The Carlyle Group Inc. (NASDAQ:CG) Q4 2022 Earnings Call Transcript

The Carlyle Group Inc. (NASDAQ:CG) Q4 2022 Earnings Call Transcript February 7, 2023

Operator: Good day, and thank you for standing by. Welcome to the Carlyle Group Fourth Quarter 2022 Earnings Conference Call. . I would now like to hand the conference over to your speaker today, Daniel Harris, Head of Investor Relations. Please go ahead.

Daniel Harris: Thank you, Kevin. Good morning, and welcome to Carlyle’s Fourth Quarter 2022 Earnings Call. With me on the call this morning is our Interim Chief Executive Officer and Co-Founder, Bill Conway; and our Chief Financial Officer, Curt Buser. 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 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. Earlier this morning, we issued a press release and a detailed earnings presentation, which is also available on our Investor Relations website. I’m going to begin with a quick discussion of our results, and then hand the call over to Bill. For the fourth quarter, we generated $202 million in fee-related earnings and $433 million in distributable earnings or $1.01 per share. Fee-related earnings for the full year 2022 of $834 million increased 40% compared to 2021 and FRE margin expanded to 37% from 33% last year.

Strong organic growth and several strategic transactions combined to deliver another year of substantial growth. We generated $1.9 billion in distributable earnings in 2022 or $4.34 per share with a good balance of earnings from FRE, net realized performance revenue and realized investment income. We entered 2023 in a strong capital position. We have $1.4 billion in cash, $2.4 billion in firm investments and $4 billion of net accrued carry on our balance sheet, in total, over $20 per share. We have nothing drawn against our $1 billion revolver, and our debt ratings from both S&P and Fitch improved to A minus ratings. The strength of our balance sheet gives us confidence that we can continue to pursue growth strategies, both organic and inorganic, to help continue to deliver additional FRE growth.

We delivered a quarterly dividend of $0.325 per common share. The combination of our balance sheet strength and sustainable growth in FRE allowed our Board of Directors to approve another increase in our fixed dividend to $1.40 per share per year, an increase of 8% year-over-year and up 40% over the past 2 years. This higher dividend will begin with Q1. And with that, let me turn the call over to our Interim Chief Executive Officer and Co-Founder, Bill Conway.

William Conway: Thank you, Dan. Good morning, everyone, and thank you for joining us today. I am pleased to be on the call to discuss Carlyle’s Fourth Quarter and Full Year Results. As you’ve heard, Carlyle delivered strong results to our stakeholders despite the challenging market environment. The firm is operating well, and I have tremendous confidence in our ability to capture investment opportunities and to continue to grow our platform in 2023. I want to talk about 3 topics this morning: the outcome of our CEO selection, the strong financial performance of Carlyle in 2022 and some general thoughts on our outlook. First, we are incredibly pleased that Harvey Schwartz will join Carlyle as the new CEO on February 15. As you all know, this was an incredibly important decision for Carlyle.

And the search committee of the Board, on which I serve, drove a robust and exhaustive search for a new CEO. Following a thorough and competitive process, Harvey was unanimously chosen by the Board as the right leader to move Carlyle forward in its next phase of growth. Harvey is a widely respected business builder with significant leadership experience in a high-performing, highly competitive global financial institution. He is a seasoned operator with a proven record of leading and developing a wide range of businesses and a demonstrated ability to invest in and develop the talent and organizational structure to manage and support these businesses. As we look to the future, there is tremendous opportunity to grow and to continue to perform Carlyle, to transform Carlyle and deliver sustainable results over the long term.

Harvey brings the experience and skill set to fully capture this opportunity. As CEO, he will set and execute a strategy that advances and accelerates the diversification plan the firm has successfully pursued as well as identify new investment opportunities to further scale the business, drive performance and deliver growth. I am confident in Harvey’s leadership and look forward to introducing him to you in the very near future. Moving on, I’d like to discuss our 2022 results. Curt will dive into our results in more detail, but I wanted to touch on a few notable points. As Dan mentioned, we generated record fee-related earnings of $834 million in 2022, an increase of 40% over 2021, which demonstrates that our strategic focus to grow FRE and diversify our earnings mix is paying off, and we earned $1.9 billion in distributable earnings despite a volatile exit environment.

We delivered investment returns that were attractive across our portfolio. Our aggregate carry fund portfolio appreciated 11% in the year, while the public markets were down about 20%. And as I said last quarter, portfolio construction and risk management matter, and we believe that this is the key differentiator that positions our investment teams to deliver superior relative performance across market cycles. Turning to our outlook. As we enter 2023, we are confident in the strong foundation of the firm and believe that we are well positioned to capture new growth opportunities, and Harvey will focus on building off this strong foundation. At its core, our business involves raising money and investing money and then making money that we’ve invested worth more.

Let me begin with some thoughts on fundraising. No doubt the backdrop for raising new capital remains challenging with headwinds more pronounced in certain areas than others. However, today’s environment is different from what we faced entering 2022. Early last year, an unexpected and sharp change in market sentiment had investors on their back foot for most of the year. With rapidly deteriorating public equity and debt prices, the denominator effect greatly reduced LP interest and ability to make new commitments. Over the past few months, at least until last week, we’ve seen a gradual reduction in market volatility. Investors still believe that they have a better handle on the magnitude of further interest rate changes. In addition, Carlyle’s longstanding relationships with the largest and most sophisticated investors around the globe is a benefit, and we continue to see strong demand for many of our investment strategies across our 3 global segments.

Our platform has continued to diversify, and it’s important to note that roughly 2/3 of our fundraising last year came from areas such as Global Credit, Global Investment Solutions, natural resources and real estate. While corporate private equity may continue to face headwinds, we see significant capital raising opportunities across our platform. We will have more strategies raising capital in 2023 than we did in 2022, including our next vintage flagship funds and credit opportunities, secondaries, co-investments and buyout funds across the globe. We anticipate that our overall dollar volume of fundraising in 2023 will be higher than the $30 billion we raised in 2022. Over the past few months, I’ve been around the world speaking with our teams and investors and feel confident in the power of our platform.

Our investors value our partnership, our global reach and our ability to construct diverse portfolios that perform across market cycles. Now that Harvey is here, it has also taken away some uncertainty about our path forward as a firm, and we think that will also have a positive impact on fundraising. Regarding capital development, today’s market conditions create new opportunities to invest capital across all of our global businesses. Recently, there’s been a wider-than-average spread in pricing expectations between buyers and sellers, which has impacted capital development. The spread is across most asset classes that has been more pronounced in private equity than other strategies, and we are — but we are starting to see evidence of this spread narrowing.

As debt and equity capital markets continue to reopen, the pace of deal activity is poised to accelerate. We deployed a record $35 billion in capital in 2022 with a good balance across equity, credit and solution strategies. And we are well positioned for further investment with $72 billion in dry powder to capitalize on an improving environment. We expect to find ample opportunities to make new investments in 2023 and beyond on behalf of our fund investors. In addition, the improving deal environment presents an opportunity for our global credit business to provide unique capital solutions to the marketplace. In 2022, we underwrote $3.9 billion of new loan activity in our direct lending strategy, and our CLO team issued 9 new CLOs while also trading $30 billion across their portfolios to better position the CLOs for the expected economic environment.

And as fund investors’ need for liquidity persists, we are well positioned to capitalize on this need to our secondaries and co-investments business. Overall, 2022 was a solid year across most financial metrics for Carlyle, and we entered 2023 with strength and momentum. With Harvey as our new CEO alongside our strong leadership team, Carlyle is well positioned and we’re confident that he will build on this momentum to bolster the firm’s position and create value for all our investors and shareholders. With that, let me hand the call over to our Chief Financial Officer, Curt Buser, to discuss our financial results in more detail.

Curtis Buser: Thanks, Bill, and good morning, everyone. I want to start by reiterating many things Bill mentioned that emphasize the strong position Carlyle finds itself in as we begin this year. We believe our investment portfolios are in good shape and are well positioned to weather economic volatility. And we expect to deliver long-term attractive performance for all of our stakeholders. We produced a robust $4.34 per share in distributable earnings in 2022, displaying the significant cash earnings power of our firm. We’ve now earned over $9 in DE per share in just the past 2 years. We remain focused on growing fee-related earnings, and it grew by 40% in 2022. And over the past 5 years, our FRE CAGR has been a robust 34%.

Our overall earnings mix continues to diversify as we have grown our credit, insurance, capital markets and solutions capabilities. Our strong growth in fee-related earnings is not driven by a single fund or strategy. Rather, our performance led us to driving broad-based top line fee growth across our global platform. Top line fee revenue growth was 25% in 2022 and was driven by the following: first, raising capital for and growing our traditional high-performing investment strategies across each segment — each of our 3 global segments. Second, organically building out new fee-generating businesses like opportunistic credit, insurance, capital markets and infrastructure credit, to name just a few, each of which added significantly to our growing fee revenue pool throughout the year.

And third, we have been actively adding new inorganic streams of earnings, such as our transactions to further scale our CLO business with CBAM, and our advisory agreement with Fortitude. These efforts have scaled our platform and helped drop more of our top line revenues to the bottom line as we expanded our full year FRE margin to 37% in 2022, an increase of nearly 400 basis points compared to 2021. FRE margin has more than doubled over the past 5 years. We have done this while concurrently investing in new product development and enhanced distribution capabilities, notably across the private wealth channel. We expect to continue to grow FRE in 2023. FRE in the first quarter will likely be similar to Q4 of 2022 before increasing in the second half of the year.

In addition, we remain highly confident in our ability to grow FRE well into the double-digit range over the mid- to longer term, in line or better than the market trends across the private capital industry. Consistent growth in fee-related earnings is supported by the attractive investment returns we produce for our fund investors. Our investment teams again delivered appreciation that outperformed public benchmarks even with increasingly higher discount and cap rate assumptions in our valuation models and elevated concerns about global recession. While only 6% of our carry fund portfolio was publicly traded at year-end, public market comparables are an important input to our valuation methodology and generally were a downward driver of valuations across our private assets during the year.

Of course, the most important valuation driver of any investment is underlying asset level performance, which, in general, continued to reflect growth in revenues and earnings, though this growth generally slowed in the second half of 2022. Our strong performance also owes to our focus on deploying capital in the sectors where we have deep industry expertise and experience. Our real estate funds appreciated 16% during 2022. Our Infrastructure & Natural Resource funds appreciated a very strong 48%, and Corporate Private Equity funds were up 6%. We realized $34 billion in proceeds for the year, which produced another year with $1 billion in net realized performance revenue. About what I previously indicated would be a good target in most years.

Looking forward, net accrued carry increased 2% year-over-year to $4 billion. A solid portfolio appreciation more than offset strong carry realizations. And we ended the year with $138 billion in fair value in our carry funds, up more than 10% compared to year-end 2021. In general, we continue to expect to generate on average $1 billion in annual net realized carry. Though depending on the year, realized performance income could be elevated as it was in 2021 when market factors were favorable or lower in years where uncertainty diminishes capital markets activity. Industry-wide activity rates slowed considerably in the past few months as buyers and sellers continue to search for evaluation middle ground, and funding markets while available are less amenable than they were just a year ago.

For Carlyle specifically, new investment and realization activity has also been slower. And so we expect a muted start to 2023 for both deployment and realizations. Thus, transaction revenue and realized performance income will be lower over the next quarter or 2. If our activity rates across the industry improve over the next few months, then our expectations for higher performance and transaction revenues will also increase. Let me now turn to some quick thoughts on each of the business segments. Global Private Equity had another strong year with fee-related earnings up 34%. Strong appreciation across Real Estate, Infrastructure and Natural Resources helped net accrued carry increase to $3.5 billion after more than $900 million of net carry realizations.

$20 billion of invested capital was generally similar to $23 billion of realized proceeds, which positions global private equity to continue to deliver attractive levels of distributable earnings in future periods. Global Credit remains our fastest-growing segment, and it benefited from both organic growth activity as well as the positive impact from strategic transactions. Top line fee revenues grew 46% in 2022, resulted in fee-related earnings more than doubling to $225 million, and fee-related earnings margins increasing by nearly 1,000 basis points to 37%. Strong investment performance across various strategies produced $70 million of net realized performance revenue. Our credit interval fund delivered attractive performance with a 10% dividend yield, while continued net inflows grew managed assets to more than $2 billion.

We raised $15 billion in new capital across 11 strategies in Global Credit in 2022, and we expect to have an active year fundraising for additional strategies in 2023, which should position Global Credit for further growth. In addition, we remain focused on helping Fortitude evaluate new growth opportunities, which would help us benefit from incremental advisory revenues. And in Global Investment Solutions, we are well positioned to see growth in this segment as we begin fundraising for our flagship products, including next vintages in our co-investment and secondary strategies. Fee-related earnings of $69 million in 2022 was lower than 2021, but we expect to see growth later in 2023, as these strategies attract new capital. In addition, with $374 million in net accrued carry and very strong fund performance, performance-related revenues are well positioned to increase over time.

In sum, we delivered strong performance for our stakeholders in 2022 and are well positioned for what will likely be a more attractive investment environment in 2023. We see tremendous opportunity to deploy capital into what we think will be a great investment for our portfolio and fund investors. Now let me turn the call over to the operator so we can take your questions.

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Q&A Session

Operator: . Our first question comes from Glenn Schorr with Evercore ISI.

Glenn Schorr: So maybe for Bill, first. Look, I think a lot of investors have been getting on board the direction of travel for Carlyle for the last couple of years, FRE growth, margin expansion, diversification. So we had a pause for 6 or 7 months. We found Harvey. Maybe talk a little bit more about why Harvey and then, most importantly, what’s he here to do relative to the strategy that all these investors are on board? And I want to know, like, is that strategy important to you and the co-founders because the process we went through is what it is? So just curious if you could talk to that.

William Conway: Sure. And thank you for the question, Glenn. First of all, I am very excited that Harvey is going to join us. He was our first choice, and he is — and I think it should be pretty obvious why. We were looking for somebody who had a really proven track record. We were looking for somebody who had experience building businesses. We were looking for somebody who had a record of managing and recruiting and training and developing talent and working in the collaborative environment. We were looking for somebody who could relate to people like you in Wall Street and tell our story, a wide range of skills. And frankly, there aren’t a lot of people who have all those skills. In Harvey, I think we found that person. He is really fantastic.

Yesterday, he and I were walking around our New York office. We went on all the floors, we were talking to people, and he was happy to see them, and they were happy to see him. And it was really not so much they want to get rid of me, but rather they were excited to see him there. We obviously have a lot of people who used to work for Goldman, and they were happy to see him; and people who just had heard about him and his track record and his skill set. So I think why Harvey and who he is and what his track record is, that was pretty clear to me that we couldn’t get anybody any better than Harvey. He was — he’s fantastic. Now what’s he here to do? I think in some ways, the path that we have is set. We want to — first of all, we want to increase the stock price.

Even though we are — we’ve got a great investment track record that doesn’t show up in our stock price, we have — how is he going to do that? Well, we have to grow our business, we have to grow our business, we have to grow our business. Particularly the fee-related earnings, but other parts of the business as well that assets and the like, he’s got a great set of experiences. Remember, he was at Goldman during the time of a financial crisis and talking about having to deal with situations that were risky and yet had great opportunity. So I don’t see dramatic changes in the basic strategy, but it will be up to Harvey. He’s going to be the CEO of the company. And I’m going to do everything I can to help him be successful and — including staying out of his way, if that’s the right part of the solution.

I can’t tell you how happy I am that he’s here.

Glenn Schorr: Well, long track record with him, so I totally agree with that. Maybe just one numbers question. I’m interested in your comments about the improving bid-ask dynamic. You have $11 or so in net accrued performance revenue, which is a lot relative to your stock price, like you said. So you realized $1 billion in performance revenue, but you picked up another $1 billion basically on the back of Infrastructure and Natural Resources. So could you expand a little bit more on what you talked about the improving bid dynamic — bid-ask dynamic? Is that like a near-term-ish thing? Or is that a hopefully second half thing? Just curious on what you think it takes to get the wheels moving again.

William Conway: That is — that the real question is. And of course, what we’re talking about there is that sellers think their businesses were worth what they were worth a year or 2 ago. And buyers say, “Well, I don’t want to pay those prices anymore.” And so there’s been a gap. I’ve mentioned in my remarks that it’s been both in the prices of equities, we see it kind of on the value of the companies that you own, but it also applies to credit. For example, there was a deal recently and we looked at where the credit spread or all in price of the credit a year ago might have been 6% or 6.5%, and now it’s double digits. So there are still certainly some disparities in valuation. However, it is getting better, Glenn. And I’d say it’s getting better slowly.

It’s not rapidly. This is not going to be something that I think it — someone is going to ring the buzz and we’re going to know that it’s where it should be. Private equity has the advantage and private debt too as well of being able to evolve and able to function in lots of different kinds of environments and to adjust to those environments. And I see that in the types of deals that we do now. We’re not doing deals that are giant deals that require billions — $10 billion of equity and $10 billion of credit. Those deals will be almost impossible to do today. But the market is gradually healing. Buyers and sellers gradually coming together. And I think it’s on both sides. I think buyers are dropping the prices down and I think — price what they’re willing to pay.

And the sellers are saying, well, maybe we’re going to have to just be able to settle for a lower price than we thought. And I think that’s across the board. It’s not going to be just in private equity, it’s not going to be just in Americas, it’s everywhere. More in the second half probably than the first.

Operator: Next question comes from Bill Katz with Credit Suisse.

William Katz: Congrats on adding Mr. Schwartz. So a question for you, guys. You mentioned that you think that asset gathering can be better in ’23 than in 2022. I was wondering if you could unpack that a little bit and maybe bifurcate between where you stand on sort of the free flagship corporate private equity portfolios versus the rest of the business with some emphasis on the solutions business?