Business Context and Reporting Period
The Carlyle Group L.P. is a global alternative asset manager operating through Corporate Private Equity, Global Market Strategies, Real Assets and Investment Solutions. This unaudited Form 10-Q covers the three and nine months ended September 30, 2016, with comparisons to the corresponding 2015 periods.
Beginning January 1, 2016, Carlyle adopted revised consolidation guidance and deconsolidated most previously consolidated investment funds. This materially reduced reported assets, liabilities, revenue and expenses without affecting net income attributable to Carlyle or the Partnership. The filing reports approximately $169.1 billion of total AUM and $123.8 billion of fee-earning AUM at September 30, 2016.
Key Financial Metrics
| Metric | Q3 2016 | Q3 2015 | 9M 2016 | 9M 2015 |
|---|---|---|---|---|
| Total revenues | $607.3 million | $297.5 million | $1,698.4 million | $2,290.4 million |
| Fund management fees | $255.1 million | $278.3 million | $817.1 million | $830.1 million |
| Total performance fees | $214.7 million | $(246.6) million | $570.8 million | $621.3 million |
| Investment income | $70.5 million | $(9.5) million | $126.2 million | $6.5 million |
| Total expenses | $661.8 million | $795.3 million | $1,668.1 million | $2,665.9 million |
| Income before taxes | $(49.7) million | $(529.1) million | $33.4 million | $560.3 million |
| Net income attributable to Carlyle Group L.P. | $0.8 million | $(83.9) million | $15.3 million | $(13.8) million |
| Basic earnings per common unit | $0.01 | $(1.05) | $0.19 | $(0.19) |
| Distributable Earnings | $228.2 million | $243.7 million | $644.3 million | $777.4 million |
| Fee Related Earnings | $30.8 million | $57.3 million | $126.7 million | $155.8 million |
Q3 total revenue more than doubled year over year, primarily because Q3 2015 included substantial unrealized performance-fee reversals. Nine-month revenue declined 26%, largely because of deconsolidation-related reductions in consolidated-fund income and lower performance fees.
Reported operating margins are not especially informative because consolidated fund activity is largely attributable to non-controlling investors. On a non-GAAP segment basis, Q3 Economic Net Income was $53.5 million, Fee Related Earnings were $30.8 million and Distributable Earnings were $228.2 million. For the nine months, the corresponding figures were $300.3 million, $126.7 million and $644.3 million.
Cash Flow, Balance Sheet, Debt and Liquidity
- Cash and cash equivalents were $1.043 billion at September 30, 2016, compared with $991.5 million at December 31, 2015. Corporate treasury investments were $95.1 million.
- Management estimated approximately $980 million of remaining cash and cash equivalents plus treasury investments after amounts allocated to specific business purposes, before ordinary-course payables and reserves.
- Net cash provided by operating activities was $127.5 million for the nine months, versus $4.443 billion in 2015. The comparison was heavily affected by the deconsolidation of investment funds and related investment cash flows.
- Net cash used in investing activities was $11.5 million; net cash used in financing activities was $73.3 million. Cash increased by $51.8 million during the nine months.
- Debt obligations were $1.277 billion, including $500 million of 3.875% senior notes due 2023, $600 million of 5.625% senior notes due 2043, $120 million of an NGP-related promissory note due 2022, $34.7 million of CLO term loans and a $24.7 million carrying value for the senior credit facility term loan.
- The senior credit facility had $750 million of unused revolving capacity and matures in 2020. Carlyle reported compliance with its corporate debt covenants at September 30, 2016.
- Common-unit distributions paid during the nine months were $98.5 million. The October 2016 declaration provided for a Q3 distribution of $0.50 per common unit, payable November 16, 2016.
- Carlyle repurchased and retired 3.339 million units for $53.6 million during the nine months under a $200 million authorization.
Material Changes Versus the Prior Comparable Period
- Fund management fees declined 8% in Q3 and 2% for the nine months. Drivers included lower hedge-fund and Investment Solutions AUM, changes from commitment-based to invested-capital fee bases, distributions and lower catch-up fees.
- Performance fees improved sharply in Q3 to $214.7 million from a $246.6 million loss, reflecting appreciation in buyout funds, particularly Carlyle Partners VI. For the nine months, performance fees declined to $570.8 million from $621.3 million.
- Investment income improved to $70.5 million in Q3 and $126.2 million for the nine months, versus losses or minimal income in the comparable periods, primarily because of stronger NGP, buyout-fund and CLO-related results.
- Fee-earning AUM declined to $123.8 billion from $128.1 billion at September 30, 2015. Total AUM was $169.1 billion, down from $182.6 billion at December 31, 2015, mainly due to distributions and redemptions.
- Global Market Strategies remained structurally weak: Q3 and nine-month Fee Related Earnings were losses of $5.1 million and $4.9 million, respectively, versus positive results in 2015. Hedge-fund AUM declined to $5.2 billion from $9.3 billion a year earlier.
- Investment Solutions began winding down DGAM's fund-of-hedge-funds and liquid-alternative activities and refocused on private-market secondaries, primary investments, co-investments and managed accounts.
- General and administrative expenses benefited from the absence of the $198.4 million intangible-asset impairment recorded in the first nine months of 2015, but included a $100 million reserve for litigation and contingencies in 2016.
Guidance, Outlook, Risks and Unusual Items
- Management expected Global Market Strategies to operate at a Fee Related Earnings loss for full-year 2016 and planned to reduce exposure to shorter-term trading businesses while expanding global credit.
- On October 31, 2016, Carlyle transferred its 55% interest in Emerging Sovereign Group to its founders. Management expected this to reduce AUM by approximately $3.6 billion and fee-earning AUM by approximately $3.4 billion. Remaining hedge-fund partnerships expected approximately $1.0 billion of additional redemptions over subsequent quarters.
- Management described high asset valuations as favorable for realizations but challenging for deploying capital and generating comparable future returns. Carry funds had $40.2 billion of remaining dry powder and the firm had $54.4 billion of total available capital at quarter-end.
- Accrued performance fees were $2.777 billion, while accrued giveback obligations were $224.4 million. A hypothetical total impairment of fund investments could have resulted in approximately $1.3 billion of after-tax realized and distributed performance fees subject to potential giveback, although management viewed that scenario as remote.
- Urbplan, a consolidated Brazilian real-estate development VIE, had substantially all loans in covenant violation or technical default. The loans were contractually non-recourse to Carlyle, but management estimated that Urbplan could require up to $35 million of additional funding over the following twelve months. Carlyle funded $10 million in Q3 and $118.2 million cumulatively through September 30, 2016.
- Legal and regulatory matters included the Guernsey Carlyle Capital Corporation litigation seeking more than $1 billion, SEC inquiries and other investigations, and a commodities-related matter involving approximately $400 million of investments. Carlyle had estimated aggregate liabilities of $162 million for litigation, regulatory inquiries and other matters.
- Carlyle expected to contribute approximately $750 million to new CLOs over five years to address U.S. risk-retention requirements effective December 24, 2016. Funding sources may include Carlyle, senior professionals, third parties and limited-recourse borrowing.
- Management stated that cash, operating cash flow and the senior credit facility were sufficient to fund anticipated needs for at least the next twelve months, subject to business conditions and other contingencies.
Investor Verification Points
- Reconcile GAAP results with Economic Net Income, Fee Related Earnings and Distributable Earnings, noting that the non-GAAP measures exclude or adjust for consolidation, performance fees, equity compensation, litigation reserves and other items.
- Assess the sustainability of fee-related earnings given declining fee-earning AUM, hedge-fund redemptions, fee-basis step-downs and the ESG transfer.
- Review the valuation sensitivity of Level III assets, accrued performance fees and giveback obligations, particularly in Corporate Private Equity and Real Assets.
- Monitor Urbplan funding requirements, covenant defaults, potential bankruptcy and possible claims against Carlyle despite contractual non-recourse provisions.
- Evaluate the effect of litigation, SEC and other regulatory inquiries, including whether the $162 million contingency reserve is adequate.
- Verify the timing and funding impact of U.S. CLO risk-retention requirements and Carlyle’s expected $750 million aggregate contribution.
- Consider the impact of the January 2016 consolidation change when comparing 2016 and 2015 balance-sheet, revenue, expense and cash-flow amounts.