Carlyle IPO may struggle to get “carry” revalued

June 20, 2011

By Jeffrey Goldfarb
The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

Carlyle will soon join the crowd — but try to stand apart from it. The U.S. private equity firm is gearing up to join rivals Apollo, Blackstone and Kohlberg Kravis Roberts as a publicly listed company. Carlyle’s unique structure could be its best hope of arguing the tough case that investing profits, or carry, should be worth more than investors currently think.

Led by David Rubenstein, Carlyle has plenty to draw investors toward its initial public offering. Assets under management have just about doubled since 2007, among the fastest rates of expansion in the industry. Adding Alpinvest’s $43 billion of assets will take Carlyle to $150 billion shortly. The Dutch fund-of-funds firm also brings a new line of business — the kind of diversification public investors like to see.

But Carlyle, whose funds own companies including BankUnited, Freescale Semiconductor and Dunkin’ Brands, faces a broader problem. Public market investors like steady management fees, but they give buyout firms scant credit for their carried interests. These gains from funds’ profitable investments are what differentiate private equity from other asset management — and what matter to buyout barons.

In the case of KKR, for instance, suppose its steady management fees are worth a multiple of 18 times the expected run-rate for 2012. Then assume its cash, investments and already-accrued carry are worth their reported value. Based on estimates by analysts at Goldman Sachs, that means the stock market is attributing no value at all to future performance fees. By similar calculations, Apollo’s future carry revenue is valued at only about two times the annual level and Blackstone’s at around four times.

Carlyle will struggle to overcome this way of thinking about carry. But it has a distinct approach. While most of its peers raise fewer, larger funds, Carlyle has 84 funds, each with a relatively narrow geographic and investment focus. And the firm boasts of returning almost $14 billion to fund investors over the last five quarters.

Carlyle might try to lure new investors into its management company with the idea that fragmenting funds in this way makes the firm’s carry revenue smoother. That’s because bad performance in one fund can’t offset gains and the associated carry in another. It’s a tough sell, but it just might give Carlyle a differentiating edge.

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