Carlyle Group, and Other Private Equity Firms, Look Good as Long as Interest Rates Stay So Low

While Bain Capital co-founder Mitt Romney was busily making headlines running for the presidency of the United States, his erstwhile colleagues in the private equity industry were busy doing deals – and none more so, it seems, than those at Carlyle Group LP (CG), which put more than $5.6 billion to work in the third quarter. That figure includes transactions that closed during the period, such as the auto body-shop chain King Collision Repair Centers, and those announced but still pending, such as the acquisitions of asset manager TCW Group and photo library Getty Images.

The fact that bond yields have fallen so much that the junk bond market can no longer plausibly be described by its former self-selected moniker of ‘high yield’ has been a boon for private equity firms, Carlyle among them. It makes financing leveraged buyouts much less costly – and thus potentially much more lucrative. Cheap financing also makes it easier for buyers of its portfolio companies to arrange financing, and for Carlyle to pocket hefty sums on those transactions.

BX Chart

BX data by YCharts

Carlyle is the latest of the big private equity firms to take its management company public, but it has generated the best returns for investors, vs. competitors Blackstone (BX) and KKR (KKR). Tracking its earnings can be a bit of a chore, since the best measure of how it is doing – economic net income, a metric that includes the market value of its various assets – isn’t a standard one. Still, Carlyle just reported that its ENI for the third quarter rose to $219 million or 66 cents a share, compared to a loss of $191 million in the year-earlier quarter. That’s a respectable earnings “beat” of two cents a share. By another measure, Carlyle didn’t do quite as well; the investment gains it generated during the quarter, calculated as pre-tax distributable earnings that are available to be paid out as dividends to investors, fell to $206 million from $244 million in the third quarter of 2011.

CG Price / Book Value Chart

CG Price / Book Value data by YCharts

Are the buyout firms good investments in their own right? They are hard animals to value, and there’s an additional risk in that investors are getting an ownership stake of a limited partnership, not of the operating company. When Carlyle went public last spring, the SEC had to require them to remove a provision that would have made it impossible for shareholders to sue management, even in the case of fraud. Like its peers, Carlyle has a decent dividend yield that just became more attractive with the announcement of a dividend of 16 cents a share, up from the previous dividend of 11 cents a share. Investors will have to weigh for themselves whether that stream of dividend income is enough to offset some of the negatives of investing in a company but not having a direct ownership interest in the deals it is negotiating. The interests of management and shareholders aren’t identical.

BX Dividend Yield Chart

BX Dividend Yield data by YCharts

There also is the question of what will happen to the private equity world if capital starts becoming more costly or less available. Carlyle and its peers have generated healthy earnings because of the amount of leverage they are able to pile on to the companies they acquire. Make that debt more costly, and the tailwind becomes a headwind.

^INX Chart

^INX data by YCharts

If that makes you wary, there is a third option, one that involves neither selling nor buying Carlyle itself. As the chart above shows, holding Carlyle shares this year has been a great strategy – but owning stock in one of Carlyle’s former portfolio companies, Dunkin’ Brands (DNKN) would also have allowed you to outperform the broad market. Moreover, the chart seems to suggest that Dunkin’ Brands has served almost as a kind of hedge to Carlyle. That’s more likely to be coincidence than any kind of correlation on the basis of which it’s safe to invest, but it is a useful reminder that there is more than one way to participate in the deals that Carlyle and other buyout firms put together than being a junior partner in their managing company.

Suzanne McGee is a contributing editor at YCharts, which includes the just-released YCharts Pro Platinum for professional investors.



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