Business Context and Reporting Period
The filing is The Carlyle Group L.P.’s unaudited Form 10-Q for the quarter and nine months ended September 30, 2013. Carlyle is a global alternative asset manager operating through Corporate Private Equity, Global Market Strategies, Real Assets and Solutions. The financial statements consolidate certain investment funds, CLOs and variable-interest entities, creating significant gross-up effects that generally do not change income attributable to Carlyle.
- Total AUM was $185.0 billion and fee-earning AUM was $137.9 billion at September 30, 2013.
- Fee-earning AUM increased 20% from $115.1 billion at September 30, 2012, driven by fundraising, investment activity, acquisitions, market appreciation and foreign exchange.
- Carlyle raised $18.3 billion of new capital commitments during the first nine months of 2013 and realized $11.0 billion for carry-fund investors.
Key Financial Metrics
| Metric | Three months ended September 30 | Nine months ended September 30 |
|---|---|---|
| Total revenues | $888.1 million, versus $858.5 million | $2.802 billion, versus $2.218 billion |
| Fund management fees | $257.9 million, versus $239.8 million | $731.5 million, versus $714.1 million |
| Total performance fees | $320.5 million, versus $356.3 million | $1.222 billion, versus $776.7 million |
| Income before taxes | $(8.6) million, versus $602.5 million | $729.7 million, versus $2.294 billion |
| Net income attributable to Carlyle Group L.P. | $2.3 million, versus $18.6 million | $32.8 million, versus $8.3 million |
| Basic earnings per common unit | $0.04, versus $0.43 | $0.72, versus $0.20 |
| Economic Net Income | $194.5 million, versus $218.5 million | $744.2 million, versus $553.4 million |
| Distributable Earnings | $104.7 million, versus $206.9 million | $438.7 million, versus $501.6 million |
| Fee-Related Earnings | $40.1 million, versus $45.5 million | $102.7 million, versus $115.0 million |
Quarterly GAAP income before taxes was negative because a $82.0 million net loss from Consolidated Funds was recorded, along with higher compensation and administrative expenses. The consolidated quarterly net margin attributable to the Partnership was approximately 0.3%; the nine-month margin was approximately 1.2%. These margins are heavily affected by consolidation, noncontrolling interests, unrealized valuation changes and unusual items.
- Quarterly compensation and benefits expense was $441.8 million, including $78.7 million of equity-based compensation and $158.9 million of performance-fee-related compensation.
- Nine-month compensation and benefits expense was $1.420 billion, including $257.0 million of equity-based compensation.
- Operating cash flow for the nine months was $2.557 billion, versus $2.052 billion in 2012. Cash flow included substantial Consolidated Fund activity and non-cash performance fees.
- Cash and cash equivalents held by Carlyle were $855.7 million at September 30, 2013, excluding $1.495 billion held at Consolidated Funds that was not available for Carlyle’s general liquidity needs.
- Operating-entity debt consisted primarily of $25.0 million of term-loan borrowings and $900.0 million of senior notes, with carrying value of $923.2 million. The revolving facility had no outstanding balance and $750.0 million of availability.
- Consolidated Fund loans payable were $15.071 billion and were generally non-recourse to Carlyle. Consolidated real-estate VIE debt had a $335.1 million principal amount and $123.8 million fair value.
Material Changes Versus the Prior Comparable Period
- For the quarter, revenue increased 3%, but income before taxes fell from $602.5 million to a loss of $8.6 million. The principal driver was the change in Consolidated Funds from a $448.9 million gain to an $82.0 million loss.
- For the nine months, revenue increased 26%, led by a $445.3 million increase in performance fees and a $144.9 million increase in Consolidated Fund interest and other income.
- Nine-month GAAP earnings declined sharply because 2012 benefited from $1.708 billion of Consolidated Fund investment gains, compared with $420.1 million in 2013, while 2013 incurred materially higher compensation and administrative costs.
- Fee-related earnings declined despite higher management fees because of fundraising costs, higher general and administrative expenses, higher interest expense and the effect of management-fee step-downs as certain funds moved from commitments to invested capital.
- Distributable Earnings declined 12% for the nine months, primarily because realized net performance fees and realized investment income decreased.
- Carlyle acquired the remaining 40% of AlpInvest on August 1, 2013 for 2,887,970 common units and approximately $6.0 million in cash, giving Carlyle 100% economic ownership of AlpInvest.
- The company issued $500.0 million of 3.875% senior notes due 2023 and $400.0 million of 5.625% senior notes due 2043, using proceeds in part to repay its revolving facility and term loan.
- Certain intangible assets were impaired by $20.8 million in the third quarter, and amortization expense increased because of prior acquisitions.
Guidance, Outlook, Risks, Contingencies and Unusual Items
- Management expected fundraising to remain strong through the rest of 2013 and into 2014, but stated that the investment pipeline was less robust than anticipated and no longer expected 2013 investment activity to exceed 2012.
- Management identified risks from competitive fundraising, lower management fees following fund investment-period expirations, market valuations, investment performance, realization timing, interest rates, foreign exchange, credit conditions and the use of significant fair-value estimates.
- Performance fees are volatile, substantially dependent on unrealized valuations and subject to future reversal or giveback. Accrued performance fees were $2.878 billion, against accrued giveback obligations of $48.7 million. Potential realized carried-interest giveback could reach approximately $1.0 billion if fund investments were deemed worthless, although management considered that scenario remote.
- Carlyle began consolidating Urbplan, a Brazilian real-estate development company, at September 30, 2013. Urbplan had $234.1 million of preliminary consolidated assets and liabilities, including $123.8 million of debt at fair value. Carlyle’s investments in Urbplan were estimated to have a fair value of zero.
- Urbplan was in technical default or out of compliance with substantially all debt covenants and was negotiating with lenders, including an extension of $24.2 million maturing in 2013. Management estimated that Urbplan could require approximately $200 million of additional funding, although Carlyle had no contractual obligation to provide it.
- Carlyle and senior professionals funded $32.0 million into Urbplan through September 30, 2013, including $6.4 million from Carlyle, and funded an additional $18.0 million after quarter-end, including $3.6 million from Carlyle.
- Carlyle had $2.722 billion of unfunded commitments to its funds, approximately $2.5 billion of which was subscribed individually by senior professionals and other employees.
- Material legal and tax matters included antitrust litigation, claims related to Carlyle Capital Corporation, New Mexico placement-agent litigation and a French tax assessment involving CEREP I. The filing states that loss amounts generally could not be estimated and that management did not believe existing matters were probable to materially affect Carlyle.
- After quarter-end, Carlyle borrowed approximately $17.2 million to fund a CLO investment, acquired Metropolitan Real Estate Equity Management for approximately $12.8 million in cash and 67,338 common units, and declared a $0.16 per-unit quarterly distribution.
Important Facts for Investors to Verify
- Reconcile GAAP results with Economic Net Income, Fee-Related Earnings and Distributable Earnings; these non-GAAP measures exclude or adjust for significant items.
- Assess the sustainability of performance fees, particularly the large accrued balance, reliance on unrealized valuations and potential giveback exposure.
- Separate Carlyle’s $855.7 million of available cash from cash and assets held by Consolidated Funds and the Urbplan VIE.
- Monitor Urbplan’s lender negotiations, required future funding, preliminary valuations, covenant defaults and potential claims against Carlyle.
- Evaluate management-fee pressure from expired investment periods, fee-rate step-downs and the timing of successor-fund fundraising.
- Review the effects of AlpInvest’s full acquisition, subsequent Metropolitan acquisition, equity issuance and continuing equity-based compensation on ownership and per-unit economics.
- Verify the status and potential exposure of the antitrust, CCC-related, New Mexico and French tax matters, as the filing does not provide clear probable-loss estimates.