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November 17, 2023

Breakingviews: Carlyle’s next takeover target should be itself

by Breakingviews.

Carlyle’s new boss Harvey Schwartz spent 21 years as a rainmaker at Goldman Sachs. One way he could leave a lasting imprint on the private equity firm he now runs is by doing a transformational deal. The twist is, this wouldn’t be a swashbuckling raid on another company. The ex-banker should instead partner with the co-founders and a deep-pocketed investor and take his own $11 billion firm private.

Schwartz took the top job in February after several years of Carlyle’s stock being a laggard. Like other private equity firms founded in the late 1980s, it was working through a leadership transition. But handing the reins from co-founders Bill Conway, David Rubenstein and Daniel D’Aniello proved hard. Warburg Pincus veteran Kewsong Lee was coronated leader in 2020, then two years later ousted amid disagreements with the founding trifecta, Reuters reported.

Part of the issue was that they felt Lee wanted too much change too quickly. In the meantime, Carlyle’s competitors plunged deep into private credit and beyond, finding ways to raise permanent capital to grow assets under management at a clip faster than Carlyle. The firm has tried to catch up, but its $60 billion of perpetual assets clocks in at only 15% of Blackstone’s hoard. With public shareholders laser-focused on steady fee income and disfavoring lumpy lucre from deals, Schwartz’s company unsurprisingly trades at a discount to peers. Its current valuation multiple of around 8 times expected earnings is less than half that of Steve Schwarzman’s firm.

Now, Carlyle’s founders might be in a position to help. Together with former partners, they command 41% of the firm through a management trust. Assume a buyer pays 10 times expected earnings, the valuation Masayoshi Son’s Softbank Group paid for Fortress Investment Management, though lower than where peers are valued. Carlyle’s take-out price would be about $38.50 per share, judging by LSEG data, a premium of a fifth and valuing Carlyle’s equity at $14 billion. If the partners roll their stake, they would need $8 billion of cash to cover the remainder.

As with any private equity firm that has gone through a change of hands, there are wrinkles. Some $3.5 billion still sits in the form of accrued performance payments eventually due from funds – that’s about $10 per share of value. Nevertheless, a deal might allow insiders to buy back Carlyle on the relative cheap – especially since the alternative asset manager’s shares are up only 7% year-to-date, while Blackstone, Apollo Global Management and KKR are all up over 30%.

Some additional funding would be needed. Part of that might come in debt. But an equity partner could help, too, like a deep-pocketed sovereign wealth fund. Schwartz may not want to carry out Carlyle’s transition anywhere other than in public. But looking at the numbers, he should reconsider: his best trade could be with himself.

Context News

Carlyle said on Nov. 7 that its net earnings available to be distributed to shareholders for the third quarter came in at $315 million, down 39% from the year prior, a steeper drop than at listed peers Blackstone, Apollo Global Management, KKR or TPG. The alternative asset manager’s shares are up roughly 7% year-to-date, while Blackstone’s, Apollo’s and KKR’s are all up over 30%. It appointed former Goldman Sachs executive Harvey Schwartz as chief executive officer effective Feb. 15, after former boss Kewsong Lee stepped down in August 2022. On a call with analysts to discuss results, Schwartz, who is expected to unveil a strategic plan for Carlyle, said the firm is “not pleased” with the pace of its fundraising. Inflows of $20 billion year-to-date fall far short of peers. A vehicle dubbed Carlyle Group Management controls 41% of the voting power of the firm’s shares through irrevocable proxies signed by former partners and senior professionals. This arrangement expires on Jan. 1, 2025.

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