The Carlyle Group Landscape Analysis

Sylvia C. Brown Communications Research MPPR-870-01.Fall2011 10/18/2011

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EXECUTIVE SUMMARY The Carlyle Group, like its industry, has always been characterized as cloaked—cloaked in mystery, power, secrets, and money. Being named after the ritzy Upper East Side hotel, the Carlyle, company founders wanted its target market—high-end investors—to think it was from old money. The Carlyle Group based its headquarters in Washington, D.C. unlike other private equity firms that set up in the financial centers of New York or even Chicago. Setting up in D.C. allowed the Carlyle Group founders to trade in what it had in spades—access. The company had access to the upper echelons of business and politics. To really make it big, though, the company found it needed more than just political pedigree; they needed a niche. With inside knowledge of the United States defense procurement processes matched with political networking that leveraged intel about defense and military-related policy decisions Carlyle became anchored in defense. In nearly a quarter of a century market conditions, investment interests, and priorities change. The Carlyle Group has changed. The firm has broadened its business model from political access to a niche buyout firm to a top-tier multi-product global alternative asset management firm. Carlyle has been planning its initial public offering (IPO) for years, in part because it believes having public currency will help it better compete with already-public firms Blackstone, Kohlberg Kravis Roberts & Company‟s investment vehicle, KKR, and Apollo. For a successful IPO, the company needs to address its communications opportunities. Problem/Opportunity Statements Turmoil in the domestic and global economies presents the Carlyle Group with an opportunity to rebrand itself as an asset management firm managing investments in diverse industries and emergent markets. Improving transparency about the Carlyle Group‟s operations can have a beneficial impact on its initial public offering and performance of the products. Private equity investment often slows or halts existing job losses.

L-R: William Conway, Daniel D'Aniello, and David Rubenstein founded the Carlyle Group. The private-equity firm filed documents that would turn it into a public company. Overnight, Carlyle's 99 partners will become millionaires and billionaires, with individual stakes valued from $3 million to $2 billion and up.

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Industry The financial industry, more specifically the private equity sector, is cloaked—cloaked in mystery, cloaked in power, and cloaked in money. Private equity (PE) is a niche market for finance. Capital investments in the sector limit communications. PE firms avoid the demands that regulators and shareholders make on public companies every quarter. Some of the communications blackout is regulatory. No mass mailings, advertisements, press releases or informational seminars are allowed when funds are being raised. The private equity sector works by using large sums of money to invest in a company. Described ideally, in its most basic terms, private equity allows the “seeds of new ideas…to germinate and the souls of the withering may be granted rebirth.” PE investment can be in one of two forms—venture capital or buyout. In the venture capital investment process the private equity firm invests funds in business start-ups with the expectations that the nascent company eventually will be profitable. The venture capital model is prevalent in the technology sector. Increasingly, the renewable energy sector is getting attention from venture capitalists. In the buyout investment, the private equity firm buys shares in a company, takes the company private, restructures the company to profitability, and then exits the company by putting it back on the public equity market (i.e., stock trading) or selling it through corporate acquisitions or selling it to other PE firms through secondary buyouts. It is believed the first private equity buyout was made between the storied money families led by J.P. Morgan and Andrew Carnegie with the sale of the Carnegie Steel Company to Morgan in the 1800s.
Buyout Process and Stakeholders

In private equity investments the purpose of investment is to align the interests of the company‟s managers and shareholders—achieving economic efficiencies for high financial value. In the early days of PE, managers and investors were financial experts rather than sector specialists. Financial experts had a “bottom-line” approach and PE firms and managers were considered cut-throat. The bottom-line approach meant laser focus on operational improvements. These operational improvements manifested as massive job losses to “cut the fat” and squeeze out profitability. The bottom-line approach certainly did little to endear the prospects of a buyout to a company‟s managers, employees, and investors, even if the company was struggling. One of the more notorious steps in the buyout process is the buyout. The private equity business is built on buying companies, often by borrowing large amounts of debt. This gave rise

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to the term leveraged buyouts (LBOs). The companies may be distressed but they are still valuable because of their market leadership and stable cash flows. With these characteristics, banks lend significant debt to the PE firm. At the same time the firm fronts a small portion of the buyout cost. The buyout usually uses as much as 70 cents of every dollar as debt they invest. The bank and firm get paid first when the PE firm takes control of the company leaving the company saddled with debt and pushing to make a profit. Adding to the rich get richer narrative, the private equity firm, following the industry standard, charges investors up to a two percent management fee on the total amount of the funds and takes a fifth of any profits it earns. The industry justifies these operations by noting PE investments are long-term and expensive commitments on illiquid assets, creating investment risk. Fundraising, or “capital calls,” last about 18 months and minimum investments can be $250,000 but often more. Bringing (in the case of venture capital investment) or returning (in the case of buyout investment) the company to profitability takes time as well, usually six-ten years. The investors who can “play” in high-stakes PE, though, are no longer just money families, like Whitney, Rockefeller or Morgan. Now, public and private pension funds and university endowments are joining the family foundations. The California Public Employees‟ Retirement System (CalPERS) is a major PE investor. The venture capital PE had its heyday in the 1960s and 1970s with investments in information technology and healthcare. Buyout PE rode high in the 1980s though the early 2000s. Company The Carlyle Group was founded in 1987 by Stephen Norris, a veteran businessman working at the Marriott hotel chain, and David Rubenstein, a veteran of politics and policy who worked his way up through President Jimmy Carter‟s Administration. Norris spearheaded the promising beginnings of the men‟s business relationship. Norris was a financial whiz and initially partnered with Rubenstein to take advantage of a gaping tax loophole by setting up dummy companies for Alaskan natives. With Norris‟ tax knowledge and Rubenstein‟s Rolodex, they became quite wealthy because of that loophole and decided to incorporate. They named the new company after the Carlyle Hotel in Manhattan‟s Upper East Side because they wanted the business to sound of old money. Eventually the U.S. Congress closed the loophole but Carlyle was positioned to become a part of the boom of the private equity sector. Daniel D‟Aniello was lured from Marriott and William Conway, a former telecommunications executive, rounded out the Carlyle Group as they moved to become a private equity buy-out firm. It cost $5 million to start the firm and financial backing primarily came from the Mellon family and Ed Mathias, an investment banker at T. Rowe Price who went on to become a managing director at Carlyle. The Carlyle Group based its headquarters in Washington, D.C. unlike other PE firms that set up in the financial centers of New York or even Chicago. Setting up in D.C. allowed the Carlyle Group to trade in what it had in spades—access. The company had access to the upper echelons of business and politics. To really make it big, though, the company found it needed more than just political pedigree; they needed a niche.

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Just as Carlyle realized its weakness a political and business powerbroker was getting into hot water. Frederic Malek was a strongman for President Richard Nixon in the Bureau of Labor and Statistics (BLS). While he was at BLS, Nixon instructed Malek to compile a list of Jewish employees who could be conspiring against him. Malek‟s role in the matter came to light in 1988 just as he was taking over chairmanship to the Republican National Committee. Malek was connected to Norris and Rubenstein through Marriott. Norris took Malek in to the firm when the scandal broke. Malek was closely tied to George W. Bush, who had just won the presidency. Malek brought the Carlyle Group‟s defining niche—the defense industry. Through Malek Frank Carlucci, a former secretary of defense, former deputy director of the Central Intelligence Agency, and friend of Congressman and Defense Secretary Donald Rumsfeld, joined Carlyle as vice-chairman. When Carlucci joined Carlyle the company established what has been called an iron triangle—political access, business acumen, and the defense industry. With Carlucci in the mix, Carlyle gained access to defense companies that became buyout targets. Carlucci‟s knowledge of defense procurement processes matched with political networking anchored Carlyle in defense. In several movies including Fahrenheit 9/11 and The Manchurian Candidate there were direct accusations and insinuations that Carlyle Group was nefarious and pushed the military industrial complex. The company‟s ties to Saudi Arabia royal families and the Middle East has intensified the accusations. After September 11 Carlyle brought out holdings of family members of Osama Bin Laden‟s families. In 2007 the company sold a 7.5 percent stake to the Abu Dhabi government (the capital of the United Arab Emirates). The Mubadala Development Company paid $1.35 billion for that minority stake of Carlyle. In nearly a quarter of a century the Carlyle Group has broadened its business model from political access to a niche buyout firm to a top-tier multiproduct global alternative asset management firm. According to its SEC filings the Carlyle Group now has $153 billion in assets under management and operates its business across four segments: 1. Corporate Private Equity: advises buyout and growth capital funds; 25 active Corporate Private Equity funds are organized and operated by geography or industry and are advised by separate teams of local professionals 2. Real Assets: U.S. real estate fund, advises 18 active real estate, infrastructure and energy and renewable resources funds 3. Global Market Strategies: high yield fund, advises a group of 43 active funds that pursue investment opportunities across various types of credit, equities and alternative instruments 4. Fund of Funds Solutions: investors in private equity and advises a global private equity fund of funds program and related co-investment and secondary activities Carlyle invests in small, medium and large companies, real estate, infrastructure projects and financial services firms. These investments are in approximately 80 companies based in the

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United States, 77 percent of which are small or medium-size businesses (fewer than 2,500 employees), as well as about 125 real estate projects, which include commercial, residential, and health care or data centers. Combined, these companies employ more than 216,000 people in the United States in all 50 states. Issue The Carlyle Group filed with the Securities and Exchange Commission to go public September 6, 2011. The offering is for $100 million, which is expected to be a placeholder. J.P. Morgan, Citigroup and Credit Suisse are serving as co-lead underwriters. Carlyle has been planning its initial public offering (IPO) for years, in part because it believes having public currency will help it better compete with already-public firms Blackstone, Kohlberg Kravis Roberts & Company‟s investment vehicle, KKR, and Apollo. External Environment According to Ed Mathias, Managing Director at Carlyle, the private equity industry has gone through four stages: 1. The Stone Age, ran from the mid-„70s to mid-„80s, when firms and deals were small. 2. The Bronze Age from 1985 to 1990 saw the industry mushroom. 3. The Silver Age from 1991 through 2001 saw the industry mature with many funds with billions of dollars to invest, drawn from around the world. 4. Then came the Golden Age from 2002 into 2007 where more than 175 funds had at least $1 billion under management, and some funds were big enough to buy Fortune 500 companies With financial markets reeling, though, private equity firms have turned to the public equity markets (i.e., stock trading). Listing gives the firm an open opportunity to tap the capital markets instead of raising investment for a particular fund that has a limited lifespan. The listing also opens a door to investors who are not wealthy enough to invest directly in a private equity fund. The first public listing was completed by The Blackstone Group under its founder Steve Schwarzman on March 22, 2007. The offering raised $4 billion in an initial public offering. On June 21, Blackstone sold a 12.3% stake in its ownership to the public for $4.13 billion in the largest U.S. IPO since 2002. Problem/Opportunity Statements Turmoil in the domestic and global economies presents the Carlyle Group with an opportunity to rebrand itself as an asset management firm managing investments in diverse industries and emergent markets. Improving transparency about the Carlyle Group‟s operations can have a beneficial impact on its initial public offering and performance of the products. Private equity investment often slows or halts existing job losses. Key Publics

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U.S. Congress Congressional and federal oversight could impose regulatory impediments that could hinder efforts to expand into new investment strategies, markets and businesses. Debt financing markets Most of Carlyle‟s investment funds invest in illiquid, long-term investments that are not marketable securities and such investments may lose significant value during an economic downturn. There‟s also the potential for poor performance of the investment funds. The mortgage bonds that banks had been using to finance private equity deals collapsed when rating agencies acknowledged these bonds included too many risky, high-interest home loans that weren't getting paid back; banks suddenly reluctant to lend at favorable terms, some $100 billion in announced private equity investments have been scrapped, and another $100 billion had to be renegotiated under less favorable terms. Domestic and global economic markets With a greater presence around the globe and in emerging markets than any other alternative asset manager volatility affects the Carlyle Group‟s business and liquidity position. The credit crunch has also made it harder for PE firms to borrow. Fundraising hit a wall. Investors The high finance investor expects annual returns of eight to twenty-five percent for alternative investments such as private equity, hedge funds and venture capital, compared with the traditional, small investor who expects 6 to 8% for stocks and 2 to 4% for bonds. However, the law of averages makes it difficult to sustain high performance year after year. With the market turmoil, all investors have become risk averse and less money is being put into private equity funds. Labor unions With its broadened portfolio and the interest in protecting and growing jobs, companies in Carlyle‟s portfolio come under greater scrutiny. It is important to build relationships with labor and employees. Ensuring all parties work toward the shared goal of generating good financial performance to keep U.S. businesses more competitive and saves jobs. Media Just like the PE industry Carlyle has operated on a schedule of years when it comes to its investments and returns and has avoided the demands that regulators and shareholders require from public companies. Becoming more accountable to the public, and thus less private will continue to set the stage for a successful transition to the public equity markets.

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BIBLIOGRAPHY Briody, Dan. The Iron Triangle: Inside the Secret World of the Carlyle Group. New York: J. Wiley, 2003. Print. Cendrowski, Harry. Private Equity: History, Governance, and Operations. Hoboken, N.J: John Wiley & Sons, 2008. Print. Davies, Megan, and Clare Baldwin. "Exclusive: Carlyle Eyes Picking IPO Banks in next Month: Sources| Reuters." Business & Financial News, Breaking US & International News | Reuters.com. 01 June 2011. Web. 9 October 2011. <http://www.reuters.com/article/2011/06/01/us-carlyle-idUSTRE7502TE20110601>. DiStefano, Joseph N. “Hecklers delay speech; Carlyle CEO notes private-equity „purgatory‟” The Philadelphia Inquirer. Web. 11 October 2011. <http://www.philly.com/inquirer/business/homepage/20080118_Union_hecklers_disrupt_Phila_ _conference.html> Heath, Thomas. "Carlyle Group Files SEC Documents so It Can Go Public - The Washington Post." The Washington Post: National, World & D.C. Area News and Headlines - The Washington Post. Web. 11 October 2011. <http://www.washingtonpost.com/business/economy/carlyle-group-filesdocuments-with-sec-to-go-public/2011/09/06/gIQAFGLR6J_story.html>. Krantz, Matt. "USATODAY.com - Private Equity Firms Spin off Cash." News, Travel, Weather, Entertainment, Sports, Technology, U.S. & World - USATODAY.com. 17 Mar. 2006. Web. 9 October 2011. <http://www.usatoday.com/money/companies/2006-03-16-private-equityusat_x.htm>. Morgan, Jamie. Private Equity Finance: Rise and Repercussions. Basingstoke: Palgrave Macmillan, 2009. Print. "The New Kings of Capitalism | The Economist." The Economist - World News, Politics, Economics, Business & Finance. Web. 11 October 2011. <http://www.economist.com/specialreports/displayStory.cfm?story_id=3398496/>.

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Pratley, Nils. "Fahrenheit 9/11 Had No Effect, Says Carlyle Chief | Business | The Guardian." Latest News, Sport and Comment from the Guardian | The Guardian. Web. 9 October 2011. <http://www.guardian.co.uk/print/0,3858,5127052-103676,00.html>. Primack, Dan. "Carlyle Group Files for IPO - The Term Sheet: Fortune's Deals Blog Term Sheet." Fortune Finance: Hedge Funds, Markets, Mergers & Acquisitions, Private Equity, Venture Capital, Wall Street, Washington. Web. 11 October 2011. <http://finance.fortune.cnn.com/2011/09/06/carlyle-group-files-for-ipo/>. Samuelson, Robert J. "Robert J. Samuelson - The Private Equity Boom." The Washington Post: National, World & D.C. Area News and Headlines - The Washington Post. Web. 9 October 2011. <http://www.washingtonpost.com/wpdyn/content/article/2007/03/14/AR2007031402177.html>. Sorkin, Andrew Ross. "Carlyle to Sell Stake to a Mideast Government - NYTimes.com." The New York Times - Breaking News, World News & Multimedia. 21 September 2007. Web. 11 October 2011. <http://www.nytimes.com/2007/09/21/business/worldbusiness/21carlyle.html>. The Carlyle Group. Annual Report. 2009. Web. 16 October 2011. <http://www.carlyle.com/Media%20Room/item10786.html> Timmons, Heather. "Opening Private Equity's Door, at Least a Crack, to Public Investors - New York Times." The New York Times - Breaking News, World News & Multimedia. 04 Nov. 2011. Web. 9 October 2011. <http://www.nytimes.com/2006/05/04/business/worldbusiness/04place.html>. Ullman, Chris. “The Carlyle Group Files Registration Statement for Proposed Initial Public Offering.” The Carlyle Group. 06 September 2011. Web. 11 October 2011. <http://www.carlyle.com/Media%20Room/News%20Archive/2011/item12058.html> U.S. Securities and Exchange Commission. The Carlyle Group L.P. Registration Statement. Web. 09 October 2011. <http://sec.gov/Archives/edgar/data/1527166/000095012311082561/w83442sv1.htm#101>.

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