The New Tycoons: Inside the Trillion Dollar Private Equity Industry That Owns Everything (Bloomberg)

by Jason Kelly

  Carlyle, given its penchant for covering the world through a combination of Rubenstein visits and local executives, in 2007 opened an outpost in the Dubai International Financial Centre, becoming the first large U.S. firm to set up an office there. The DIFC, built around a signature squared arch known as The Gate, became an expat banker hub, where French-cuffed Europeans and Americans mixed with Emiratis and other Arabs in dishdasha, the traditional dress. In the food court below the Gate still stands an outlet that’s an emblem to U.S./Gulf private-equity cooperation. Caribou Coffee, a Starbucks rival started in Minnesota, was eventually bought by Arcapita, a private-equity firm in Bahrain funded by Arab investors whose North American offices are located in Atlanta.a KKR eventually followed Carlyle to Dubai with a small office, as did Blackstone. All of them heralded the region as a fast-growing land of opportunity, with potential deals aplenty. They conceded that it wouldn’t be like the United States or Europe, with traditional leveraged buyouts, take-privates, and transactions that gave the U.S. GPs controlling stakes in their targets. Instead, they would more likely be partners with local investors, or buy minority stakes in high-growth companies.

  The opportunity, of course, turned out to be a mirage, at least immediately, and especially in and around Dubai. By late 2009, the emirate was enveloped in a real estate and credit crisis of its own, requiring the bailout from Abu Dhabi. It became a symbol of excess in its own right, shorthand for bubble.

  Yet Dubai’s troubles and the so-far missed, or elusive, opportunities in terms of investments can’t overshadow the enormous role the sovereign wealth funds continue to play in the world of private equity. By most accounts, they will become the biggest source of capital for private-equity funds within the next decade, a shift that stands to have profound implications on the form and strategy of the industry. The sovereign wealth landscape is increasingly influenced by Asia, and especially China. As in many other aspects of the global economy, China has emerged as both an ally and potential threat to private equity. China Investment Corp., a sovereign wealth fund, bought a stake in Blackstone around the time of its IPO in 2007. Schwarzman and his biggest competitors have pursued deals in China. At the same time, China has feverishly developed its own private equity industry to rival their U.S. counterparts. All of this serves to add another element of competition to the mix.

  Carlyle’s Rubenstein believes that the big investors will continue to press for lower fees and in some cases ask for co-investment vehicles that give them more discretion over where their money goes. Meanwhile some SWFs will follow the Ontario Teachers’ model and nurture staffs that can invest money directly and avoid third-party managers for at least some of their private-equity strategy. “The economic model is evolving a little bit,” Rubenstein said.

  He maintains that ultimately people like him—professional private-equity investors—will win the lion’s share of money to be invested in leveraged buyouts and related businesses. It’s an admittedly self-interested opinion. But the tens of billions he raised across the world during the past two decades give his take a little more credence.

  a Arcapita filed for Chapter 11 bankruptcy protection in 2012.

  Notes

  1. Jason Kelly, “Private Equity Finds the Easy Money Gone,” Bloomberg Businessweek, August 26, 2010.

  2. Hui-yong Yu, “Oregon Pledges $525 Million to KKR’s New Buyout Fund,” Bloomberg News, January 26, 2011.

  3. Jason Kelly and Jonathan Keehner, “BCE Lenders May Sidestep C$10 Billion in Losses,” Bloomberg News, December 8, 2008.

  4. Jason Kelly, “Ontario Teachers’ Gives Blackstone, KKR a Run for Their Money,” Bloomberg Businessweek, March 1, 2010.

  5. Michael Marois, “California Prison Physician Ranks Atop State Payroll Figures,” Bloomberg News, July 6, 2011.

  6. Robert Novy-Marx and Joshua Rauh, “The Crisis in Local Government Pensions in the United States,” Northwestern University’s Kellogg School of Business, 2011, Forthcoming in Growing Old: Paying for Retirement and Institutional Money Management after the Financial Crisis, Robert Litan and Richard Herring, eds., Brookings Institution, Washington, DC.

  7. “Private Equity Principles 1.0,” Institutional Limited Partners Association website. http://ilpa.org/principles-version-1-0/

  8. “Private Equity Principles 2.0,” Institutional Limited Partners Association website. http://ilpa.org/principles-version-2-0/

  9. Jonathan Keehner and Jason Kelly, “The People vs. Private Equity,” Bloomberg Businessweek, November 28, 2011.

  10. Beth Jinks and Jason Kelly, “New York Pension’s Schloss Raising Allocation to Private Equity,” Bloomberg News, September 28, 2011.

  11. Devin Banerjee and Sabrina Willmer, “Blackstone’s Biggest Investment Shows Clients’ Clout,” Bloomberg News, December 9, 2011.

  12. Dalton Conley, “Seeking SWF,” Democracy, Issue 12, Spring 2009. www.democracyjournal.org/12/6674.php?page=all

  Chapter 2

  All the Money in the World

  Inside Carlyle

  David Rubenstein begins most every speech he gives with a survey of the audience, polling to see what type of crowd he’s speaking to. “How many of you are LPs? GPs? Consultants?” Depending on what’s happening in the world, he might ask whether Greece is going to default or whether the Democrats will keep control of the U.S. House of Representatives. Usually he’ll throw a funny question in, like, “How many of you think my taxes are going up?”—a reference to a long-standing effort in Washington to change how buyout managers’ profits are taxed.

  To many in and around the industry, he is the most recognizable private-equity manager, thanks to the sheer volume of his appearances. He is ubiquitous, giving dozens of speeches a year around the world and visiting investors. He would, as the saying goes, turn up for the opening of an envelope.

  Rubenstein told me several years ago he subscribed to Woody Allen’s axiom that 80 percent of success is simply showing up. He is an indefatigable fund-raiser and is almost singlehandedly responsible for the firm’s growth by assets under management through his near-constant visits, some to places where no private-equity manager had been before, especially in the Middle East. “Because of David, the amount of money Carlyle can raise is essentially infinite,” one rival manager said, with a mix of admiration and envy.

  His approach to an audience of hundreds, a dozen, or one is disarmingly understated. His sense of humor is sneaky and dry. On the sidelines of a speech in Dubai in 2007, I asked him what had changed about the Middle East. Without missing a beat, he said, “More reporters from New York.”

  His own travels are reflected in Carlyle’s myriad funds, which in sheer numbers (89 as of May 2012, the vast majority of which were private equity) dwarf any of its competitors. In private equity, Blackstone has one large global fund and a handful of smaller regional funds, including one in China; KKR has a similarly small number. The ability to raise money and recruit local teams to manage them is fundamental to the firm’s business model and its biggest competitive advantage over its peers. The basic structure allows a manager in say, Brazil, to hang out a Carlyle shingle and receive fund-raising help from Rubenstein and the fund-raising team numbering in the dozens. In exchange, Carlyle gets a generous slice of the partnership and a proportion of the carried interest once the fund has made investments and reaped profits.

  Competitors dismiss Carlyle’s approach as a franchise model—the private-equity equivalent of opening up restaurants around the globe, with a familiar name but sometimes uneven quality, usually the further away from the headquarters you are. The f-word is not popular with Rubenstein or other Carlyle executives, who insist that programs like “One Carlyle,” spearheaded by chairman Daniel D’Aniello, along with financial incentives to encourage cooperation, keep everyone singing from a single Carlyle songbook and financially rewarded to do so.

  Rubenstein’s mien is nerd-charming. His Woody Allen approach puts him on the road upwards of 250 days a year, demanding that he subsist on l
ittle sleep. He eschews caffeine and meat. His white hair contrasts with his chosen uniform of blue pin-striped suits and white shirts. He speaks quietly, rarely raising his voice or getting overly animated about much of anything, and eye contact in one-on-one conversation is often elusive. On stage, he undergoes a mild transformation, leveraging his aloofness into an eccentric, dryly humorous persona. During one appearance in 2012, he noted that his mother encouraged him to be a dentist instead of the lawyer he became.

  By the design of the founders, Rubenstein is the face of the firm, to both investors and to the press. He concedes it’s a role that didn’t come naturally, but he has overcome whatever latent shyness he has through sheer force of will. He consumes media nonstop, reading several books a week along with a complement of daily newspapers and magazines, and seems to enjoy parrying with reporters, professors or colleagues. Watching him chat people up, it’s as if he has an overstuffed file cabinet in his head where he’s constantly pulling out folders, stuffing notes into them, and moving on to the next topic to do the same thing. His wonky nature was honed in his early career, as a domestic policy adviser in the Carter White House, which he speaks of both as a formative time and uses as a punch line in speeches and interviews, especially when asked about inflation. “In the Carter White House, I got it to 19 percent—very difficult to do. I’ve often said to people in the Federal Reserve, ‘If you’re worried about deflation, bring me back, because I can cure that problem.’”1

  He grew up in a blue-collar Jewish neighborhood in Baltimore, where his father was a postal worker and his mother worked in a dress shop. He won scholarships to Duke University and the University of Chicago Law School, and began to go down a well-trod Washington path, winning a job at law firm Shaw Pittman after leaving the White House after Carter lost to Ronald Reagan.

  As he navigated through his thirties, he found himself bored with practicing law and, he said, not especially good at it. He read an article that said entrepreneurs start their companies by the time they are 37. He took note of a leveraged buyout deal for Gibson Greetings, led by a New York firm called WesRay, which had delivered a $200 million return on a $1 million investment. WesRay was an investment firm created by the late former U.S. Treasury Secretary William E. Simon and Raymond Chambers (the firm’s name was derived from Chambers’s first name and Simon’s initials). WesRay also led leveraged buyouts for Avis Rent A Car and Wilson Sporting Goods.

  Rubenstein convinced his former colleague from the Carter years, another former Treasury secretary, Bill Miller, to start a firm in Washington to pursue similar deals. Rubenstein soon found that he and Miller didn’t have the same vision.2 Miller was focused on advisory work; Rubenstein, who’d kept his law job while he helped out Miller, wanted to make investments. So he called Ed Mathias.

  Mathias first met Rubenstein in 1977, at a dinner hosted in Washington by the late Bob Brimberg, a relentless networker who’d earned the nickname “Scarsdale Fats.” Then working for Carter, Rubenstein had been identified as an up-and-comer in Washington circles. His Herculean work ethic—the first to arrive, the last to leave, he often bought meals from the vending machine—helped the myth. Mathias, who then and now had a knack for collecting interesting people and staying in touch with them, was intrigued by the 20-something Rubenstein. His impression of the future Carlyle co-founder: “He was purposeful. He is totally serious about what he undertakes and there’s not a lot of emotion. He doesn’t internalize the risk of failure. That has not changed in 35 years.”

  Mathias occupies an angular interior office at Carlyle that looks out into the cross-shaped lobby dominated by a massive, four-sided clock (the building that houses the firm was used as a set in the movie “Broadcast News”). Today, he’s involved in Carlyle’s efforts around growth capital, investments that aren’t classic leveraged buyouts and have some similarities to venture capital. As a long-standing member of the firm, he also has the ear and trust of the founders. In the run-up to Carlyle’s 2012 IPO, he was named to the firm’s board of directors. He spoke of Carlyle like a proud parent, and indeed, he helped birth it.

  Back at T. Rowe Price, Mathias and his bosses saw what was going on in venture capital in the nascent leveraged buyout business where a handful of players like KKR were making extraordinary returns. They wanted to test-drive this business. Mathias pulled together a syndicate of investors that included his firm, as well as Baltimore investment bank Alex. Brown & Sons. First Interstate Bank of Los Angeles, and the Mellon family, one of Mathias’s clients.

  Mathias put together a total of $5 million, $2 million for working capital, and $3 million for investments. Then he and Rubenstein set about rounding out the group.

  Rubenstein got in touch with Steven Norris, a Marriott executive he knew through legal work at Shaw Pittman. Norris recommended a colleague, Daniel D’Aniello. Another contact of Mathias turned him on to Conway, who had risen to become chief financial officer of MCI and, Mathias was told, was restless. Rubenstein cold-called Conway. Mathias interviewed Conway at Gary’s Steak House, a now-defunct restaurant in downtown Washington. He agreed to join.

  For his part, D’Aniello was a relatively happy guy. He was working amid a veritable dream team of finance whizzes within Marriott. His colleague Steve Bollenbach would go on to run Hilton Hotels; one of his bosses, John Dasburg, would go on to be CEO of Burger King.a

  A week into his tenure at Marriott, D’Aniello got a call from Bill Marriott, Sr., asking him to come up and translate a bevy of financial instruments that at the time were transforming the hotel business. D’Aniello became the senior Marriott’s go-to guy on matters financial

  Bill Marriott Jr. was in charge when D’Aniello was contemplating joining Rubenstein. It was a conversation at the younger Marriott’s office that sealed D’Aniello’s decision to leave and help form Carlyle. Summoned to discuss his potential new job, D’Aniello arrived to explain himself to Marriott. He invoked the senior Mariott’s own story. “I’m only emulating your father’s example of following his dreams. I’d like to have your blessing to pursue an opportunity like that.” Years later, when they ran into each other at a business event, Marriott said, “I don’t know why you ever left us. You’re only paying more taxes.” While D’Aniello’s father-in-law worried that he might be taking a grass-is-greener approach, he realized he didn’t want to risk regret. “I didn’t want to be 70, sitting in my rocking chair saying, ‘Why didn’t you give yourself a shot?’”

  He did and the four original partners—the three who remain today, plus Norris—went to work. They named their company after the famed hotel in New York after reading a biography of Lazard banker Andre Meyer who’d lived in Carlyle on Manhattan’s Upper East Side.3 Soon, several of their backers realized that having a stake in a firm like Carlyle posed conflicts, mainly because anything Carlyle bought would be off the table as a potential customer for banking services. The founders pooled their money and bought out Alex. Brown, T. Rowe Price, and First Interstate Bank. Mellon stayed in for a number of years more. The founders’ stake went from 52 percent to 90 percent. “One of our most profitable investments ever,” D’Aniello said, “was the one in ourselves.”

  One holdover of the earliest days was Mathias, who called Conway and Rubenstein in 1993 and said he was thinking about leaving T. Rowe. They asked him to join Carlyle. “It wasn’t a big deal with job interviews and catharsis,” Mathias said. “We had an affinity for each other.”

  As with the other big firms, there was a deal that helped define Carlyle: the $130 million purchase of BDM International from Loral in 1990. The defense industry was a natural place for the Carlyle founders to look for deals for a variety of reasons. First, its epicenter was in the neighborhood, giving them a built-in advantage. They’d also managed to link up with former U.S. Defense Secretary Frank Carlucci and signed him up as an adviser, the notion being that he could provide introductions and ideas. BDM was the first case.

  In the late 1980s and early 1990s, the fall of the Berl
in Wall reoriented the global landscape. Defense-related companies were cheap, largely because the larger companies who’d earlier swallowed them up didn’t see a bright future for Cold War-geared units. As part of a deal where Loral bought Ford Aerospace, Carlyle bought the BDM subsidiary from Loral. Carlyle and its investors made 14 times their money by the time they fully exited BDM seven years later, but D’Aniello and Conway both said BDM was as significant for what it taught Carlyle about the broader opportunity in defense and other government-related firms as well as the private sector

  “BDM changed everything,” Conway said. Beyond being financially rewarding for Carlyle and its investors, “it showed we understood businesses that do business with the government.”

  The company also helped bolster the nascent Carlyle network; as the firm looked at similar deals, it regularly consulted former BDM executives. It would also provide a template for future nondefense deals, where Carlyle would use seasoned executives to source deals, conduct due diligence, and serve on boards of directors. “In the beginning, this business was all about financial capital,” Conway said. “It became apparent to us that intellectual capital was really what was in short supply.”

  The results of the first fund, totaling $100 million, showed how much understanding the businesses you bought mattered. About 42 percent ended up in aerospace and defense deals and that $42 million became more than $372 million. The remaining $58 million of the fund invested outside of those areas ended up worth $30 million, Conway said.