Business Context and Reporting Period
The filing is The Carlyle Group L.P.’s unaudited Form 10-Q for the quarter ended March 31, 2012. Historical results are presented for Carlyle Group, the predecessor entity, before the May 2012 reorganization and initial public offering. Carlyle is a global alternative asset manager operating through Corporate Private Equity, Global Market Strategies, Real Assets, and Fund of Funds Solutions.
The May 2012 IPO and reorganization are not reflected in the historical financial statements, but pro forma information is provided. Carlyle completed its IPO on May 8, 2012, issuing 30.5 million common units at $22.00 per unit and receiving approximately $619.9 million of net proceeds.
Key Financial Metrics
| Metric | Q1 2012 | Q1 2011 | Change |
|---|---|---|---|
| Total revenue | $1,110.9 million | $1,317.3 million | Down 16% |
| Fund management fees | $234.4 million | $228.0 million | Up 3% |
| Performance fees | $640.8 million | $874.7 million | Down 27% |
| Investment income | $21.5 million | $41.4 million | Down 48% |
| Income before taxes | $1,505.8 million | $772.3 million | Up 95% |
| Net income | $1,494.1 million | $766.2 million | Up 95% |
| Net income attributable to Carlyle Group | $629.2 million | $896.2 million | Down 30% |
| Economic Net Income | $392.1 million | $533.4 million | Down 26% |
| Fee Related Earnings | $34.0 million | $40.2 million | Down 15% |
| Distributable Earnings | $178.8 million | $283.9 million | Down 37% |
| Net cash provided by operating activities | $479.9 million | $772.7 million | Down 38% |
| Cash and cash equivalents | $523.2 million | $596.8 million | Period-end balance |
Net income attributable to Carlyle represented approximately 56.6% of total revenue; this ratio is not a conventional operating margin because consolidated fund gains, non-controlling interests, and partnership accounting materially affect the presentation. The company’s non-GAAP segment revenue margin based on Economic Net Income was approximately 43.9% in Q1 2012, compared with 46.3% in Q1 2011.
Assets Under Management and Liquidity
- Total AUM was $159.2 billion at March 31, 2012, up from $147.0 billion at December 31, 2011.
- Fee-earning AUM was $117.0 billion, up from $111.0 billion at December 31, 2011 and $81.6 billion at March 31, 2011.
- Approximately $40.0 billion of capital was available for investment at March 31, 2012.
- Cash provided by operating activities was $479.9 million; investing activities used $48.2 million and financing activities used $424.8 million.
- Operating-entity cash was $523.2 million. The additional $1.4 billion of cash held at Consolidated Funds was not available for Carlyle’s general liquidity needs.
Debt and Balance Sheet
- Total assets were $29.2 billion and total liabilities were $17.1 billion at March 31, 2012. Consolidated Funds accounted for much of the increase from December 31, 2011 and are generally non-recourse to Carlyle.
- Operating-company loans payable were $1.1 billion, consisting principally of a $500 million term loan, $568.1 million drawn under a revolving credit facility, and a $40 million Claren Road acquisition loan.
- All $500 million of subordinated notes payable to Mubadala had been redeemed by March 31, 2012.
- Consolidated CLO borrowings totaled $13.98 billion of principal, with a fair value of $12.45 billion; these obligations are collateralized by CLO assets and are generally non-recourse to Carlyle.
- After the IPO, the company repaid the $568.1 million revolving-credit balance and the $40 million Claren Road loan. As of May 21, 2012, $500 million remained outstanding under the new term loan and $735.7 million of revolving capacity was available, including $14.3 million reserved for an employee investment-loan guarantee.
Material Changes Versus the Prior Comparable Period
- Revenue declined primarily because performance fees fell $233.9 million, reflecting the absence of the prior-year catch-up in Carlyle Partners V and lower performance fees in Corporate Private Equity and Global Market Strategies.
- Fund management fees increased due primarily to the 2011 acquisitions of ESG and AlpInvest, higher Claren Road AUM, and acquired CLO management contracts. Transaction and portfolio advisory fees declined to $10.7 million from $31.1 million.
- Consolidated fund investment gains changed from a $184.3 million loss to an $872.1 million gain, largely due to fair-value gains in AlpInvest vehicles and CLOs. Most of this result was attributable to non-controlling interests and did not materially benefit Carlyle’s attributable earnings.
- Economic Net Income, Fee Related Earnings, and Distributable Earnings declined despite higher GAAP net income, highlighting the effect of consolidated-fund accounting and non-controlling interests.
- Consolidated fund assets rose to $24.8 billion from $20.5 billion, while consolidated-fund liabilities rose to $13.8 billion from $10.4 billion, primarily because of newly consolidated funds and CLOs.
- Fee-earning AUM benefited from the acquisition of four European CLO management contracts with approximately $2.9 billion of AUM, completed February 28, 2012 for approximately €32.4 million.
Outlook, Commentary, Risks and Unusual Items
- Management expected continued fundraising, capital deployment, and growth in complementary businesses, but stated that results depend on market conditions, investment realizations, fundraising, and investor demand.
- Management anticipated higher compensation and general and administrative expenses in 2012 due to additional personnel, public-company infrastructure, acquisitions, and expanded reporting, legal, accounting, and insurance requirements.
- Management noted that management fees may decline as older funds move beyond their investment periods, fee rates step down, and distributions reduce fee-earning invested capital.
- Performance fees are highly volatile, include unrealized fair-value amounts, and may be reversed. Accrued performance fees were $2.49 billion at March 31, 2012, compared with $89.2 million of accrued giveback obligations.
- If all fund investments were deemed worthless at March 31, 2012, previously realized and distributed carried interest subject to potential giveback would have been $961.4 million on an after-tax basis, although management considered this scenario remote.
- The May 2012 reorganization changes the treatment of senior professional compensation from equity distributions to compensation expense. Pro forma results include additional compensation and equity-based compensation costs; a nonrecurring approximately $58.4 million charge related to the exchange of carried-interest interests was expected in Q2 2012.
- Pro forma results also reflect a proposed quarterly distribution of $0.16 per common unit, with the first payment reduced for the portion of the quarter following the IPO. Distribution decisions remain at the general partner’s discretion.
- Material risks include investment valuation uncertainty, reliance on performance fees, private-market illiquidity, leverage and credit risk, foreign exchange and geopolitical exposure, regulatory scrutiny, tax disputes, litigation, and potential clawbacks of carried interest.
- Outstanding legal and regulatory matters include Carlyle Capital Corporation-related litigation, a DOJ antitrust inquiry, the Foy v. Austin Capital matter, and proposed French and Italian tax assessments relating to a non-consolidated real estate fund. The filing states that potential losses generally cannot be estimated and are not expected by management to be probable or material, but some matters remain unresolved.
- As a newly public company, Carlyle entered into a tax receivable agreement requiring corporate taxpayers to pay eligible former owners 85% of certain realized tax savings. Payments could be substantial and may exceed actual cash tax savings under specified circumstances.
Most Important Facts for Investors to Verify
- Reconcile GAAP net income of $1.49 billion and attributable income of $629.2 million with non-GAAP Economic Net Income of $392.1 million and Distributable Earnings of $178.8 million.
- Assess the sustainability of the $117.0 billion fee-earning AUM base, including fund fee step-downs, realizations, distributions, fundraising, and the effect of acquisitions.
- Review the post-IPO capital structure, including the $500 million term loan, available revolver capacity, leverage covenant, tax receivable agreement, and unit exchanges by pre-IPO owners.
- Evaluate the sensitivity of accrued performance fees and potential giveback obligations to changes in private-market valuations and fund-level investment performance.
- Separate Carlyle operating-company liquidity from cash, assets, debt, and investment gains belonging to consolidated funds that are not available to Carlyle or generally recourse to it.
- Monitor the accounting and cash-flow impact of treating senior professional compensation and newly granted equity awards as expenses after the IPO.
- Track unresolved litigation, regulatory inquiries, tax assessments, indemnification exposure, $1.33 billion of unfunded commitments, and the company’s ability to fund future investments and distributions.