Earnings Call Transcript - CG Q4 2020

Operator, Operator

Ladies and gentlemen, thank you for standing by and welcome to the Carlyle Group Fourth Quarter 2020 Earnings Call. At this time, all participants are in a listen-only mode. After the speakers' presentation, there will be a question and answer session. I would now like to introduce your host for today, Mr. Daniel Harris, you may begin.

Daniel Harris, Host

Thank you, Kevin. Good morning, and welcome to Carlyle's fourth quarter and full year 2020 earnings call. With me on the call is our Chief Executive Officer, Kewsong Lee, 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 reconciliations of these measures to GAAP in our earnings release. 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. For the fourth quarter, we generated $145 million in fee-related earnings and $237 million in distributable earnings with DE per common share of $0.64. For the year FRE was $520 million and DE per common share was $2.05, both up from 2019 levels. We declared a quarterly dividend of $0.25 per common share. This quarter we are reporting our results under our new segment structure, which is more aligned with how we operate our business. All equity investment strategies are now captured in a single segment global private equity, which includes our former corporate private equity and real asset segments. All of our credit investment strategies remain in global credit and our investment solutions segment continues to house our portfolio management strategies. As a reminder, we look forward to hosting our first Investor Day as a corporation on February 23 at 8:30 a.m. Registration is open and we do encourage you to pre-register if possible at ir.carlyle.com. At our upcoming Investor Day, our leadership team will discuss our corporate strategy and financial objectives as well as the opportunities for each of our businesses. I'm sure many of your questions today could be tied to our longer-term outlook and topics we'd like to cover comprehensively at Investor Day and as such we may defer responding to these questions and address them at that time and in context with our broader plan. And with that, let me turn the call over to our Chief Executive Officer, Kewsong Lee.

Kewsong Lee, CEO

Thank you, Dan. 2020 was a year of growth and positive change for Carlyle, despite the challenging and complex environment. Our focus in 2021 is to build on our current momentum, and we look forward to providing more detail on our strategy for accelerating growth at our Investor Day in two weeks. Today, I'd like to focus on three points. First, Carlyle delivered very strong results for shareholders in 2020. Second, our investment portfolio is in great shape. And third, our business model and organization proved extremely resilient and adaptable to the changing environment. Let me start by focusing on our 2020 results, which were strong across all metrics. We generated a record $520 million in fee-related earnings, with margins in excess of 30%. The substantial progress from just a few short years ago when FRE was less than half of this year's level. Continuing to grow FRE remains a primary strategic focus. Distributable earnings increased 18% in 2020, and we expect continued growth in earnings as our investment portfolios perform and mature. Our investment activity picked up sharply throughout the year. Despite the challenging environment, we exited the year with great momentum deploying $9 billion of capital in the fourth quarter alone, and $18 billion for the year. Our ability to consistently deploy in good times and bad demonstrates the value of our global platform and multi-asset class approach. We also accelerated our exit pace, realizing $7 billion for our fund investors in the fourth quarter and $21 billion for the year. Since the beginning of 2020 we've taken eight of our portfolio companies public and have over $17 billion of current value in public securities that, when realized, will generate proceeds for our LPs and earnings for our shareholders. The final highlight is that we raised $27.5 billion in new capital during the year with nearly 90% of the capital raised from our global credit and investment solutions segments. We will have much more to say about the trajectory and scale of our next fundraising cycle at Investor Day. Let me now move to some remarks on our investment portfolio which is diverse, balanced, and in great shape. A few highlights: our private equity buyout funds appreciated 19% in aggregate in 2020. Our largest fully invested fund, US Buyout 6, appreciated 46% in 2020 and our latest fully invested Asia Buyout fund was up 34%. Our global credit funds also performed extremely well despite significant volatility during the year. Our opportunistic credit fund appreciated 21% in 2020 and our structured credit strategy appreciated 16%, positioning both strategies for future growth. When combined across the firm, our strong performance drove our net accrued carry balance up 36% in 2020 to a record $2.3 billion, which positions us very well for a substantial step-up in realized performance revenue over the next few years. The last point I want to make is on the resiliency of our business model and adaptability of our firm. Nearly all—just about 98% of our capital is committed to us for the long term, in many cases, 10 years or more. These fund structures provide us with predictable and stable management fees regardless of market volatility. While the remote environment last year was personally challenging for each of us, our people and platform adapted rapidly during the year and our business operations were virtually unaffected by COVID. Our global investing platform pivoted quickly to operate in the new environment. Our investment teams effectively sourced and closed new deals, carefully monitored our portfolio, and completed IPOs and exits. We found new investment opportunities in regions like India and China and pivoted to private equity growth, particularly in healthcare and technology. We also provided flexible credit solutions to sponsors and corporates despite the volatile environment. At the same time, we spent countless hours with our limited partners developing a new cadence that enabled us to forge deeper relationships with them despite not meeting in person and raised over $27 billion in a year when we weren't in the market with our flagship global private equity funds. 2020 has demonstrated our resiliency and ability to adapt, and we find ourselves well-positioned to manage through the challenges ahead to deal with the continued impact of COVID on economies, markets, and our portfolios. Most importantly, we remain focused on the health and safety of our people and we owe our success in 2020 to their dedication, hard work, and expertise. I want to say a sincere thank you to each and every one of them for their extraordinary efforts last year. Let me turn the call over to our Chief Financial Officer, Curt Buser, to go through our results, and then I'll come back with some final thoughts.

Curt Buser, CFO

Thank you, Kew, and good morning. We performed well in 2020 despite the pandemic and economic volatility throughout the year. We generated $762 million in distributable earnings, our best year since 2015 and DE per share of $2.05 for the year increased 20% over 2019. Before digging into our financial results, I'd like to touch on three items. First, our outlook for 2021 fee-related earnings and realized performance revenues. Second, the trajectory of our effective DE tax rate. And third, stock-based compensation expense and equity awards. First, fee-related earnings were $520 million in 2020 and excluding $30 million in cost recoveries during the first quarter, adjusted FRE of $490 million increased more than 8% year-over-year despite not raising new capital for any of our global private equity flagship funds. FRE margin on the adjusted basis was 30%, up nearly 200 basis points relative to 28% in 2019. For the year, global credit fee-related earnings of $99 million more than doubled the 2019 level. While investment solutions FRE of $37 million was also more than double the prior year. In both cases, top line growth drove the majority of the year-over-year increase and margins expanded substantially in both segments. Looking at 2021, we expect realized performance revenues to continue to grow, and we expect to produce similar to slightly higher FRE compared to adjusted 2020 results. Consolidated top line management fee revenues should modestly increase with more noticeable growth in investment solutions and global credit more than offsetting some downward fee pressure in global private equity, as portfolio realizations increase. Global private equity will see growth in management fees and in FRE when our next multiyear fundraising cycle begins for our large flagship funds, which we do not expect to meaningfully affect our 2021 FRE results. Our net accrued carry of $2.3 billion is now 18% higher than its previous peak balance and the remaining fair value invested in our carry funds of $95 billion is 50% greater than its average balance during the period of 2012 to 2017 when our net realized performance revenues averaged over $600 million annually. With our funds performing well and assuming no material surprises in the capital markets, we expect realized performance revenues to gradually increase in 2021 and then in the years thereafter surpass our prior annual averages. Regarding our outlook on our DE tax rate; in our first year as a full corporate taxpayer, our effective DE tax rate was 5%. The relatively low rate benefited from the utilization of legacy net operating loss carry-forwards in addition to the basis step-ups and tax amortization arising from our corporate conversion. For 2021, we expect our effective DE tax rate will increase to the mid-teens as we fully utilize the remaining legacy NOLs early in the year. Thereafter the effective rate is likely to continue to increase annually before settling in the low 20s in later years. Of course, this outlook is based on current tax laws and should changes arise in any jurisdiction, our expectations for effective tax rates may change as well. Moving on, stock-based compensation expense was $29 million in the fourth quarter and $117 million for the year, down 23% from $151 million in 2019. The decline owes to the positive impact of granting fewer year-end stock awards than in previous years, as well as the departure of certain senior executives during the year. As part of this year's compensation cycle, we granted long-term strategic equity awards to a small number of our most senior executives, which are predominantly tied to achieving milestones in our strategic plan. As a result, we expect our equity-based compensation expense to increase to amounts comparable to 2019. Let's shift to a broader discussion of our results. Overall, we had an active year and have great momentum entering 2021. As Kew noted earlier, we raised $27.5 billion in new capital in 2020 with both global credit and investment solutions posting record fundraising years. Global credit surpassed its previous record by nearly 50% and investment solutions raised more than twice as much as any prior year. During the fourth quarter, investment solutions had a final closing on its $9 billion AlpInvest Secondaries program, which rounded up nearly 40% larger than its predecessor and its new co-investment strategy is now raising capital. In global credit, we had an initial closing on our second opportunistic credit fund, and activity in several platform-wide strategies; both segments are positioned well for future growth. Fund performance was particularly strong. The fourth quarter carry fund appreciation of 11% in corporate private equity, 3% in real estate, 3% in natural resources, 7% in global credit carry funds, and 7% in investment solutions. Fee-related earnings in the fourth quarter were $145 million with a 34% margin, up from $108 million at a 26% margin in the fourth quarter of 2019, with the upside largely owing to higher total fee revenue and lower G&A expenses. Fee revenues for the fourth quarter of $429 million increased 5% from last year, largely driven by higher transaction fees of $21 million, nearly double a year ago and up from virtually zero in Q3 2020. During the fourth quarter, we also activated fees on our new Japan Buyout Fund, increasing global private equity management fees from Q3. Fee earning assets under management was $170 billion, up 3% for the quarter and 6% over last year with a 28% increase in investment solutions and then an 11% increase in global credit, both driven by strong fundraising offsetting a modest decline for global private equity, as we continue to realize proceeds for our fund investors. Shifting to expenses, cash compensation was $202 million for the fourth quarter and $822 million for the full year, 4% higher than 2019. We continue to be disciplined on managing compensation expense. G&A expense was $73 million in the fourth quarter, down from $95 million a year ago. For the year, G&A of $241 million declined 27% year-over-year, owing to lower travel expenditures as well as a $30 million litigation cost recovery in the first quarter. G&A expenses should increase in 2021 due to a normalization in both items but we believe G&A expenses are likely to remain below prior peak levels as we capitalize on learnings over the past year. Net realized performance revenues were $87 million in the fourth quarter and for the year increased 50% from 2019. The majority of realized performance revenues this quarter was from our six US Buyout funds with carry from our Real Estate funds making up most of the remainder. In sum, we continue to be pleased with the durability and sustainability of our fee earnings and we are increasingly optimistic about the opportunity for growing DE over the coming years. We look forward to speaking with you all in a few weeks when we will go into more detail on our growth plan. With that, let me turn it back over to Kew for some final thoughts.

Kewsong Lee, CEO

Thank you, Curt. We have worked hard over the past few years and our results this year reflect the momentum we have built. We're proud of the performance we delivered on behalf of our limited partners and our shareholders in 2020. And we are excited about the opportunities in front of us. We look forward to speaking with all of you in more detail on February 23rd. And let me now turn the call over to the operator to take your questions.

Operator, Operator

Our first question comes from Craig Siegenthaler with Credit Suisse.

Craig Siegenthaler, Analyst

Thanks. Good morning, Kew, Curt. Hope you are both doing well.

Kewsong Lee, CEO

Hey. Good morning.

Craig Siegenthaler, Analyst

So we wanted to start with the impressive fundraising results from the solutions business, which now almost has $60 billion of AUM. Could you provide us an update of how you view the addressable market, the competitive landscape, and also the growth trajectory for your secondaries and co-investment businesses across both AlpInvest and Metropolitan?

Curt Buser, CFO

Craig, let me start. So in global credit, it was a very good year, nearly $10 billion of capital raised, good growth across the platform, and it's nicely disbursed in terms of the various components of the business, including even the CLO business. And in AlpInvest, $14 billion of fundraising this year—a record year for fundraising—its AUM has been growing nicely. And the thing to also remember in the case of AlpInvest is the burn-off that we had in a lot of AUM in early years is really from some of the two major investors or shareholders in that business prior to our ownership. So really the growth in AUM is even bigger than what you kind of see by looking at the aggregate numbers because you have to take into account that historical run-off. The team has really done a nice job of repositioning the industrial base across that whole platform, and that secondaries program was $9 billion now in terms of the total program size; it didn't turn on fees really until the fourth quarter, and so that should be a nice driver of fee revenue growth for that next year. And then as you think about the co-investment program, they're not just in raising their next kind of generation of that, and that will be additive to next year as well; so really well-positioned for continued growth.

Kewsong Lee, CEO

Hey, Craig, it's Kew. Taking a step back, if you think about it, clearly, the private capital markets have really grown and are huge, and so it shouldn't surprise all of us that large LPs and small LPs have a need for what I would call portfolio management solutions as they optimize risk and allocation to the asset class. And the way they do that is by first focusing on secondaries, second, trying to add co-investment opportunities, and third, obviously, in a diversified way they're looking for potentially ways to pick up interesting new GP commitments, but in a more diversified way. And AlpInvest is a platform that lets them do that. This whole area of alternatives I think is just going to continue to grow on the heels of the fact that the broader industry is growing. So that's a big picture number one. Number two, it used to be that these types of solutions were very bespoke in the past, but increasingly, we're seeing large carry over from our existing LP base as we try to minimize or add to deployment, manage risk, work on co-investment strategies, etc. About 40% of the LPs in solutions I believe are also LPs in our existing global private equity and global credit franchise. So there is a huge cross-sell, but also an introduction to all of Carlyle, which solutions offers us to be able to introduce to our LP base. Finally—and we're going to get into this in Investor Day—the performance of these strategies has been terrific and we're going to show you more of that in two weeks, so please be patient. But that performance is the underlying driver for why we believe in these three very focused strategies, secondaries, co-investments, and primary fund-to-funds. We see real growth opportunity ahead of us in solutions.

Craig Siegenthaler, Analyst

Great. Kew, thank you for the comprehensive response.

Kewsong Lee, CEO

Thanks, Craig.

Operator, Operator

Our next question comes from Mike Carrier with Bank of America.

Dean Stephan, Analyst

Hey, good morning. This is Dean Stephan on for Mike Carrier. Given the active deployment levels in the fourth quarter, can you just update us on the deployment outlook heading into '21, maybe what the pipeline is looking like and how quickly the $13 billion in pending fee earning AUM can potentially be invested or activated moving forward? Thanks.

Kewsong Lee, CEO

Hey, Dean, it's Kew here. I mean, look, we're about as busy as we've ever been, our pipelines are really full. The good news is our platform—be it regionally, be it different asset classes, be it different investment strategies, be it different investment sectors—we're well-positioned to go to where the opportunities are and be one step ahead. Valuation levels are certainly very high, no doubt about it, but also the ability for us to add value, work with our teams to grow these businesses and help them is also high. That's the challenge, which is to keep finding these deals. Last year was a good indication of the way this platform can pivot; if there's volatility, we see opportunities in credit. If traditional buyouts get way too expensive, we see ways to grow in private equity growth investing. If certain western economy markets are a little bit less active, we saw a lot of activity in the Far East, in India and in China. Our pipelines are very busy; valuation levels make it very difficult, but our platform is very well positioned to keep finding great opportunities and create value.

Curt Buser, CFO

Just adding on the $13 billion—a little over $13 billion of pending fee earning AUM is relatively evenly spread across the three segments, a little bit larger in global credit and investment solutions than in global private equity. A lot of that is really tied to as the funds either turn on as we complete fundraising or as we invest capital; both providing good FRE ramps, particularly in global credit and investment solutions.

Dean Stephan, Analyst

Got it. Thanks, guys.

Kewsong Lee, CEO

Thanks, Dean.

Operator, Operator

Our next question comes from Robert Lee with KBW.

Robert Lee, Analyst

Great. Good morning, thanks for taking my question. I just wondered, maybe focus on the capital management a little bit. So just want to maybe refresh on, as you look forward particularly with realizations ramping, you have the stable quarterly dividend. How should we think of dividend growth from here and where does —how do you think of down the road buybacks versus reinvesting it in the business, and how do you think of that trade-off?

Curt Buser, CFO

Robert, hey, thank you for that question. Managing capital to really drive the business is obviously our core priority, making sure that that capital really is driving growth in earnings and growth in the business. Ensuring that we have capital to invest in our funds, in new initiatives available for strategic growth initiatives, is always a priority for us. Our cornerstone is to maintain our fixed dividend, and looking at how we plan to grow that, as we have indicated in the past, is really as FRE grows, that's how we will grow our fixed dividend. I would not expect anything near term because I have already indicated that FRE will be similar to this past year, or slightly up. When we are really well-positioned for growth in FRE, that way we can underpin that six businesses. Regarding dilution management, we want to be around 1% in terms of dilution. We're cautious about our use of capital and buybacks in 2020, given the pandemic and uncertainties. But you can see us being active in managing that dilution both through equity grants as well as through buybacks.

Robert Lee, Analyst

Great. Thank you.

Kewsong Lee, CEO

Thanks, Rob.

Operator, Operator

Our next question comes from Bill Katz with Citigroup.

Bill Katz, Analyst

Okay. Thank you very much for taking the question, and good morning. So maybe one for Curt; could you sort of go back to your guidance on the realization outlook for 2021 and I just sort of wondering the jump-off point, is it the full year '20 as we look to '21? Is it the pacing for the fourth quarter growing off there? And then, maybe the interplay of how that will tie to in terms of the comp ratio against those revenues? Thank you.

Curt Buser, CFO

Bill, thanks for your question, and good morning. Yes, as we talk about net realized performance revenues, we had $246 million of realized carry this past year, up about 50% from the prior year, but well below our average that we ran between 2012 to 2017 of over $600 million a year. We're clearly positioned to surpass $600 million, but that won't occur in 2021 outlook. Capital markets could do something and we could exceed expectations to the high, but we could also miss, and predicting carry is always really hard to do precisely. What I said in my remarks in particular is expect a gradual increase and things to watch are just in the past year, Carlyle Partners VI turned on carry in Q3. We said that we weren't taking carry at a full 20% rate, which was true through all of 2020; we did not take carry on CP VI at the full rate. There are many other funds that have not yet turned on carry that are in accrued carry. Asia buyout IV is a good example, Japan III is a good example. As those funds also get to positions where we're comfortable from a fallback management perspective, that's what we'll signal to you as the bigger funds turn on, so you will kind of know what that trajectory is. But right now, I would be cautious about applying the same math to 2021.

Michael Cyprys, Analyst

Is that math fair to apply to the next couple of years beyond 2021, would you say, or is there anything different with the portfolio today that could result in a different outcome than that sort of 50% roughly?

Curt Buser, CFO

Yes. You always have to be a little careful in that math only because a lot of it has to do with the makeup at any point in time. I would say it's more of a correlation as opposed to causality, but over long terms in good markets and capital markets, we want to make sure that all of the big buyout funds are producing carry; that's where it gets a little bit more comfortable.

Gerry O'Hara, Analyst

Great, thanks. Perhaps one just on global credit; fundraising has obviously been getting stronger and clearly there's momentum building in that segment. Can you give us a sense of what products are seeing the most traction and even what the pipeline for new solutions might look like? Thank you.

Kewsong Lee, CEO

Sure, Gerry, it's Kew here. You're right, there is great momentum in the global credit segment; it's a broad platform. Our credit opportunity strategy is doing quite well. We're seeing, and all of you are seeing this, the CLO market is coming back, certainly, a pickup in activity level from last year, and we are projecting to see continued strengthening in that market. We have global infrastructure credit for instance in the market raising funds. This is a segment that's very scalable given what we have set up, and we're also seeing real traction with respect to platform-wide special accounts and strategic accounts that can be on any one singular account quite large. So let me hold there and just say we're pleased with the platform and the progress, but we have more to come in two weeks.

Glenn Schorr, Analyst

Hi, thanks. You piqued my interest a little bit. Curt, you mentioned when you were talking about the equity grants that there are, obviously, senior people and that's quite long-term milestones. Wonder if you could talk a little bit about the long-term milestones that they're tied to. I know they are aligned with the same things investors are looking for, but just any specifics there; I think people find it interesting?

Curt Buser, CFO

Glenn, hey, thanks for your question. As I said, these grants are mostly to the most senior people in the firm that can really drive our FRE and our earnings results. They are largely—or predominantly performance testing as opposed to time testing. There is a component of time, but it's mostly performance. These milestones are really what underpins the strategic plan and a lot of that is FRE. As we grow FRE, you'll see vesting. We think that alignment is very good. Hopefully, that helps.

Glenn Schorr, Analyst

And the lumpiness—yes, definitely. I think the lumpiness or I should say, maybe even the stair-stepping historically of FRE is due to some of the big capital raises. Has the growth in both global credit and investment solutions been enough to help smooth the cycle, if you will, or do we need to see more growth in say infrastructure, retail, capital markets, the like? Is that even a goal to smooth that lumpiness?

Curt Buser, CFO

Well, for talking fee-related earnings, I think over the past three years we've seen nice step-up in fee-related earnings in each annual year, and I would say over the last three years that lumpiness has not been that lumpy. For 2021, I have been very clear that you can expect similar FRE to 2020 as adjusted for that $30 million or slightly up. You will see more growth within the two segments of credit and solutions and some pressure on the fee side in global private equity, simply as its realizations we're expecting to be really good and so that will put some downward pressure. As they get back end from a fundraising perspective, that will bring back up management fees and FRE in that sector, but that's in later years. So again, stable to slightly up next year or this year, 2021.

Adam Beatty, Analyst

Hi, good morning, and thank you for taking the question. I want to circle back on the discussion around solutions from a competitive standpoint. Not that competition there is new, but some of the standalone providers have recently gotten more attention from public offerings and such. So just wanted to see how Carlyle and AlpInvest are positively differentiated there, and also you mentioned the interaction between solutions and the rest of Carlyle; is that perceived by LPs as an advantage? Thank you.

Curt Buser, CFO

Let me start, and then maybe Kew will jump in here. The thing that I would point you to in terms of how we compete in the market for solutions, AlpInvest in particular—it's a long-standing business with great relationships with its respected GPs that invest with us, but look at its track record. The performance in solutions, particularly in AlpInvest funds, has been phenomenal. That really is a distinguishing factor in terms of how investors into that platform view us. Carlyle, as well as the solutions platform, goes to market under a separate brand. We have strong walls internally to ensure key information around their relationships do not reach those walls, but the things from a fundraising perspective in terms of they want to make introductions and the like really helps build the platform using our distribution model.

Kewsong Lee, CEO

Adam, the only thing I would add is, first of all, from our LPs perspective, this is a complementary strategy, not a substitute strategy. They are engaging AlpInvest as a way to further optimize allocation into private markets, gaining efficiency through co-invest, etc. This is very much now in the discussion with our LPs regarding adding to their allocations to private capital alongside Carlyle funds. So that's a huge advantage in the sense of it's now a portfolio discussion, and that's why I say the existing client base of Carlyle is going to be a huge advantage for us as we try to keep growing AlpInvest. Second, competition is good; it will foster further growth in this market. As I said, all of these strategies will benefit from the fact that there are trillions of dollars in private markets right now, and these LPs are trying to figure out how to optimize allocation and risk into private equity and private credit strategies. To a certain extent, healthy competition will create more awareness and growth in this segment, which I think has solid tailwinds.

Operator, Operator

And I’m not showing any further questions at this time. I'd like to turn the call back over to Daniel Harris.

Daniel Harris, Host

Thank you, Kevin. Thank you all for your time this morning and throughout the course of the past year. We are very much looking forward to speaking with all of you on our Investor Day on February 23rd. Any other questions you have today, please feel free to follow up with Investor Relations. We hope you have a great day.

Operator, Operator

Ladies and gentlemen, this does conclude today's presentation. You may now disconnect and have a wonderful day.