | $6.1 million | $30.6 million | $14.5 million | $70.1 million |
| Basic earnings per common unit | $0.07 | $0.42 | $0.18 | $0.99 |
| Distributions declared per common unit | $0.26 | $0.33 | $0.55 | $1.94 |
Approximate pretax margins were 11.2% in Q2 2016 and 7.6% for the first six months, compared with 55.4% and 54.7%, respectively, in the comparable 2015 periods. The decline primarily reflects lower performance fees and the absence of large consolidated-fund gains recorded in 2015. Fee Related Earnings were $44.9 million in Q2 and $95.9 million for the first six months, compared with $47.3 million and $98.5 million, respectively. Distributable Earnings were $287.5 million in Q2 and $416.1 million for the first six months, compared with $386.1 million and $533.7 million.
- Fee-earning AUM was $125.3 billion at June 30, 2016, down from $130.0 billion a year earlier. Total AUM was $175.6 billion, including $55.1 billion of available capital.
- Cash and cash equivalents were $807.3 million, supplemented by $62.6 million of corporate treasury investments. Management stated that approximately $811 million remained available after amounts allocated for specific purposes, subject to ordinary-course payables and reserves.
- Debt obligations were $1.277 billion, including $1.1 billion of senior notes, a $120.0 million NGP promissory note and other term loans. The $750.0 million revolving credit facility was undrawn.
- Six-month operating cash flow was negative $394.0 million, compared with positive $3.297 billion in 2015, primarily because consolidated-fund investment purchases exceeded sales and settlements. Excluding consolidated funds, operating cash flow was positive $34.8 million, compared with $1.324 billion in 2015.
- Total assets were $9.586 billion and total liabilities were $7.800 billion at June 30, 2016. These balances are not directly comparable with December 31, 2015 because of deconsolidation.
Material changes versus the prior comparable period
- Revenue declined 29% in Q2 and 45% for the first six months. Performance fees decreased $84.0 million in Q2 and $511.8 million for the first six months, reflecting fewer exits, lower appreciation in Corporate Private Equity and different fund-level carry dynamics.
- Corporate Private Equity distributable earnings declined to $235.1 million in Q2 and $339.6 million for the first six months, from $345.1 million and $539.0 million. Lower realized net performance fees were the principal driver.
- Real Assets improved materially: six-month distributable earnings increased to $58.5 million from a loss of $25.1 million, primarily because of stronger real estate performance and the absence of the prior-year French tax-related loss.
- Global Market Strategies generated Q2 distributable earnings of $6.7 million, up from $4.0 million, but six-month distributable earnings declined to $7.5 million from $12.5 million. Fee-earning AUM declined to $28.7 billion from $31.3 billion, mainly due to hedge-fund redemptions.
- Investment Solutions distributable earnings increased to $6.7 million in Q2 and $10.5 million for the first six months, while fee-earning AUM fell 10% year over year to $27.2 billion.
- Carlyle began winding down DGAM’s fund-of-hedge-funds and liquid-alternative initiatives, recording $8.9 million of restructuring expenses for the first six months and estimating an additional $1.8 million of wind-down costs.
- The company repurchased 2.252 million units for $36.2 million during the first six months under a $200 million authorization.
Guidance, outlook, risks and unusual items
- No broad corporate earnings guidance is provided. Management expects Global Market Strategies to operate at a Fee Related Earnings loss for the balance of 2016 while it reviews and potentially restructures the segment.
- Management expects available liquidity to fund capital needs for at least the next twelve months. Carlyle expects approximately $40.2 billion of remaining carry-fund dry powder and $55.1 billion across the firm.
- Management described market conditions as supportive for realizations but challenging for new investments. Carlyle reported $5.3 billion of proceeds and $2.9 billion of investments during Q2. Brexit-related volatility could affect valuations, particularly for investments with significant U.K. or European operations.
- Accrued performance fees were $2.867 billion, offset by $222.8 million of accrued giveback obligations. Previously recognized carried interest may be clawed back if fund values decline; the filing estimates potential after-tax giveback of approximately $1.7 billion under an extreme liquidation scenario.
- Urbplan, a consolidated Brazilian real estate VIE, was in technical default or covenant noncompliance on substantially all of its loans. Its debt was contractually non-recourse to Carlyle, but management estimated that up to $45 million of additional funding could be required over the following twelve months. Carlyle and senior professionals had funded $355.7 million cumulatively through June 30, 2016.
- The filing reports a $1.0 billion damages claim in the Carlyle Capital Corporation litigation, ongoing regulatory inquiries, and $62 million of accrued litigation and regulatory contingencies. Management did not believe existing matters were probable to have a material effect, but acknowledged that adverse outcomes could be material in a particular period.
- Carlyle expects to contribute approximately $750 million to new CLOs over the next five years to comply with U.S. risk-retention rules effective December 24, 2016. The eventual allocation between Carlyle, professionals and limited-recourse borrowing remains uncertain.
- The filing notes an auditor-independence matter involving an Ernst & Young foreign affiliate that provided services to a portfolio company. The services were being transitioned away, and management, the audit committee and EY concluded that audit independence was not impaired.
- Adoption of the future revenue standard could materially delay performance-fee recognition. The filing also identifies significant valuation judgment because much of Carlyle’s portfolio is measured using Level III inputs.
Most important facts for investors to verify
- Reconcile GAAP net income with Fee Related Earnings and Distributable Earnings, and review the impact of deconsolidation on year-over-year comparability.
- Track fee-earning AUM, hedge-fund redemption requests, fundraising, distributions and the conversion of funds from commitment-based to invested-capital fee bases.
- Assess the sustainability and realizability of the $2.867 billion accrued performance-fee balance after employee compensation, taxes, non-controlling interests and giveback obligations.
- Review Global Market Strategies’ expected 2016 FRE losses, restructuring costs and continuing AUM declines.
- Evaluate liquidity after the $2.975 billion of unfunded fund commitments, debt service, distributions, unit repurchases, tax receivable agreement payments and potential Urbplan funding.
- Monitor Urbplan covenant defaults, lender negotiations, additional funding needs and possible litigation or impairment exposure.
- Review the status and potential exposure of the Carlyle Capital Corporation litigation, regulatory inquiries, French tax appeal and commodities-related disputes.