If you love a good conspiracy theory but find Ron Paul’s and Rick Perry’s calls to kill Ben Bernanke for counterfeiting a little played out, do we have some good news for you. The Carlyle Group, a mild mannered private equity firm by day that at night transforms into an evil conspiracy among George Bush, Skull & Bones, the Saudi royal family annd the Illuminati, is about to get a lot more public attention.
Bloomberg reports that Carlyle is shopping an IPO. While we do worry that IPOs by smart private equity managers have a pretty solid tradition of top-ticking (Blackstone IPOed in June 2007 and the market has never been the same since), we like David Rubenstein’s efforts to get valued for making good investments instead of just for having a ton of money:
Now Rubenstein and the firm’s most senior executives are spending time on Wall Street, seeking to convince investors that Carlyle’s model of spreading money into many small funds generates steadier earnings than competitors who concentrate larger sums in fewer pools, the people said. Rubenstein is arguing that Carlyle should be valued more like a traditional asset-management company.
Carlyle’s pitch is tailored to counter public investors’ perceptions about private-equity incentive fees, or carry. Stockholders place little value on these earnings, which are unpredictable especially during times when an economic slowdown makes it tougher to exit investments. …
Even as Carlyle aims to persuade investors to pay more for carry, the firm is also trying to convince them its management fees outside of leveraged buyouts are on the rise, the people said. The company is seeking to replicate Blackstone’s success in getting shareholders to pay up for its diversification efforts. Blackstone’s valuation stems in part from hedge funds, including a fund-of-funds manager, because inflows and earnings from that business are less volatile than private equity, according to Marc Irizarry, a Goldman Sachs Group Inc. analyst.
Shareholders of listed private equity companies tend to prefer stable management and monitoring fees to carry, as reflected in analysts' multiples for those income streams: Bloomberg cites BofA's Guy Moskowitz valuing BX at 20x management fees and 8x carry; JPMorgan’s Kenneth Worthington values APO at 16x PE management fees, 15x capital markets management fees, and 6x carry.
The reasons for this are fairly obvious – management fees (the 2% of the “2 and 20” that GPs charge to their investors, though Carlyle will tell you it’s more like 1%), and transaction and monitoring fees that they charge to the companies they own (which average around 1% of deal value and 1.5% of EBITDA, respectively), are pretty stable and depend mainly on cash deployed.
Carry, on the other hand, is the money that the firms make from raking 20% of the profits – which requires that there be profits. Which in turn depends on making good investments, improving profitability, and finding an exit. And this market is not a great time to rely on that – as JPMorgan pointed out last week:
Oops! But even leaving aside recent unpleasantness, it seems that management fees generally dwarf carry – one study this year found that in 1995 to 2004 vintage private equity funds, 8.4% of committed capital was paid out in management fees while 2.5% was paid out in carry. This ignores monitoring fees, which also go largely to GPs and which “increase the fixed amount limited partners pay managers by 39 to 68 percent." So private equity funds make their living mostly off stable recurring fees, not off of improving companies and selling them at a profit. Which means that they may prefer to spend their time maximizing assets under management - and fees - rather than searching for good deals and improving portfolio companies.
When private equity managers started listing, this was the big worry: that the private equity model of long-term focus on big returns, rather than smoothly growing quarterly profits, would be a casualty of public markets. That may have mattered less than we thought - even unlisted private equity firms seem to make most of their money on smooth non-performance fees - but it's hard to argue that public shareholders of PE firms don't prefer stable revenues to a long-term focus on making good investments and improving portfolio company profitability. If Carlyle has to go public - and obviously there's a lot of money for its executives in doing so - its push to get credit for its carry counts as a moderately good thing.
Carlyle Pitches Wall Street on IPO Valuation [Bloomberg]