The Carlyle Group Inc.

Moat: 1/5

Understandability: 4/5

Balance Sheet Health: 3/5

The Carlyle Group is a global investment firm that deploys capital across various asset classes, including private equity, credit, and real estate.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

The Carlyle Group Inc., while a global giant in asset management, faces an intensely competitive landscape with low barriers to entry and limited evidence of a sustainable competitive advantage or “moat” in their current structure.

Business Overview

Carlyle operates across three core segments: Global Private Equity (GPE), Global Credit (GC), and Global Investment Solutions (GIS).

  • Global Private Equity (GPE): The bread and butter of the company, this segment focuses on direct investments in private companies, often partnering with management teams to create value and grow these businesses. Strategies include buyouts, growth capital, and strategic investments.
  • Global Credit (GC): This segment offers credit solutions for investments and businesses, including credit funds, middle market direct lending, and distressed debt. This area has been prone to some recent volatility and investor concerns.
  • Global Investment Solutions (GIS): This segment builds customized solutions for clients, such as investment advice, private wealth management services, and co-investment options, etc.

The lines between these segments are not always clearly defined, as they often overlap and share resources, especially their investment teams. This complexity adds to the difficulty in making a precise moat evaluation.

AUM represents the amount of assets under management. Management fees are generated as a percentage of AUM. So the higher the AUM, the greater the potential of higher revenue and profits. This makes AUM a primary performance metric.

Industry Dynamics and Competitive Landscape

The asset management industry is characterized by intense competition and relatively low barriers to entry for new funds. It’s not an industry with natural monopoly powers, and it isn’t especially hard for another firm to create competing products. The value that these businesses provide is dependent on the perceived expertise and the performance of the managers running the funds. This allows investors to very readily switch between different managers, and doesn’t provide any significant lock-in effects. The main sources of competition come from the number of well-established firms with a wide range of investment strategies, and it also comes from newer firms trying to establish themselves in the market. There are a lot of substitutes available.

What Makes The Carlyle Group Different

Carlyle tries to differentiate themselves with their unique global reach and expertise in niche areas. But they have recently been undergoing a strategic review, which has made it clear, that they had been overly focused on fundraising and not enough on generating returns for their investors. To make matters worse, there have been internal cultural issues and scandals that have further eroded the trust that investors and potential investors have in the company. The other way Carlyle separates itself is through its “integrated model”, where different teams within their organization share knowledge and resources to improve performance across different asset classes. Their large and diverse base does make them able to source unique and different transactions, and to execute on these. That’s what Carlyle claims to be anyway.

But, the company has also been facing operational challenges, including high employee costs, inconsistent performance across all segments, and some internal friction and lack of accountability among the staff.

The competitive landscape is becoming more challenging. As the number of participants in private markets grows, even traditional private equity firms have to fight to attract investments and talent. Competition has grown over the last few years, and Carlyle is facing more competition on all sides from smaller private equity firms to global giants in the space.

Moat Analysis

Moat Rating: 1 / 5.

Carlyle currently does NOT have an economic moat. Lack of Intangible Assets: While it has a well-known brand, its brand doesn’t provide it with pricing power or customer captivation; investors are unlikely to choose Carlyle funds based on brand perception alone. They seek specific skills, experience, and high performance. Low Switching Costs: The company’s clients face very few barriers to switching to a competitor. Many other private equity firms exist with similar strategies and capabilities, and investors don’t have any significant costs to switch to these firms. No Network Effect: The network effect doesn’t apply to the asset management space, which means that no company is inherently better just because more clients/investors have chosen the firm already. There is not a network of users that would make the offering better with the increase in users. Cost Disadvantages: As a big player, Carlyle’s cost structure is comparable to other large competitors and doesn’t give it a competitive edge, and it has been facing issues from rising employee costs that have put them at a disadvantage.

Financial Analysis

Let’s go over the company’s financials, using a couple of main points:

  1. Revenue and Assets Under Management (AUM): Carlyle’s AUM has been growing over the last few years, reaching $381B as of December 31, 2022, then decreasing to $373B as of September 30, 2023. This demonstrates that the company’s main selling point, which is its ability to manage assets, is still valuable for investors.
  2. Profitability: The company’s income statement is rather volatile. It faces several issues with performance revenue. The company’s net income has varied greatly between 2019 to 2023. The company does not have predictable income, but a lot of its profits are based on successful fund performance.
    • This lack of stability means that it is difficult to assign a proper valuation and to have confidence about how the company would perform in the future.
  3. Capital Structure and Leverage: Carlyle has a considerable debt load that can magnify both profits and losses. This can make the company vulnerable to financial distress in uncertain times. There isn’t as much financial stability as investors would like in the company.
    • It does have a high debt-to-equity ratio, and has very little equity available for each dollar of debt. This makes the company very susceptible to any macroeconomic downturns or financial hardship, and also does not make it a worthwhile investment in general, as a relatively large proportion of profits are paid towards debt repayment.
  4. Expense Growth: The company’s expenses have been growing recently as a result of poor performance on investments. This implies that even in the good times of the market, it faces significant problems regarding efficiency and operation of its businesses. It may be the fault of poor employee productivity, as well as the high salary that the company must pay to retain top-tier talent.
  5. Net Interest Margin: The difference between income earned on loan investments and the interest payments the company makes on its debt is too low to be considered a form of competitive advantage, but rather just reflects how the company operates its businesses.

Understandability

Understandability: 4 / 5 While its business model is clear to see—it is an asset management company—the various investment strategies of its many funds, the unique nature of all of the investments, coupled with the complex accounting of such a large and diverse business makes it difficult to fully understand the company and its operations. It is easier to understand than something more technical, like a software company, but will require a detailed read-through of the financial statements to fully get a complete understanding.

Balance Sheet Health

Balance Sheet Health: 3 / 5

  • The company has a large number of assets, but is highly reliant on debt.
  • There have been considerable variations in earnings in past few years.
  • The company is undergoing a period of uncertainty due to strategic changes, so it’s difficult to gauge its future performance and financial health.

Risks to the Moat and Business Resilience

  • Increased Competition: The financial services sector is seeing increasing competition, as mentioned earlier. This could squeeze Carlyle’s margins, while new entrants might attract both clients and talent from the company, putting downward pressure on its AUM.
  • Poor Performance: Bad investment decisions and poor performance are a huge threat to the company’s business, leading to losses in profits and AUM. It is hard to make up for a company with poor performance. If it has poor returns, it cannot attract any new funds or investors.
  • Macroeconomic Downturn: Global economic downturns, including high inflation and high interest rates, could reduce the amount of funds available for investments, while making the company’s highly leveraged capital structure more vulnerable to defaults and bankruptcies.
  • Management Issues: Scandals and a high number of executives leaving could erode the trust that investors have in the company, leading to a significant loss of capital.
  • Regulation: Increased regulation on alternative investments may affect the business. And Carlyle has been facing more and more pressure from increased regulations. The cost and impact of compliance may also hurt the business in the short and long run.
  • Lack of Alignment: Carlyle might be too focused on short-term profits that would come from a surge in revenue or AUM, and might not be focusing enough on long-term value creation that comes from improved investments.

In summary, while the Carlyle Group is a prominent name in asset management, it’s unlikely to have significant barriers to entry, and faces immense competition from others in the industry. These factors combine to make it an unfavorable investment with higher downside and lower upside, as things currently stand for the company.