Carlyle Co-Founders Warn on Frothy Valuations, Hedge Fund Underperformance

Carlyle co-founder Bill Conway stated in their recent Q2 earnings call:

The question on everyone's mind is probably why aren't you investing more money? We invested $1.6 billion in our carry funds from the second quarter; we are slightly more than half of that amount outside United States. So far this year we have invested about $3.1 billion. Let me put this investment pace into perspective. Over the past eight years we have invested about $79 billion in our carry funds averaging almost $10 billion per year, which is approximately what we invested in 2014. Our annual investments have ranged from high of $14.5 billion in 2007 to a low of $5 billion in 2009.

There are several factors driving this year's cautious investment pace. Most importantly we think prices in many assets classes are high. Our caution is further driven by uncertainties in Greece, fluctuations in the Chinese stock markets, continued high levels of leverage and a significant movement in energy prices. Also, with corporations struggling to find growth, they have turned to M&A to meet revenue targets while private equity activity has remained relatively muted. 

We believe current conditions will service catalysts for the next round of buying opportunities and while we cannot predict when all these opportunities will present themselves, the breadth of our platform and our dry powder positions us to take advantage when the time comes.

Conway recall the warning signs leading to the 2008 financial crisis.  Carlyle lost their hedge fund Blue Wave Partners due to poor returns and redemptions  Here's what Carlyle chiefs said about hedge funds in the recent analyst call:

Unfortunately, our significant hedge funds were down about 4.3% in the quarter.  

However, management fees from our hedged fund in investment solutions businesses are in total down about $19 million from Q2 of last year due to net redemptions and foreign exchange.

The decrease in distributable earnings primarily reflects a $19 million decline in fee related earnings as a result of lower management fees of $10 million from our hedge fund partnerships and $9 million in higher fund raising expenses associated with raising our second energy mezzanine fund which is not yet commenced management fees.

And our significant hedge funds largely remain below the high water marks and therefore are not contributing any meaningful group performance fees in 2015 as they did in the first half of 2014.

JP Morgan analyst Ken Worthington mined this concern:

Just on the hedge funds, the AUM decline this quarter and seems poised maybe to decline further in coming quarters. I guess first as you see it what are the issues? Obviously there have been some performance problems but is there maybe a greater issue with regard to either oversight or ownership structure or even management selection of purpose. Two, is there something that US managers need to or maybe are able to address here and then three, how do you return that the hedge fund specific operation kind of back to growth? Thanks.

 Conway replied:

I think that the -- it has been volatile and tough environment generally for investing. Sometimes I look at them and I wondered how it can be so low based upon all the volatility I see in the market. I don't think there is any kind of systematic problem with regard to our oversight or the job of the people running the hedge funds are doing or governance or anything like that. Obviously the hedge funds particularly Claren Road; they had a tough time in the first half of this year. But they do have a long track record of strong risk adjusted returns, very a proven team that's been doing the job, same people that when we initially acquired 55% of the business. We are working closely with them to sustain and restore the confidence that their investors have had with them for more than a decade, hopefully we and they will be able to do that. But I don't see it as a systematic problem or anything like that.

Carlyle's hedge funds made the wrong bets in all the volatility. Blue Wave Partners and Carlyle Capital Corporation were the canary in the coal mine that became the Fall 2008 financial crisis.  A hedge fund advisor recently suggested investors redeem their Claren Road investments.

FinAlternatives reported on a Carlyle commodity hedge fund that's virtually disappeared due to high redemptions

The founders of Carlyle’s Vermillion Asset Management hedge fund unit have left the firm amid steep losses and investor redemptions in its flagship commodities fund.

Chris Nygaard and Drew Gilbert, who founded Vermillion in 2005 and sold 55% of it to Carlyle in 2012, parted ways with Carlyle at the end of June, according to The Wall Street Journal. 

The firm’s Viridian commodity hedge fund, which trades oil, metals, and agricultural products, lost 23% in 2014, which touched off a wave of redemptions that brought assets in the fund from nearly $2 billion to under $50 million.

When asked how to grow Carlyle's hedge fund business Conway replied:

The best and the most -- the best way to grow is to have the hedge fund perform. Hedge funds perform, they can grow themselves. People want to be in their funds. I mean hedge fund like Claren Road it had some redemptions. A year ago they were turning money away. I think they turned away $1 billion a year ago because of -- they just didn't feel that they had the market conditions or the right opportunities to put that money to work. And so these things can turn pretty quickly in terms of what might happen. But the things that were causing to turn are performance. You perform, people are happy; they give your more money. You don't perform, the opposite happens. 

Will there be another Carlyle Group hedge fund run?  Investors may want to add cash like Carlyle to position themselves for the next round of buying opportunities.   

Update 8-1-15:  After shrinking a $1.7 billion hedge fund to less than $50 million, Carlyle chiefs dangled a new pot of gold for investors.  “We are successfully repositioning our commodities business, particularly in commodities finance, to capture an enormous global opportunity.”

Disturbing Wealth Secrets of the 1%

Economist Sam Wilkin wrote in Wealth Secrets of the 1% (Daily Mail):

...behind almost every great fortune, there lies what he calls a 'wealth secret'. This is a piece of knowledge or a technique that, while not exactly criminal, certainly skirts the customs of the time, and possibly the laws as well. All of them, he says, involve 'some sort of scheme for defeating the forces of market competition'. Many involve legal manoeuvrings or the exercising of political influence. Boldness and fearlessness are a given. Mild psychopathy probably helps, too. 

Private equity began in the 1980's as leveraged buyout organizations.  LBO's skirted customs, landing junk bond king Michael Milken in jail.  The 1980's saw the rise of Dr. Deming, Dr. Juran and Phillip Crosby.  Dr. Deming's theory focus on systems, variation, knowledge, psychology and their interaction is absent from corporate board rooms.  Dr. Deming cared about the human spirit and proposed win/win.

Corporate boards designed executive compensation programs where people at the top win, convenient as boards are interconnected groups of other corporate executives.  Management adopted the practices of Michael Milken, supplanting far worthier management theorists.  It's the age of Milken management where the top take all they can while they can.  The rest be damned. 

America's Red and Blue political teams cater to the .1%, which is largely represented by the PEU class.  Customs skirted, check.  Legal and financial manipulation (tax avoidance, management fees, dividend recaps), check.  Exercising of political influence on a bipartisan basis, check.  Boldness, fearlessness, psychopathy and the complete and total absence of guilt, check. 

The rich made their way to the top on the backs of others.  It's that simple.

Will Carlyle's Bad Claren Road Bets Nix Founder's "Great Revolution"?

Bloomberg reported:

Carlyle Group co-founder David Rubenstein, 65, said the “great revolution” coming to the industry will be the ability to add non-accredited investors, or those with a net worth lower than $1 million or those earning less than $200,000 a year. Regulations of fund structures should change to allow such people to put some of their retirement savings in private equity vehicles, said Rubenstein.

Seeking Alpha may have thrown water on Rubenstein's vision with its summary of a WSJ report:

Influential hedge fund consultant Cliffwater LLC has advised clients invested in Carlyle Group's (NASDAQ:CG) Claren Road Asset Management to pull their money. The details of Cliffwater's about-face - the group was a strong proponent of Claren Road not long ago - aren't known, but Claren Road's flagship fund lost 4.9% in June, and shed 10% last year. 

Claren Road has $4.9B in AUM, and Cliffwater has clients with about $800M of that. As recently as September, Claren Road had $8.5B in AUM, but soured bets on Greece and the GSEs have stung results.

Cliffwater's call doesn't necessarily mean a rush of redemptions at Claren, as some clients could ignore it, and others have their own bureaucratic hoops to jump through before making a decision to pull money. 

Carlyle purchased a 55% stake in Claren Road in 2010, part of a move to diversify beyond LBOs. 

Carlyle already rolled up two mutual funds that failed to garner traction, i.e. investments.  

Carlyle Monetizes Telecable

Interactive Investor reported The Carlyle Group will sell Telecable, a Spanish telecommunications company, to Zegona,  a firm founded by two former Virgin Media executives.  Carlyle's price is 650 million Euros, up 250 million Euros from its 2011 purchase price of 400 million Euros. 

Carlyle's 62.4% profit over four years is respectable but hardly in line with the PEU's claims of nearly 30% annual returns.  It's not clear how many millions more Carlyle took in annual management fees, deal fees, dividend recaps or the myriad of other ways private equity underwriters bleed affiliates.

Zegona employs a "buy, fix and sell" strategy.  What's to fix after four years of Carlyle ownership?

Add Union Pacific to Rail Safety Delaying Lobbyists

The Intercept reported CSX and Burlington Northern lobbied to delay the implementation of safety regulations after Amtrak's deadly crash in Philadelphia.  Union Pacific spent $1.45 million in the second quarter.  They spent $1.25 million internally and $200,000 on five lobbying firms.

Union Pacific's board has two former White House Chiefs of Staff, Red team Andy Card and Blue squad Mac McLarty.    Last year each earned over $260,000 in board compensation.  Given connections are all that matters in our nation's capital Union Pacific's additional $530,000 should help stave off the people's servants.

Profits are more important than people.  They're needed to fund political campaigns/  Once elected these servants cater to one public and do their best to ensure their ongoing profitability. That doesn't include people traveling by anything other than private jet. 

YouTube Takes Down Jeb "Work Longer" Video

The video is still available at ABC News, at least for now.  Was a non-disparagement clause involved?

Carlyle Cans PES COO

The Carlyle Group paid Philadelphia Energy Solutions COO David M. Ritter $2.4 million for 13 months work.  Philly.com reported:

The chief operating officer of Philadelphia Energy Solutions Inc. resigned quietly in April, only 13 months after he was brought in to run the sprawling former Sunoco refinery in South Philadelphia, a filing with the U.S. Securities and Exchange Commission reveals.

According to the SEC filing, Ritter was paid a base salary of $525,000 and received severance of $1.3 million. 

Ritter received a $125,000 bonus when he started work, an $85,000 relocation reimbursement, and a $350,000 year-end incentive bonus. 

I'm not sure how much that works out per fire/explosion, but I imagine it's a handsome sum.  Investors can get in on two PES IPOs.

The company's initial public offering is complicated because it is occurring at the same time that PES is spinning off its logistics operation into a separate publicly traded entity.

Carlyle started the logistics division in October 2014.  It's hard to believe nine months later it will be spun off, but that's the PEU way.

Distressed Debt & Carlyle Group Investments

Bloomberg reported on ballooning high yield debt:

The pool of distressed U.S. corporate bonds, typically those yielding more than 10 percentage points above benchmarks, has swelled to $127 billion, from the low last year of $43.7 billion, Bank of America Merrill Lynch index data show. This month alone, Peabody Energy’s $4.8 billion of bonds have fallen 14.9 percent, while Cliffs Natural Resources’s $2.5 billion of notes have declined 14.6 percent.

The most-indebted companies are generally more vulnerable to hiccups, such as oil prices that have fallen to about $52 a barrel from as high as $61.82 last month.

“How high will energy default rates go?” UBS analysts Matthew Mish and Stephen Caprio wrote in a July 9 report. “We have been very consistent on this question: 10 to 15 percent by mid-2016.”

Private equity underwriters love market dislocation.  They can buy distressed companies on the cheap.  The Carlyle Group used distressed debt to take over companies no longer able to pay their bondholders.

David Rubenstein of Carlyle Group (CG) told Rhonda Schaffler of TheStreet.com that he thinks valuations are high and he is finding very few opportunities. He told her that "we don't really want to put money out the door, just because we have money to invest." That one single line should be taped to the wall above every home computer set up in the nation. Individual investment returns would increase dramatically. He did say that he was finding opportunities in energy and health care.

Front door or back door?  Ask the folks at Brintons or Mrs. Fields about Carlyle's debt restructurings, also known as a pre-pack.  I don't think they have good memories of the experience.  Carlyle loves energy at the moment.  I hate to think what they can do to ruin our healthcare system further. 

Michael Milken: Father of Modern Management

Management practice in the world today perversely rewards a handful of people at the top, who excel by employing financial engineering tools.  Employees and their pension plans are sacrificed for the enrichment of executives and board members, who happen to be executives for other firms employing the same financial manipulations.

Businesses may use the language of former fathers like W. Edwards Deming, Peter Drucker, Peter Senge, Peter Block and Stephen Covey, but these are just words.  Dr. Deming's teachings on Profound Knowledge have been relegated to two words buried deep inside a corporate compliance program.  Continuous improvement is merely a set of tools to be applied, not a comprehensive, integrated management theory which requires it be updated as new theories are confirmed.

Michael Milken's leveraged buyout organizations are the foundation for management today.  Dr. Deming decried their existence as the antithesis of constancy of purpose.  Extrinsic motivators distort and Milken's greed landed him a $600 million fine and in jail.  Yet, this fraudster's practices can be seen over and over in the most cursory examination of private equity, an updated name for leveraged buyout organizations.

Companies use the language of employee appreciation.  What call with Wall Street analysts doesn't begin or end with the CEO thanking his employees for all they do day in and day out to provide outstanding service?  Never mind senior leaders just decimated that service, yet again, with their latest round of cuts intended to maximize executive compensation.

Fraud is the basis for today's management practices.  Management uses fraudulent words.  Their personal enrichment is criminal in scope and collusion is clearly behind board approved executive pay schemes.  All hail Michael Milken, the father of today's management practices.  The theory is "Get mine first by whatever means possible.  Legality isn't required."

Dr. Deming, Peter Drucker, Peter Senge, Stephen Covey and Peter Block created theory and knowledge for the betterment of everyone.  Milken lied, cheated and stole to join the monied class, the group that now makes an annual pilgrimage to hear him speak and spread his toxins.  Appearances would have Milken a prophet, but closer examination reveals his focus, profit by any means.

Update 7-28-15:  Bad management theory resulted in excessive executive compensation at the expense of everything else.  I can hear Dr. Deming bellow, "Will they ever learn?"

Update 8-15-15:  And the mother might be Carly Fiorina, former HP CEO.  Fortune described her contributions to horrific management, "A new defensive, finger-pointing style of leadership led to waves of firing. Dissent was equated with disloyalty....Despite such carnage, Fiorina pocketed over $100 million in compensation for her short reign—including a $65 million signing bonus and a $21 million severance."

Update 8-21-15:  Amazon's Jeff Bezos knows how to crush the human spirit in Milken like fashion.  

Health Insurance Prices Takeoff: Worker Pay Stagnant

PPACA is not bending the health care cost curve downward as promised.  It is sending premiums into the orbit.   NYT reported:

Health insurance companies around the country are seeking rate increases of 20 percent to 40 percent or more, saying their new customers under the Affordable Care Act turned out to be sicker than expected. 

Blue Cross and Blue Shield plans — market leaders in many states — are seeking rate increases that average 23 percent in Illinois, 25 percent in North Carolina, 31 percent in Oklahoma, 36 percent in Tennessee and 54 percent in Minnesota.

The government projected a less than one percent increase for national health expenditures under PPACA.

We estimate that overall national health expenditures under the health reform act would increase by a total of $311 billion (0.9 percent) during calendar years 2010-2019, principally reflecting the net impact of (i) greater utilization of health care services by individuals becoming newly covered (or having more complete coverage), (ii) lower prices paid to health providers for the subset of those individuals who become covered by Medicaid, (but with net Medicaid costs from provisions other than the coverage expansion), and (iii) lower payments and payment updates for Medicare services. Although several provisions would help to reduce health care cost growth, their impact would be more than offset through 2019 by the higher health expenditures resulting from the coverage expansions.

Now that coverage is soaring once again, the government remains on the hook:

The PPACA establishes the Exchange premium subsidies during 2014-2018 in such a way that the reduced premiums payable by those with incomes below 400 percent of FPL would maintain the same share of total premiums over time. As a result, the Federal premium subsidies for a qualifying individual would grow at the same pace as per capita health care costs during this period. 

Annual premium growth of 20 to 50% will blow a monster hole in PPACA's financial footing.  PPACA was a predictable debacle.  People are paying more to be underinsured and face hurdle after hurdle accessing health care services.

What are health insurers doing with their extra cash?  Buying one another.  Forbes stated:

The big are getting bigger: Aetna and Humana, the nation’s number three and number four health insurers by revenue, are merging.  Aetna will pay about $230 per share for Humana, in a $37 billion cash and stock deal, the largest-ever deal in the health insurance industry.

It’s also the latest major merger in an increasingly frantic health care marketplace. On Thursday, Centene  announced that it was buying HealthNet for nearly $7 billion, and CVS last week bought the Target pharmacy business for $2 billion.  (And the other two big health insurers, Anthem and Cigna have also talked about merging.)

PPACA "appears to have only helped major insurers, by driving millions of new customers into the market. Aetna and Humana have seen their stock valuations triple in the past five years, since PPACA was signed into law, and the other three major insurers also have seen huge gains."

If you like America's consolidated airline industry service which in my experience has consistently provided less for more money, you'll love PPACA.  Just as the private plane set no longer flies commercial, the people reforming the system, executives, board members, lawmakers and lobbyists/consultants, will have no trouble accessing concierge level healthcare. Most of us will pay an unconscionable amount to be underinsured and still face financial obliteration from one major health care episode.

Pay raises for five years, zero to miniscule.  One year increase in health insurance premiums, 25 to 50%.  That's bending the cost curve in a way to make PPACA an instant failure.

Update 7-25-15:  Health insurer Anthem plans to buy Cigna in a $48 billion deal.  Expect even less for more money.  Watch how executive pay balloons.

Update 3-15-18:   Skyhigh healthcare costs differentiate the U.S. from the rest of the globe.  PPACA's cost curve bent in the wrong direction, acceleration.

Update 7-4-19:   Health equity declined since 1993 despite PPACA's promises.

Update 9-25-19:  Employers shifted costs to employees via higher deductibles and increased co-pays.   PPACA has not helped make healthcare more affordable.  It has made a lot of money for the PEU boys.

Update 4-16-20:  A coronavirus pandemic revealed America's broken healthcare system and PPACA's many shortcomings. How many  22 million newly unemployed  can afford the premiums?  How many of these will get COVID-19 and die at home without proper care?  

Update 4-3-22:   The average health insurance premium more than tripled for a family plan since PPACA passed in 2010.  Cost curve bent but in the wrong direction.  Concave went convex.   

Carlyle Group's Paradigm Precision Downgraded by Moody's

Moody's downgraded Carlyle Group affiliate TurboCombustor Technology, dba Paradigm Precision.  Various Florida entities provided nearly $5 million for TurboCombustor/Paradigm to add 200 jobs at their Stuart, Florida plant.  There's no report from the Governor's office on Carlyle's performance the last two years.  Let's hope Carlyle's job promises are better met in Florida.  Texas got virtually nothing for giving Carlyle affiliate Vought Aircraft Industries $35 million for six years.

The downgrade reflects levels of cash flow generation that continue to trail expectations coupled with recent weakness in operating performance that has led to a further tightening on an already strained cash flow profile. Moody's anticipates negative free cash flow for 2015

This will hurt employment as Carlyle sheds expenses in order to make principal and interest payments on $330 million in debt.  The question is how much?  Carlyle won't tell and if Florida Governor Rick Scott is like Texas counterpart Rick Perry, expect any number to be a whopper of a lie.  Government aided employment numbers are like fish tales.

The company will add jobs in Poland according to a recent press release.  The drive to produce in lower wages countries is clear from this part of their press release.

TurboCombustor/Paradigm gets 30% of sales from the U.S. Military.  Bloomberg reported the company received a nearly $10 million contract in May for afterburner flame holders.  Carlyle's sponsorship reveals a number of PEU practices.

Uncle Sam part of the revenue stream?  Check
Sending work to cheaper parts of the globe?  Check
Getting $ millions to add U.S. jobs?  Check

Let's hope it's not another Vought where Texans gave Carlyle $1 million per job lost over a period of six years.

Update 9-25-16:  Summer 2016 brought another Moody's downgrade for Carlyle's TurbocCombustor.  

Rubenstein: NY Billionaire Bubble vs. Greek Pensioner Debacle

TheStreet.com reported:

Rubenstein said The Carlyle Group is a large investor in Europe but the firm has not invested in Greece in recent years and has no plans to do so now. 

Carlyle's investor class includes public pension funds.  Elderly Greeks have been hit hard by this week's bank closures (BBC).

Reports said many pensioners waited outside branches from before dawn, only to be told withdrawals were being done alphabetically. Many were then asked to return on the following days.

Konstantinos Nikolopoulos, 70, was told by his bank that his pension was unavailable. "They told me they don't know when they will have the money and asked me to come again tomorrow just in case," he said.  "This situation is out of control."

Rubenstein sees a potential bubble in New York real estate:

"I suspect apartments built for billionaires in New York City might be a bit of a bubble. I'm not sure there's enough billionaires to fill all of them."

Billionaires are a growing class in the U.S. and globally.  Contrast their increased wealth with elderly Greeks:

Monthly pensions have gone down to an average of €833 ($924; £594) from an average of €1,350 in 2009

That's a 35% decline in monthly income over the last six years.  For some it could get worse.

Creditors want Greece to quickly phase out a top-up payment it gives to close to 200,000 of the country's poorest pensioners

The global race to the bottom on benefits includes pensions.  While some elderly have family members to support them others are not so lucky.

Zina Ravi, 79, relies entirely on her pension and says she is still in debt every month.  She is one of the high numbers of Greeks claiming a pension - and is having to help a middle-aged son who is now one of many unemployed Greeks.

It's not the right time for The Carlyle Group to invest in Greece.  There's no government to protect Carlyle's PEU investments or provide Carlyle risk reduced ways to make 30% annual returns. Rubenstein believes Greece could change.

The financial betting class voted thumbs down on Greece's government debt.

Current bets have the house wanting big premiums to insure Greek debt.  Watch the vote from Sunday's referendum.  Will Greeks celebrate July 5th as a new Independence Day? 

Update 7-5-15:  "No" voters have the early lead  

PEU Carlyle Group Likes Mega Yacht Space

The Carlyle Group closed on Lauderdale Marine Center in time for July 4th fireworks.  South Florida Business Journal reported:

The Carlyle Group has acquired the largest yacht repair facility in the nation, the Washington D.C.-based company announced Wednesday.

Lauderdale Marine Center is the largest yacht repair facility in the U.S. in terms of the number of large vessels it can haul and service. It can accommodate boats up to 200 feet with 19 covered sheds and 156 wet slips. It has three marine travel lifts with haul-out capacity up to 330 tons and features 7,000 linear feet of dockage.

Carlyle affiliate BankUnited loaned Lauderdale Marine Center $60 million in 2013.  Carlyle exited BankUnited in March 2014, making billions thanks to Sheila Bair's FDIC

Carlyle's estimated purchase price for LMC is $140 million.  The Real Deal reported:

"Favorable demand trends in the mega-yacht industry and the high barriers to entry for new supply in Southeast Florida attracted us to the investment.”

Spoken like a true PEU.  I can heard Carlyle's David Rubenstein's sales pitch to his fellow billionaires.

 "You're coming to Basel in December.  Bring the (name of the yacht).  We'll take care of everything your baby needs.  Guaranteed." 

This is the crew who earlier this year gave income inequality lip service at Davos.  Trends are favorable for the mega yacht space in our PEU world, where politicians Red and Blue love PEU.

Update 2-29-20:   Lauderdale Marine Center hosted an event where attendees could "see a video of the yard’s history and hear about upgrades including its designation as a U.S. Foreign Trade Zone (FTZ), new docks for larger yachts, new boat lifts, and new parking areas."