by Jason Kelly
I pressed Rubenstein on the point of retirement, or leaving Carlyle in some fashion, and it’s clearly something he thinks about constantly, echoing a sentiment from every one of the 60-something private-equity founders. He made an interesting point about the difficulty of letting go. “When you’re the founder of a company, an entrepreneur, you recognize the people you work with may not have the same entrepreneurial bent,” he said. “They may actually enjoy working for a larger company or one where they did not have to take the risk of getting it off the ground.”
This argument serves to underscore a crucial point about all of these firms, and one that was a common theme throughout almost every conversation I had with people inside and outside the big firms. Because the firms are so much created in the image of their founders, succession isn’t just about who will do the next couple of decades worth of deals. With their names literally or figuratively on the door, the founders are thinking beyond who is willing and able to run the firm. They need to find someone they trust to nurture the legacy of the men themselves. Most companies with similar scope and stature dealt with these issues long ago, and the fact that private-equity firms are dealing with it for the first time underscores the relative immaturity of the industry. They are far from the tiny private partnerships they began as. If Rubenstein’s vision is to become permanent beyond his stewardship, he and the other founders have to figure out the best ways to let go.
If KKR are the barbarians, Carlyle is the spooky, government-connected group in the public imagination. Roots in defense deals are largely responsible. Carlyle’s is one part Wall Street technology (the LBO) mixed with its hometown’s most pervasive business (the government and defense). Its first chairman was Carlucci, who cemented the perception that Carlyle was a key institution in the military-industrial complex. Former Secretary of State James Baker III was an adviser. Former U.S. President George H. W. Bush also advised the firm, specifically on doing business in Asia. Former U.K. Prime Minister John Major also served as an adviser. The founders stressed that none of the politicians advised on deals and were there simply to lend credibility to potential and current investors.
The associations clearly helped Carlyle in the early days establish a name for itself. As the years wore on, it found the darker interpretations of those relationships hard to shake. What was a cottage conspiracy theory during the 1990s, when the former government officials were kicking around Carlyle, blossomed into much broader, darker rep after the terrorist attacks of September 11, 2001.
Aside from public pension funds, who are in many cases by law compelled to reveal where they’ve invested money, the identities of other limited partners are a well-guarded secret. Rubenstein’s success in raising money, especially in the Middle East, where networks of families have accrued astonishing wealth from natural resources like oil and natural gas, had brought a number of investors who prized that sort of secrecy and discretion. One secret revealed in the wake of the 2001 terrorist attacks was that one such wealthy Middle East family was the bin Ladens of Saudi Arabia.
On the day of the actual attacks, Carlyle was holding its annual investor meeting, with presentations to limited partners by the founders and other Carlyle partners and advisers. Former President George H. W. Bush had spoken the previous evening at dinner. Among the investors on hand: Shafiq bin Laden, one of Osama bin Laden’s numerous half-brothers and a representative of a family that had invested $2 million in Carlyle’s second flagship buyout fund (a $1.3 billion pool).5
Michael Moore’s documentary Fahrenheit 9/11 seized on the situation, drawing the connection between Bush’s Carlyle ties and bin Laden, suggesting Carlyle was far more nefarious than a simple Washington influence peddler, especially given its close ties to the defense industry. The firm and the bin Laden family ended their relationship later in 2001, but the association was persistent, and while dissipated, still lingered a decade later. After Osama bin Laden was killed by a team of U.S. Navy SEALS in 2011, Fortune’s Dan Primack mused in an online article whether enough time had passed whereby Carlyle could take investments from the bin Laden family again.6
Broadening its adviser base beyond the government made sense. The number of defense-related deals is finite, and Carlyle was confident its reputation had evolved to the point where it would continue to see almost any deal worth doing in that area, often before anyone else. The founders also surmised that the model of having experienced, well-connected advisers to help open doors could easily translate to the broader corporate world.
The firm chose former IBM’s Gerstner as Carlucci’s successor in 2003. Gerstner, who retired as Carlyle chairman in 2008, helped usher in an era of partners and advisers with roots outside the Beltway and in the Fortune 500. Carlyle in 2005 hired former Bank of America Chief Financial Officer James Hance as a senior adviser to consult on financial deals. Other advisers included former 3Com CEO William Krause.
Even while bulking up on corporate expertise, Carlyle continued to hire from the ranks of government and government contractors. Arthur Levitt, the former chairman of the Securities and Exchange Commission, and former Air Force Chief of Staff John Jumper were tapped as senior advisers.b
The firm used its well-connected advisers to begin a relentless expansion throughout the world and Rubenstein’s wanderlust led Carlyle beyond the United States faster and more meaningfully than any other major private-equity firm. Fund-raising trips doubled as location-scouting missions as Carlyle pieced together a growing web of funds designed to exploit a combination of its capital and local expertise.
Carlyle from the early days was active in tapping the vast and secretive wealth of the Middle East, where Rubenstein’s willingness to visit in person, and often, played well into a culture that not only prizes, but demands, long-term relationships in business.
That work reached a milestone in 2007, when Carlyle announced that Mubadala bought a stake in Carlyle. The deal was a variation on Carlyle’s theme of going local in overseas markets. This was a way to get even deeper into a somewhat mystifying part of the world. At the same time, Mubadala got access to Carlyle beyond what was available to an ordinary limited partner. The fund owned a piece of the firm itself.
Mubadala, while backed by the government, isn’t a typical sovereign wealth fund. In Abu Dhabi, that’s handled by ADIA. Mubadala’s mission is to make investments that more directly benefit the emirate and it spent its first few years assembling an eclectic portfolio. Beyond the Carlyle stake, Mubadala sponsors a Formula One team, an association it used to bring a car race to Abu Dhabi. The fund also made an audacious, and so far losing, bet on perennial runner-up chipmaker Advanced Micro Devices, creating a joint venture that announced plans to open a semiconductor factory in Abu Dhabi.
Mubadala also played a key role in helping the founders begin to reap riches from what they created. In 2010, Carlyle took a $500 million loan from Mubadala in large part to pay a dividend to the owners, including the founders and the California Public Employees’ Retirement System. Carlyle repaid the loan in late 2011 and early 2012, a move that helped avoid Mubadala converting the debt to equity at a discount to the IPO price.
Mubadala was a key tenet of establishing the firm as global in its approach. Carlyle’s founders argued their version of diversification—geographic—put them on that path before any of their competitors, including Blackstone. That view was crucial to Carlyle’s pitch for one of its most important deals, the long-mulled initial public offering.
The founders, all headed toward their sixties at the time, seriously contemplated going public back when Schwarzman got his deal done and Kravis got as far as filing an S-1, in 2007. Just as the credit crisis derailed KKR’s plans and diverted that firm into a European two-step to an NYSE listing, the state of the financial world scuttled any plans for Carlyle to gain a public listing.
By 2011, the founders were more than ready and saw the year shaping up to be a perfect environment to prime the market’s interest. A lack of exits in the post-cr
edit crisis era meant there was a backlog of companies to sell or take public, which helped distributions and therefore profits. More friendly credit markets allowed new deals to get done. And importantly, limited partners were ready to commit money again, helping accelerate Rubenstein’s money-raising machine.
The firm took additional steps to bolster assets under management and business expansion. The founders hired Morgan Stanley’s Michael “Mitch” Petrick to build out a credit business and pulled off the acquisition of AlpInvest, a European private-equity fund-of-funds whose broad portfolio immediately goosed Carlyle’s total AUM and gave it a new line of business. Carlyle also bought a stake in a hedge fund, Claren Road.
The moves bulked Carlyle up to an extent that it and Blackstone were getting ever closer in terms of assets under management, a fact not lost on those at either firm, from the top executives on down. Privately, they sniffed at the composition of each other’s assets. Blackstone was heavily weighted toward hedge funds, Carlyle’s AlpInvest number included holdings in other private-equity funds.
The new businesses were meant to learn from Blackstone’s experience as a public company, which underscored investors’ desire for predictable streams of income and smoother trajectories for the overall profits. Petrick’s business accounted for 24 percent of Carlyle’s profit in the first nine months of 2011.
At Carlyle, moves to diversify from a product perspective failed before, sometimes spectacularly. A hedge fund, Carlyle Blue Wave, was shuttered in July 2008 after its assets dropped by more than 30 percent, to about $600 million from the $900 million the fund started with in March 2007. The fund dropped 10 percent in 2007, and had gained 2 percent for 2008 when it was liquidated. Comparable funds had returned an average of 4.8 percent from March 2007 to the closure.7
The Blue Wave closure felt less traumatic than another failure a few months previous. The more public misstep came with Carlyle Capital Corp., a publicly traded debt fund that collapsed earlier in 2008. Designed to invest in mortgage-backed securities, the fund initially won support from private investors, including many of Carlyle’s long-time limited partners in its more traditional private-equity funds. The three Carlyle founders put their own money in; other Carlyle executives followed their lead. Altogether, Carlyle employees had $230 million on the line.
Carlyle Capital went to raise money in the public markets in 2007, even as the market was starting to get shaky. That was apparent in the fund’s own offering, which was cut by 25 percent. Public investors put up more than $300 million. Combined with Carlyle money and private investors, the fund’s total equity was about $900 million.
A lawsuit filed after the collapse said Carlyle marketed the fund as aiming for leverage of around 19 times, meaning Carlyle would borrow up to $19 for each dollar of equity. The lawsuit said the actual leverage was more than 30 times.8
In such situations, such a bet goes wrong if the price of the underlying assets fall so much that lenders can make margin calls, and that’s just what happened. Carlyle pressed the lenders, which included huge banks like Citigroup and Deutsche Bank, to refinance the debt. Those negotiations, which Carlyle described at the time as “exhaustive,” failed. And so did Carlyle Capital, which had to be liquidated to meet those margin calls.
The Carlyle Capital collapse in March foretold a coming storm far beyond the firm, predicted ominously in coverage at the time. “Carlyle won’t be the end of it,” Greg Bundy, executive chairman of Sydney-based merger advisory firm InterFinancial Ltd. told Bloomberg News at the time. “There’s more to come. The problem is no one can give you an educated guess about how much.”9
Even an educated guess probably would not have come close to what happened later that year. While Carlyle Capital certainly resonated within the firm as its single biggest failure to date, it was ultimately a kitchen fire compared with the apocalyptic blazes that scorched Wall Street later that year, bringing the global financial system to the brink of collapse.
The failures of CCC and Blue Wave didn’t diminish the founders’ ambitions and their conviction that building the firm beyond private equity was not only desirable but necessary to keep satisfying investors, both the limited partners and their anticipated public shareholders. What Carlyle knew was that they needed a dedicated effort that would give them tighter control over any new businesses and for that they needed someone to run the show who ultimately was in the mix of the firm’s most senior levels. “We decided there had to be someone on the operating committee who owns it,” Youngkin said.
Rubenstein went into recruiting mode to find someone to fit the bill.
One morning in early 2010, Mitch Petrick was in Vail, Colorado for a family ski trip. He’d recently left Morgan Stanley after two decades, a month after a management overhaul led to his demotion from the head of sales and trading at the Wall Street firm. He was weighing his options and had already laid the groundwork for his own, independent firm. David Rubenstein had arranged this meeting at Lodge at Vail to convince him otherwise. Petrick sent the rest of his family to the slopes and listened.
The two men repaired to the empty bar, where the odor of beer and the previous night’s après-ski revelry was still hanging in the air. An atypically casual Rubenstein, clad in khaki slacks and a sweater, went to work on Petrick. “He is the consummate salesman,” Petrick said. “He was very persuasive that this made a lot more sense than doing it on my own.”
Rubenstein laid out a vision for Petrick akin to the yellow legal pad he’d shown Pete Clare almost two decades earlier. Petrick’s business, now known as Carlyle Global Market Strategies, or Carlyle GMS, would be a brand in its own right. Its aim would be to go into every corner of the world just as Carlyle did in private equity. The difference from previous efforts would essentially be Petrick and a strong mandate from the founders.
“This is the difference between running a fund and running a business,” Petrick said. “There’s an institutionalization above it and much better transparency on what we’re doing and how we’re doing it. That’s not to say we won’t run into problems, but we’ll know how we got there. You can’t draw a Plan B in the middle of the battle.”
The devotion of human and financial resources to Petrick’s business marked the biggest shift in Carlyle’s evolution since its decision to move beyond one fund two decades previous. Its success will be crucial to ensuring the firm does in fact keep growing. “This place is not just a private-equity firm anymore,” Petrick said.
Carlyle’s decision to restart discussions around its IPO was an indication that the industry’s boom and bust was far enough in the past and even before the registration was filed, the Carlyle IPO became a hot topic on Wall Street. Here was a brand-name financial firm contemplating an offering of itself, a sign that the smartest dealmakers thought it might be time to do another big deal. Blackstone’s IPO still resonated in private-equity and Wall Street circles as a perfectly timed IPO, at least from the perspective that Schwarzman and Peterson were able to get paid handsomely for their stakes.
A leaner and somewhat chastened group of big underwriters scrambled to pitch Carlyle in the summer of 2011. The three founders, Youngkin, and CFO Friedman entertained presentations from the banks, most of whom sent not just their investment banking heads but the CEO of the whole bank, to make the case.
Stories about the horserace popped up in newspapers, wire services, and on business news channels. In the end, JPMorgan Chase, Citigroup, and Credit Suisse won the coveted lead spots on the offering. Despite an ugly turn downward in the equity markets during the second half of 2011, Carlyle pushed ahead with the initial filing, with the notion that it would be ready if and when markets recovered.
Just as with Blackstone almost five years earlier, dealmakers, bankers, and journalists were eager to get a look beneath the covers, specifically at the pay details. After an austere few years, folks wondered whether there was still huge money to be made in private equity.
Carlyle gave its answer late one January T
uesday in an amended registration filing that detailed compensation. The three founders had collected a combined $413 million in 2011, the vast bulk of it coming from distributions from its funds. Each founder got $134 million, plus a $275,000 salary and a $3.55 million bonus. By comparison, Schwarzman had earned $398.3 million in 2006, the year before Blackstone’s IPO.
The compensation of the founders was one of several areas where Carlyle bucked convention in its filing to go public. The firm made it clear that unlike most publicly traded companies, it wouldn’t form a compensation committee to set founders’ pay. That would remain in the hands of the founders themselves, as it had from the beginning. In another case, Carlyle proposed that it would settle disputes with shareholders through confidential arbitration and prohibit class-action lawsuits from being brought against it. After consulting with the Securities and Exchange Commission, and facing concern from Carlyle investors (many of whom are active shareholders in public companies in addition to backers of buyout funds), Carlyle dropped the provision. The decision came just as a handful of U.S. senators pressed the S.E.C. to block the offering because of the arbitration clause.
In early February 2012, I sat with Rubenstein in front of hundreds of students and executives at Columbia Business School’s annual private-equity conference. The title for the conference was “Out of the Storm but Not Out of the Woods,” and the morning keynote was a discussion between Rubenstein and Clayton Dubilier & Rice founder Joseph Rice, one of the early practitioners of private equity whose firm bridged the eras of financially driven deals to ones that required dedicated operating teams.
It was at least Rubenstein’s second public speech in 72 hours; two days earlier he spoke at a Bloomberg-sponsored conference on China. The elephants in the room that morning on Columbia’s campus were the IPO, which Rubenstein studiously avoided discussing, and Romney, which he and Rice did take on.
