The Carlyle Group L.P. — FY 2016 Form 10-K Summary
Reporting period: Fiscal year ended December 31, 2016. The filing is for The Carlyle Group L.P., a Delaware publicly traded limited partnership, rather than a corporation. Carlyle operates four segments: Corporate Private Equity, Real Assets, Global Market Strategies and Investment Solutions.
Business context
Carlyle is a global alternative asset manager with approximately $157.6 billion of AUM, $115.0 billion of fee-earning AUM and more than 1,600 employees across 35 offices at year-end. The firm raised approximately $14 billion of gross commitments, invested $17.9 billion through carry funds, realized approximately $29.6 billion and reported approximately 12% carry-fund portfolio appreciation during 2016.
Management repositioned Global Market Strategies toward private credit, exited its hedge-fund businesses, began winding down commodities activities and restructured Investment Solutions around private-market secondaries, primary funds, co-investments and managed accounts.
Financial and operating metrics
| Metric | 2016 | 2015 | Change |
|---|---|---|---|
| Total revenue | $2,274.3 million | $3,006.2 million | Down 24% |
| Fund management fees | $1,076.1 million | $1,085.2 million | Down 1% |
| Performance fees | $751.8 million | $824.9 million | Down 9% |
| Investment income | $160.5 million | $15.2 million | Up $145.3 million |
| Income before taxes | $45.3 million | $402.2 million | Down 89% |
| Net income | $15.3 million | $400.1 million | Down 96% |
| Net income attributable to Carlyle Group L.P. | $6.4 million | $(18.4) million | Improved |
| Basic earnings per common unit | $0.08 | $(0.24) | Improved |
| Distributable Earnings | $651.7 million | $922.5 million | Down 29% |
| Fee Related Earnings | $(18.5) million | $198.8 million | Down $217.3 million |
| Net cash from operating activities | $(300.6) million | $3,902.8 million | Declined materially |
Reported margins contracted sharply: total revenue less total expenses produced income before taxes of approximately 2.0% of revenue in 2016, compared with approximately 13.4% in 2015. The comparison is affected by consolidation changes, including the January 1, 2016 deconsolidation of most consolidated funds.
- Liquidity: Cash and cash equivalents were $670.9 million and corporate treasury investments were $190.2 million. Management estimated approximately $685 million of remaining cash and treasury liquidity after amounts reserved for specific purposes.
- Credit facility: $25.0 million was outstanding under the term loan; the $750.0 million revolving facility was undrawn. The facility matures May 5, 2020 and requires fee-earning assets of at least $65.3 billion and a total leverage ratio below 3.0x.
- Debt: Debt obligations totaled $1.265 billion, including $500 million of 3.875% senior notes due 2023, $600 million of 5.625% senior notes due 2043, CLO term loans and a $108.8 million NGP-related promissory note.
- Distributions: 2016 distributions declared were approximately $1.55 per common unit, or $131.1 million. The stated policy targets approximately 75% of Distributable Earnings per unit, net of taxes and tax receivable agreement payments, subject to the general partner’s discretion.
- AUM trend: Total AUM declined from $182.6 billion to $157.6 billion, primarily due to distributions, divestments, redemptions and foreign exchange. Fee-earning AUM declined from $131.0 billion to $115.0 billion.
Material changes versus prior comparable period
- Corporate Private Equity performance fees fell to $289.6 million from $698.2 million, while Real Assets performance fees increased to $321.1 million from $49.3 million.
- Global Market Strategies generated a $159.1 million ENI loss and a $157.4 million Distributable Earnings loss, compared with losses of $40.3 million and $38.8 million, respectively, in 2015. The result included approximately $175 million of commodities-related contingency reserves and $25 million of Claren Road separation costs, partially offset by $25 million of insurance recoveries.
- Fee-earning AUM in Global Market Strategies fell 22% to $24.1 billion, reflecting the transfer of ESG and Claren Road, hedge-fund redemptions and lower CLO collateral balances. Hedge-fund AUM was immaterial at year-end versus $8.3 billion in 2015.
- Investment Solutions fee-earning AUM decreased 4% to $27.1 billion, while the segment’s Distributable Earnings increased to $20.4 million from $12.9 million as cost reductions offset lower fee revenue.
- Operating cash flow became negative, largely reflecting investment activity and the changed consolidation profile of consolidated funds. Stand-alone operating-entity cash flow, excluding consolidated funds, was $305.3 million.
- Carlyle repurchased and retired 3.7 million units for $58.9 million under a $200 million authorization.
- On January 1, 2016, adoption of revised consolidation guidance deconsolidated approximately $23.2 billion of assets and $16.1 billion of liabilities without affecting net income attributable to Carlyle or partners’ capital.
Guidance, outlook, risks and unusual items
- Management described 2017 as a transition year because several large funds are in late-stage harvesting. Exit activity and distributions may decline, and fee-earning AUM may fall before successor funds begin generating fees.
- Carlyle began a fundraising cycle targeting approximately $100 billion of new commitments over four years through 2019. Success depends on investment performance, distributions, valuation levels and investor allocations.
- Management expects increased fundraising for successor buyout and Real Assets funds, but fundraising costs will rise and fee activation may lag capital commitments.
- Accrued giveback obligations were $160.8 million at year-end, including approximately $157 million related to Legacy Energy funds. Net accrued performance fees attributable to Carlyle Holdings were approximately $1.07 billion.
- Urbplan, a consolidated Brazilian real estate development company, had substantially all loans in covenant default or technical default. Its principal debt was $144.4 million, carried at a $79.4 million fair value, and management indicated that restructuring or insolvency may be necessary. Carlyle had funded $121.6 million directly through year-end and expected any additional support, if provided, not to exceed $30 million.
- Litigation, regulatory and other contingencies totaled $140 million of recorded liabilities. Significant matters include the CCC Guernsey litigation seeking more than $1 billion, SEC inquiries concerning monitoring-fee acceleration and other practices, and commodity-related misappropriation claims involving approximately $400 million of investments.
- U.S. CLO risk-retention rules became effective December 24, 2016. Carlyle expects to contribute approximately $750 million to new CLOs over the next five years, funded through Carlyle, professionals, third parties and potentially limited-recourse borrowing.
- Other principal risks include market and valuation volatility, leverage and refinancing risk, regulatory and tax changes, competition for capital and investments, key-person risk, cybersecurity, foreign exchange, litigation, conflicts of interest and potential giveback obligations.
Most important facts for investors to verify
- Reconcile GAAP results with management’s non-GAAP measures, particularly Distributable Earnings of $651.7 million versus net income attributable to Carlyle of $6.4 million.
- Assess the sustainability of fee-earning AUM after substantial 2016 distributions, fund harvesting and the exit from hedge funds.
- Review the timing and funding sources for the $2.8 billion of unfunded fund commitments and the expected $750 million of CLO risk-retention investments.
- Evaluate potential cash demands from the $160.8 million giveback accrual, the $140 million litigation and regulatory accrual, tax receivable agreement obligations and Urbplan support.
- Confirm the effect of consolidation changes on period-over-period revenue, expense, cash-flow and balance-sheet comparisons.
- Monitor 2017 fundraising, successor-fund fee activation, realization activity and the conversion of accrued performance fees into cash.
- Review the independent valuation assumptions underlying the predominantly Level III AUM and performance-fee balances.