The Carlyle Group L.P. — 2017 First-Quarter Form 10-Q
Reporting period: Three months ended March 31, 2017; filed May 3, 2017. The filing entity is The Carlyle Group L.P., not Carlyle Group Inc. The company is a global alternative asset manager operating through Corporate Private Equity, Real Assets, Global Market Strategies and Investment Solutions.
Key Financial Metrics
| Metric | Q1 2017 | Q1 2016 | Change |
|---|---|---|---|
| Total revenue | $1,120.1 million | $483.1 million | +132% |
| Income before taxes | $327.7 million | $15.3 million | + $312.4 million |
| Net income | $321.9 million | $7.9 million | + $314.0 million |
| Net income attributable to Carlyle Group L.P. | $83.0 million | $8.4 million | + $74.6 million |
| Basic earnings per common unit | $0.97 | $0.10 | Increased |
| Diluted earnings per common unit | $0.90 | $0.01 | Increased |
| Economic Net Income | $400.1 million | $88.5 million | +352% |
| Fee Related Earnings | $25.5 million | $51.0 million | -50% |
| Distributable Earnings | $55.4 million | $128.6 million | -57% |
| Fee-earning AUM | $114.9 billion | $130.3 billion | -12% |
| Total AUM | $161.9 billion | Not clearly provided for the comparable date in the filing text | Not clearly provided |
| Operating cash flow | $514.9 million | $19.7 million | + $495.2 million |
Revenue and Profitability
- Performance fees increased to $681.6 million from $145.2 million, driven primarily by unrealized appreciation in Corporate Private Equity funds. Unrealized performance fees were $598.4 million versus $13.4 million.
- Fund management fees declined 15% to $246.3 million, reflecting lower fee-earning AUM, changes from commitments to invested-capital fee bases, lower hedge-fund AUM and lower transaction and portfolio advisory fees.
- Corporate Private Equity generated $568.0 million of consolidated performance fees, including significant contributions from Carlyle Partners V, Carlyle Partners VI and Carlyle Asia Partners IV.
- Total compensation and benefits rose 72% to $535.9 million, primarily because performance-fee-related compensation increased to $317.1 million from $69.5 million.
- GAAP results were substantially boosted by unrealized fair-value gains, while distributable and fee-based earnings declined because realized performance fees and recurring fee-earning AUM were lower.
Cash Flow, Balance Sheet and Liquidity
- Cash and cash equivalents were $799.2 million at March 31, 2017, compared with $670.9 million at December 31, 2016. Corporate treasury investments were $148.9 million.
- Management stated that approximately $839 million of cash and treasury investments remained after amounts allocated to specific requirements, although this estimate excludes ordinary-course payables and certain reserves.
- Total assets were $10.4 billion and total liabilities were $8.6 billion. Consolidated CLOs and other funds materially increase reported assets, liabilities and cash flows but are generally non-recourse to Carlyle.
- Debt obligations were $1.33 billion, excluding $3.59 billion of loans payable by Consolidated Funds and $77.8 million of Urbplan debt measured at fair value. The company was in compliance with its own debt covenants at quarter-end.
- Operating cash flow was $514.9 million, but included substantial consolidated-fund activity and non-cash performance fees. Financing cash outflows were $331.4 million, including $330.5 million of net payments on Consolidated Fund borrowings and $13.7 million of common-unit distributions.
- On April 6, 2017, after quarter-end, Carlyle borrowed $250 million under its $750 million revolving credit facility.
- Unfunded commitments to Carlyle funds totaled $2.59 billion, of which approximately $2.3 billion was subscribed individually by senior professionals and other professionals.
Material Changes Versus the Prior Comparable Period
- Reported revenue, GAAP net income and Economic Net Income increased sharply because of strong portfolio appreciation and related unrealized performance fees.
- Fee Related Earnings fell from $51.0 million to $25.5 million and Distributable Earnings fell from $128.6 million to $55.4 million, highlighting weaker recurring fee and realized-income generation despite strong valuation gains.
- Fee-earning AUM declined from $130.3 billion to $114.9 billion, primarily because of realizations, distributions, reductions in fee bases and the exit from hedge-fund businesses.
- Total AUM at March 31, 2017 was $161.9 billion, supported by approximately $4.9 billion of market appreciation and $2.7 billion of new commitments during the quarter.
- Carlyle transferred its 63% ownership interest in Claren Road to its founders on January 31, 2017 and continued winding down or exiting certain hedge-fund and commodities activities.
- The March 2017 NGP agreement further aligned Carlyle’s interests with NGP. It resulted in accelerated expense recognition of $20.8 million in NGP investment income and additional partnership-unit-related compensation arrangements.
- The company adopted ASU 2016-9 for stock compensation on January 1, 2017; the effect on total partners’ capital was not material.
Outlook, Commentary and Risks
- Management described 2017 as a transition year and expects Fee Related Earnings to remain below 2016 levels during 2017 because of fundraising costs and investment in the credit business. Management expects Fee-earning AUM and Fee Related Earnings to grow in 2018 after new capital is raised and fees become active.
- Carlyle raised approximately $3 billion of new capital in the first quarter and expects an accelerating level of fundraising. It continues to target $100 billion of gross new capital over the four-year period beginning in 2016 and ending in 2019.
- Fundraising in 2017 is expected to be weighted toward Real Assets, with Corporate Private Equity fundraising expected to accelerate later in 2017 and into 2018. Credit and Investment Solutions funds are also expected to raise capital.
- Management reported favorable transaction-financing conditions and expects M&A activity to remain strong, but noted high asset prices and competitive investment markets.
- Performance fees are highly dependent on fair-value changes, realizations and fund-level return hurdles. Unrealized performance fees may reverse, and realized carried interest may be subject to giveback obligations.
- Accrued performance fees were $3.02 billion, accrued giveback obligations were $161.2 million, and the potential after-tax giveback if all carry-fund investments became worthless was approximately $1.1 billion, a scenario management views as remote.
- Urbplan, a consolidated Brazilian real-estate VIE, had substantially all loans in technical default or covenant non-compliance. Its projected cash flows may be insufficient to satisfy debt obligations, creating restructuring or insolvency risk. Carlyle states that the debt is non-recourse, does not expect additional funding for debt service and does not expect any additional funding for other purposes to exceed $25 million.
- Carlyle recorded approximately $175 million of liabilities for litigation, regulatory examinations and other matters. Significant matters include the unresolved Carlyle Capital Corporation litigation, regulatory inquiries and claims relating to approximately $400 million of misappropriated petroleum commodities investments.
- U.S. risk-retention rules for CLOs may require approximately $750 million of contributions to new CLOs over the next five years, with the ultimate portion funded by Carlyle not yet determined.
- The company expects to adopt revenue-recognition guidance in 2018, which will reclassify carried-interest-related amounts from performance-fee revenue to investment income and may affect the presentation of historical results.
Most Important Facts for Investors to Verify
- Whether the large Q1 performance-fee gain is realized or unrealized and the potential for subsequent reversals.
- The sustainability and timing of management’s projected 2018 recovery in Fee-earning AUM and Fee Related Earnings.
- The effect of the April 6, 2017 $250 million revolver borrowing on leverage and liquidity.
- The status, restructuring prospects and potential additional funding requirements of Urbplan.
- Potential exposure from litigation, regulatory inquiries, commodity-related claims and the $175 million accrued contingency balance.
- The amount of Carlyle’s direct versus employee-funded share of the $2.59 billion of unfunded fund commitments.
- The effect of CLO risk-retention requirements and future capital needs on distributions and unit repurchases.
- The impact of the planned 2018 accounting change on reported revenue, investment income, comparatives and performance metrics.
- The filing’s non-GAAP measures, particularly Fee Related Earnings, Economic Net Income and Distributable Earnings, should be reconciled to GAAP income before taxes because they exclude or adjust for significant items.