Business Context and Reporting Period
The filing is The Carlyle Group L.P.’s unaudited Form 10-Q for the three months ended March 31, 2015, filed May 7, 2015. Carlyle is a global alternative asset manager operating through Corporate Private Equity, Global Market Strategies, Real Assets, and Investment Solutions. The financial statements consolidate certain Carlyle funds, CLOs, and Urbplan, which materially gross up reported assets, liabilities, revenues, expenses, and cash flows but generally do not affect net income attributable to Carlyle.
At March 31, 2015, total assets under management were approximately $192.7 billion, including $129.4 billion of fee-earning AUM, compared with $142.1 billion of fee-earning AUM at March 31, 2014. Common units outstanding were 68.9 million at April 30, 2015.
Financial Performance and Key Metrics
| Metric | Q1 2015 | Q1 2014 | Change |
|---|---|---|---|
| Total revenues | $1,136.8 million | $1,147.4 million | Down 1% |
| Fund management fees | $269.5 million | $260.3 million | Up 4% |
| Total performance fees | $573.0 million | $620.5 million | Down 8% |
| Total expenses | $1,027.0 million | $1,099.0 million | Down 7% |
| Income before taxes | $615.3 million | $472.4 million | Up 30% |
| Net income | $604.8 million | $456.4 million | Up 33% |
| Net income attributable to Carlyle | $39.5 million | $24.6 million | Up 61% |
| Basic earnings per common unit | $0.58 | $0.46 | Up 26% |
| Diluted earnings per common unit | $0.54 | $0.41 | Up 32% |
| Distributions declared per common unit | $1.61 | $1.40 | Up 15% |
| Fee-related earnings | $51.2 million | $37.2 million | Up 38% |
| Distributable earnings | $147.6 million | $182.6 million | Down 19% |
| Economic net income | $272.7 million | $311.7 million | Down 13% |
Reported net income margins were approximately 53% in Q1 2015 versus 40% in Q1 2014, but these margins are heavily affected by consolidated-fund accounting and are not representative of Carlyle’s operating economics. Net income attributable to Carlyle represented approximately 3.5% of consolidated revenue, compared with 2.1% in the prior-year period.
Operating cash flow was $1,475.0 million, compared with $989.8 million in Q1 2014. Consolidated cash flow includes substantial fund-level activity, including $2.1 billion of consolidated-fund investment purchases and $2.0 billion of sales and settlements. Cash and cash equivalents held by Carlyle operating entities were $1,024.8 million at March 31, down from $1,242.0 million at December 31, 2014. Management estimated approximately $840 million remained after amounts allocated for specific purposes.
Operating-entity debt consisted principally of $500.0 million of 3.875% senior notes due 2023, $600.0 million of 5.625% senior notes due 2043, and approximately $38.4 million of loans payable. No revolving credit facility borrowings were outstanding at March 31, 2015; $750 million remained available. Consolidated CLO borrowings were $16.6 billion and generally non-recourse to Carlyle.
Material Changes Versus the Prior Comparable Period
- Management fees increased because of newly raised funds entering investment periods and catch-up fees, partly offset by fee-basis step-downs, lower hedge-fund AUM, distributions, and foreign exchange effects.
- Performance fees declined primarily because hedge funds remained below high-water marks. Carlyle’s carry-fund portfolio appreciated approximately 6%, with private investments up 2% and public investments up 15%.
- Corporate Private Equity was the strongest segment: ENI increased to $289.0 million from $258.4 million and distributable earnings increased to $193.9 million from $147.7 million.
- Global Market Strategies weakened: ENI declined to $9.6 million from $56.2 million, primarily because of $2.1 billion of hedge-fund redemptions, lower performance fees, and foreign-exchange-related investment losses.
- Real Assets reported ENI of negative $33.4 million versus negative $16.5 million. Distributable earnings fell to negative $61.7 million, largely because of the French tax matter and related realized investment losses.
- Investment Solutions ENI declined to $7.5 million from $13.6 million, primarily due to euro depreciation and lower performance fees.
- Equity-based compensation increased to $89.9 million from $74.2 million, including a $7.5 million cumulative catch-up from revised forfeiture assumptions.
- Economic net income and distributable earnings declined despite higher GAAP net income, reflecting lower net performance fees and an $82.0 million realized investment loss in the segment reporting results.
- Fee-earning AUM declined to $129.4 billion from $142.1 billion year over year, driven mainly by foreign exchange, distributions, fee-basis changes, and hedge-fund redemptions.
Guidance, Outlook, Risks, Contingencies, and Unusual Items
The filing does not provide formal full-year earnings guidance. Management described slowing U.S. economic growth, elevated asset valuations, lower interest rates, a stronger U.S. dollar, weaker energy-related capital spending, and continuing market volatility. Carlyle invested approximately $1.5 billion and realized approximately $4.6 billion from 102 investments during the quarter, but stated that future investment and exit activity may accelerate or be delayed depending on market conditions and regulatory reviews.
- Urbplan: The Brazilian real estate VIE had approximately $214.8 million of loan principal, $139.6 million of fair-value debt, and was generally in covenant default or technical default. No acceleration notices were outstanding, and the debt was contractually non-recourse to Carlyle. Urbplan was estimated to require approximately $90 million of additional capital over the following 12 months; Carlyle and its professionals expected to provide additional funding, although no contractual funding obligation existed.
- French tax matter: On April 15, 2015, a French tax court issued an adverse opinion against CEREP I for approximately €105 million, including interest. Carlyle stated that it would appeal, but expected to fund approximately €74 million after CEREP I’s assets. A $34 million loss was recognized in Q1 2015.
- Giveback exposure: Accrued giveback obligations were $176.6 million. If all fund investments were deemed worthless, potential after-tax giveback exposure could be approximately $1.4 billion, although management viewed that scenario as remote.
- Contingent consideration: Maximum potential cash obligations related to acquisitions and the NGP investment were $714.8 million, with $395.4 million recognized as liabilities. The NGP-related $183.0 million obligation was expected to be payable in early 2016 if performance conditions were met.
- Commitments: Unfunded commitments to Carlyle funds totaled $3.1 billion, of which approximately $2.8 billion was subscribed by senior professionals and other individuals. Operating-entity contractual obligations totaled approximately $3.6 billion, excluding consolidated-fund and Urbplan obligations.
- Litigation: A settlement of the “club bids” antitrust litigation was approved in March 2015. Other proceedings included the New Mexico placement-agent matter and a Guernsey lawsuit related to Carlyle Capital Corporation seeking $1.0 billion in damages. Management did not believe existing proceedings were probable to have a material effect, but acknowledged that adverse outcomes could materially affect a particular period.
- Credit facility amendment: On May 5, 2015, Carlyle extended the senior credit facility maturity from August 2018 to May 2020, revised the management-fee-earning-assets covenant to a $65.3 billion minimum, permitted deduction of unrestricted cash from indebtedness, and reduced the ratings-based pricing grid.
- Accounting changes: ASU 2015-2 and ASU 2014-13 become effective in 2016 and may change consolidation and CLO measurement presentations. The company also stated that pending revenue-recognition guidance could materially delay performance-fee recognition.
Most Important Facts for Investors to Verify
- Reconcile GAAP net income with fee-related earnings, economic net income, and distributable earnings; these measures produced materially different trends.
- Assess the sustainability and realizability of the $3.8 billion accrued performance-fee balance, including the $176.6 million giveback accrual and potential $1.4 billion downside exposure.
- Monitor fee-earning AUM, hedge-fund redemptions, foreign exchange effects, and the transition of funds from commitment-based to invested-capital fee bases.
- Review the French tax appeal, the expected €74 million Carlyle funding obligation, and the continuing investigation.
- Evaluate Urbplan’s covenant defaults, expected $90 million capital requirement, potential impairments, and any claims against Carlyle despite contractual non-recourse provisions.
- Verify liquidity available at the operating-company level rather than relying on consolidated cash, which includes amounts unavailable to Carlyle and fund-level cash.
- Review future distributions against distributable earnings, tax receivable agreement payments, capital commitments, contingent consideration, debt service, and giveback requirements.
- Consider the substantial use of Level III valuations and the sensitivity of reported performance fees and investment values to market multiples, discount rates, default rates, recovery rates, and foreign exchange.