Carlyle rainmakers cast dark cloud over returns

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David Rubenstein

Carlyle Group co-founders William Conway and David Rubenstein on July 27 said that soaring stock markets and intense competition for deals will make it harder for private equity firms to reap big profits on leveraged buyouts in the foreseeable future.

“Right now, it is tough to earn returns of 20% or more in the private equity business,” Conway said on an earnings call Wednesday, referring to the returns historically achieved by the industry’s top-performing funds.

Private equity firms aim to outperform stocks and other financial instruments by acquiring underperforming companies, fixing them up and selling them for a profit years later, often using debt to juice returns. Over the past couple of decades, they have become a favourite of pensions and other big investors after early buyout funds delivered outsize returns.

But rising stock valuations and competition for deals from corporate buyers and fellow private equity firms have made bargains harder to come by, which could lead to smaller returns for fund investors down the line.

“We’re constantly outbid around the world by other private equity firms” and companies, Conway said. The firm, which manages $ 175.6 billion of assets, reported a decline in its second-quarter profit on smaller gains in its buyout funds and declines in its hedge fund business.

Still, he and others said, even returns relatively low for private equity by historical measures are better than many other investments in today’s low-interest-rate environment.

Investors are “willing to take lower rates of return than the kinds that we’ve averaged over our history,” Rubenstein said. “It’s just so difficult now with low interest rates and low equity market appreciation to get these kind of returns anywhere else.”

On Wednesday, Carlyle’s shares fell 2.3%, to $ 16.87.

Some $ 225 billion in private equity capital was raised by US firms or international firms targeting the US last year, the most since 2008’s $ 242 billion haul, according to Dow Jones LP Source.

Data provider Cambridge Associates’ US private equity index rose 5.9% in 2015, outperforming the 1.4% total return for the S&P 500, which includes dividends. The median return of institutions with at least 15% of assets in private equity was 3.6% last year, versus 0.9% for those with a 5% to 15% allocation, according to a Cambridge Associates survey of 453 such investors.

Leveraged buyouts – in which firms use high-interest-rate loans to purchase companies – were a major force in deal making in the years leading up to the financial crisis, when a parade of $ 20 billion-plus takeovers led KKR co-founder Henry Kravis to declare a “golden age of private equity.” After the 2008 stock-market collapse, buyout firms made a killing on bargain bets picked from the rubble, such as Apollo Global Management’s investments in chemical company LyondellBasell Industries.

Lately, higher valuations have made big-ticket buyouts harder to find. Regulation aimed at limiting risky lending by Wall Street banks has made debt less available, limiting access to a key ingredient of buyout firms’ returns on successful deals.

Moreover, corporate buyers sidelined during the crisis have come roaring back, fuelling a record year for announced mergers and acquisitions in 2015. Companies’ ability to cut costs while combining businesses gives them a leg up, and they stockpiled cash during the downturn. Globally, private equity firms have announced $ 103 billion in leveraged buyouts this year, the slowest period since 2012 and far below pre-crisis heights.

Doubts about private equity firms’ ability to generate hefty returns has weighed on their stocks. Shares of Blackstone Group and Apollo have dropped more than 15% over the past year, while KKR and Carlyle have declined more than 35%.

Private equity firms have been moving beyond leveraged buyouts for years, expanding into credit, real estate and other businesses. They are also shaking up the buyout model, buying minority stakes in publicly traded companies and amassing smaller companies in fragmented industries.

Blackstone President Hamilton “Tony” James told analysts last week that the firm expects its private equity business to continue delivering the kind of returns its fund investors have come to expect, noting that low interest rates have made it less expensive to fund deals.

Blackstone, he said, is focusing more of its money and attention on “buildups where we take a small company, great management team and assemble a national champion.” The firm last week reported a rise in its second-quarter profit.

Scott Nuttall, the head of KKR’s global capital and asset management group, told analysts Tuesday that markets remain dislocated. Valuations of foreign and small US companies have lagged behind those of big businesses that make up the S&P 500, presenting opportunities for the firm to invest, he said.

Write to Matt Jarzemsky at

This article was published by The Wall Street Journal

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