The Carlyle Group Inc. (NASDAQ:CG) Q3 2023 Earnings Call Transcript

The Carlyle Group Inc. (NASDAQ:CG) Q3 2023 Earnings Call Transcript November 7, 2023

The Carlyle Group Inc. beats earnings expectations. Reported EPS is $0.87, expectations were $0.72.

Operator: Good day and thank you for standing by. Welcome to the Carlyle Group Third Quarter 2023 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. [Operator Instructions] Please be advised that today’s conference is being recorded. I would now like to hand the conference over to your speaker today, Daniel Harris, Head of Investor Relations.

Daniel Harris: Thank you, Josh. Good morning, and welcome to Carlyle’s third quarter 2023 earnings call. With me on the call this morning is our Chief Executive Officer, Harvey Schwartz; and Chief Financial Officer, John Redett. Earlier this morning, we issued a press release and a detailed earnings presentation, which is also available on our Investor Relations website. This call is being webcast, and a replay will be available on our website. We will refer to certain non-GAAP financial measures during today’s call. These measures should not be considered in isolation from or as a substitute for measures prepared in accordance with generally accepted accounting principles. We have provided a reconciliation of these measures to GAAP in our earnings release to the extent reasonably available.

Any forward-looking statements made today do not guarantee future performance, and undue reliance should not be placed on them. These statements are based on current management expectations and involve inherent risks and uncertainties, including those identified in the Risk Factors section of our annual report on Form 10-K that could cause actual results to differ materially from those indicated. Carlyle assumes no obligation to update any forward-looking statements at any time. So turning to our results. For the third quarter, we generated $205 million in fee-related earnings and $367 million in distributable earnings with DE per common share of $0.87. Our net accrued carry balance was $3.5 billion as of the end of the quarter, and we declared a quarterly dividend of $0.35 per common share.

In order to ensure participation by all those on the call today, please limit yourself to one question and return to the queue for any additional follow-ups. And with that, let me turn the call over to our Chief Executive Officer, Harvey Schwartz.

Harvey Schwartz: Thanks, Dan. Good morning, everyone, and thanks for joining us. Today, I’ll update you on the areas where we have strong momentum and where we’re focused on accelerating growth. Before getting into that, let me touch on the macro. An already complex environment has become increasingly uncertain with the tragic events unfolding in the Middle East. Multiple wars, along with higher rates and economic uncertainty has increased volatility and reduced confidence levels. As we all know, sentiment is the greatest market elixir, and negative sentiment has slowed transaction activity over the past year. That said, despite the challenging market backdrop, deal activity has shown signs of improvement as third quarter buyout activity was at the highest pace in over a year.

However, my own opinion is that lower activity levels and reduced confidence will likely persist for a bit longer. As we said in the past, our view is that rates will stay higher for longer. After 20 years of declining rates and central bank market intervention, the overall cost of capital has shifted higher and may remain so for some time. Market participants have reluctantly accepted this reality and begun repricing assets based on this outcome. However, as is often the case in market regime shifts, this process of market digestion will take time. Ultimately, higher rates could dampen economic activity. Complex and uncertain environments don’t necessarily mean a lack of opportunity as we’ve seen over decades navigating through all market cycles.

Our goal investment teams continue to stay focused on generating excess alpha in this market environment. And with over $70 billion of dry powder across our platform, we have the flexibility to deploy capital and build on strategic partnerships. Now let me shift to areas of focus as we position the firm for growth. First, our insurance strategy has very strong underlying momentum. Fortitude’s announced transaction with Lincoln Financial has met all closing conditions and is expected to close later this month. We will pick up approximately $24 billion in new AUM from the increase in Fortitude’s general account assets as well as additional capital that rotates into Carlyle funds. In addition to this transaction, our team is developing new investment and distribution strategies that target the needs of insurance investors and our private credit business.

We see substantial growth and potential new transactions across the insurance vertical. Next, private wealth. The Carlyle brand has always been received well in the private wealth channel, and we’re building on that momentum. We have raised over $45 billion from this channel over time. And this year, we have raised more than $3 billion. I feel good about this channel given the strength of our brand. Over the coming quarters and years, we expect to accelerate product development and see further growth in sales and distribution. There’s a lot of upside in private wealth, and we expect our footprint to be significantly larger in coming years. Moving on, we’re seeing momentum across several of our investment strategies in the market today. A few examples include Japan buyout, U.S. real estate and secondaries.

Each of these strategies are on track to grow meaningfully due to strong investment performance, our deep client relationships and an attractive set of deployment opportunities. During the quarter, we raised $6.3 billion in new capital, bringing year-to-date fundraising to $20 billion. Overall, we’ve not been pleased with our pace of fundraising thus far in 2023, but our current expectation is for a step higher in new capital raise throughout the fourth quarter. With the final close of our latest U.S. buyout strategy, we now have $105 billion of corporate private equity assets under management, including $21 billion in dry powder across our CP funds that allow us to pursue deals of any size around the globe. We continue to raise capital for next vintage Asia, Europe and Japan buyout strategies, which should further add to this amount in the coming quarters.

Moving to credit. This is an area we’re focused on accelerating our growth and expect to be significantly larger over time. Global Credit has built a diverse set of strategies to serve an increasing number of institutional and private wealth LPs to manage over $150 billion in assets today, nearly triple the level of just three years ago, including the world’s largest CLO business. Our team is focused on the significant opportunity ahead to attract assets that migrate from bank balance sheets to private capital strategies, a trend we expect to play out over the next several years. Finally, let me focus on expense management. We have made faster progress in this area than I originally expected. I give a lot of credit to the team for driving this process.

We’ve identified several areas that have already led to a lower run rate of expenses. As a result, we delivered better-than-expected third quarter FRE. I expect an even larger impact in 2024. The changes we’re making across the firm are improving our organizational structure, emphasizing our areas of strength, enhancing our ability to grow and helping to maintain best-in-class talent across our platform. Closing, our leadership team is focused on taking meaningful actions to drive long-term value for our investors and shareholders. With that, let me now turn the call over to John.

John Redett: Thanks, Harvey. Good morning, everyone. As Harvey highlighted, we delivered better-than-expected results this quarter, supported by our focus on expense management and our diversified global platform. We produced $367 million in distributable earnings or $0.87 in DE per share. Year-to-date, we have generated over $1 billion of DE or $2.38 in DE per share. We finished the third quarter with $382 billion of assets under management, up 4% year-over-year. AUM is poised to increase upon the closing of the Fortitude transaction with Lincoln, which should occur in late November. We expect this transaction to add $40 million in incremental FRE. Across our global platform, we deployed $4.1 billion of capital this quarter with nearly 1/3 in our solution strategies and over $1 billion in real estate, infrastructure and natural resources.

Despite investment headwinds, we deployed $12.6 billion of capital year-to-date 2023. We realized $5.6 billion of proceeds this quarter for our LPs, largely across our energy, power, solutions and credit strategies. Year-to-date, we have returned over $15 billion in cash to our LPs, a higher level than we deployed. Carlyle is one of the few firms that has been able to deliver this outcome. We raised $6.3 billion in capital in the quarter, generally split between each of our segments. And as Harvey said, we expect a stronger fourth quarter of fundraising. In Solutions, we raised $2.4 billion largely for our secondaries and co-investment strategies, which will continue to raise capital and finalize their fundraising in 2024. In Global Credit, we attracted new capital for opportunistic credit, direct lending and our private wealth fund, CTAC.

An year-to-date, we have raised nearly $1 billion for Carlyle Strategic Solutions, our asset-based finance strategy. In Global Private equity, we closed our eighth U.S. buyout fund and along with our growth sleeve, raised over $16 billion of committed capital. In addition, we raised capital across the latest vintage NGP strategy, Asia buyout and renewables. Shifting to fee-related earnings. Management fees totaled $518 million in the third quarter, up modestly compared to the prior year. We have $10 billion of pending fee-earning AUM that will activate fees largely as we deploy additional capital. Capital markets activity remained slow and transaction and advisory fees of $11 million declined sharply from last year. That said, we expect Q4 transaction revenue to grow as we have good visibility into near-term fee generation.

Fee-related performance revenue of $23 million were higher than the third quarter of last year, but as we previously signaled, it declined sequentially. Global Credit FRPR continue to move higher with good asset flows and strong performance in our evergreen products, while Global Private Equity declined sequentially, a trend that is likely to persist in Q4. Cash compensation and benefits of $256 million declined more than $30 million compared to the second quarter due to lower fee-related performance revenue compensation as well as our efforts to operate the firm more efficiently. To date, we have actioned approximately $40 million in annual run rate expense savings. Our work here remains in the early innings. G&A expenses were also lower as we benefited from expense discipline and lower fundraising costs.

We expect G&A expense to modestly increase in Q4 due to year-end seasonality that we remain focused on controlling annual expense growth in 2024. Overall, third quarter fee-related earnings of $205 million were relatively flat to the last quarter. We now expect to deliver a higher level of FRE in the second half of 2023 relative to the first half. FRE margin in the third quarter was 37%, and we remain focused on driving this margin higher over time. Our net accrued carry balance totaled $3.5 billion with a small decline from Q2 due to realizations. Our global carry fund portfolio appreciated 2% in the quarter with relative strength in infrastructure, natural resources and credit. And our real estate portfolio continued to be pressured by higher rates despite strong underlying asset performance.

Wrapping up, despite the challenging backdrop, we’re executing across the firm and see good opportunities across our global platform to create value for both investors and shareholders. With that, let me turn the call over to the operator for your questions.

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Q&A Session

Operator: [Operator Instructions] Our first question comes from Patrick Davitt with Autonomous Research.

Patrick Davitt: Could you better frame any potential timing dynamics between 3Q and 4Q gross flows? Maybe a better idea of how much AUM has already closed so far in 4Q? And then more broadly, perhaps update us on your thoughts on the potential sizing of remaining large funds in the market over the next 6 to 12 months?

Harvey Schwartz: So as I said, Patrick, and thanks for the question. As I said in my prepared remarks, we’re not particularly pleased with the year-to-date fundraising. I think — and we talked about this a bit. With my arrival, one of the things that I really wanted to focus on as a new CEO and a new company was really spend a lot of time internally, having my people get to know me and then a lot of time externally. I’ve now met with, I think, over 200 of our investors globally in about nine months. And I can really feel the momentum building. And so we would expect a meaningful step up in fourth quarter fundraising. I can’t promise these things. Market environments could be delays. But it feels quite good. And then when you think about the funds we have in the marketplace now, real estate, secondaries, Japan, I think as we come into 2024 — and as I said, the momentum feels quite positive, and we’ll see how fourth quarter shakes out, but we’re feeling pretty optimistic.

Operator: Our next question comes from Alex Blostein with Goldman Sachs.

Alex Blostein: I was hoping if we can dig into the expenses a little bit more — so nice progress on expenses so far this quarter, you alluded to run rate savings, and there is more to go from there. So maybe help us frame kind of what’s really run rate in the third quarter? How do you expect that to shake out into the end of the year? And then more importantly, what are your early thoughts on FRE growth and expense trajectory for next year?

John Redett: Alex, it’s John. As we said on our second quarter earnings call, we really want to drive our FRE margin higher. It’s a key focus area for the firm. In the third quarter, we saw a slight uptick in the margin. But we — look, we’ve been really focused on our expense base. I think we’ve made some progress. As I said earlier, we’ve already actioned $40 million run rate. And I expect this number quite frankly to grow as we continue to focus on expenses. And I would say, overall, we’ve gotten at the expenses faster than we thought we would. I’ve been in the CFO seat for five weeks, and I’m pretty pleased with the pace of which — in terms of what we’re getting at. Look, every single expense is on the table, I’d tell you. There is no such thing as a sacred expense, but this is very much a process. And I would just describe it as very, very early days. But overall, we’re pleased with the progress we’ve made in the third quarter.

Operator: Our next question comes from Craig Siegenthaler with Bank of America.

Craig Siegenthaler: So my question is on the CLO business. And just given that you just did the CBAM deal and you’re the largest CLO manager in the world now, we thought you’d have a unique perspective on this. But as you noted, defaults are picking up off a very, very low base. I wanted your perspective on where you see them trending over the next year? And also, given the subordination inherent in the CLO, what are you thinking in terms of loss translation with the equity first loss tranches? And also, I remember this issue came up a few years ago, but are there scenarios where there could be triggers where management fees could turn off the CLO vehicles?