Krause Fund Research Spring 2020 The Carlyle Group (CG) April 14, 2020 Stock Rating HOLD Financial Services – Alternative Asset Management Analyst Target Price $25 - 27 Justin Koress Krause Fund DCF Model $27 [email protected] Relative P/E Ratio (EPS20) $21 Relative P/B Ratio $25 Investment Thesis Price Data Current Stock Price $22.68 We recommend a HOLD rating for The Carlyle Group because of its diversified 52Wk RanGe $15.21 - $34.98 investments within key drivers in the Asset Management industry, such as Key Statistics corporate private equity, with an emphasis to capitalize on the ESG investment Market Cap (B) $7.90 trend. However, CG’s use of leverage will expose them to extreme risks associated Shares OutstandinG (M) 348.23 with COVID-19. Five Year Beta 1.77 Current Dividend Yield 4.17% Drivers of Thesis Price/EarninGs (TTM) 8.04x Price/EarninGs (FY1) 13.98x • With private capital dry powder at a record $2.3 trillion dollars, Profitability alternative managers will be able to create high-quality investments at Profit MarGin 35.07% distressed valuations in response to COVID-19. Return on Equity (TTM) 39.88% Return on Assets (TTM) 17.15% • CGs management team has a proven track record in locating Debt to Equity Ratio 365.01% companies that weather economic downturns, providing tremendous investment opportunities in a destabilized market. 25.00 • The alternative asset management business is intensely competitive, with competition based on a variety of factors, including investment 20.00 performance, a record number of private investment funds, and lack of 19.00 20.28 investor liquidity due to COVID-19. 15.00 14.57 10.00 Earnings Estimates 8.01 Year 2017 2018 2019 2020E 2021E 2022E 5.00 EPS $2.58 $0.89 $3.05 $1.62 $1.94 $2.09 0.00 Analyst P/E ROE Estimates — — — $1.55 $1.98 $2.21 Source: Factset 12 Month Performance Company Description Source: Factset The Carlyle Group is a leading global alternative asset management firm that specializes in Corporate Private Equity, Real Assets, Global Credit, and Investment Solutions, and advises on a broad array of specialized investment funds and other investment vehicles that invest in a wide range of industries, geographies, asset classes, and investment strategies1. 1 Industry Analysis be the leading source of revenues among alternatives by that time. Passives/ETFs has taken over $1.3trn of inflows since 2008 in Domestic US equities, while active has seen outflows of Alternative fund managers anticipate a move from 2 over $1trn . This trend is a challenge for active managers CLOs/Loans, Distressed Debt and Private Real Estate into trying to compete for assets. The Asset manager space is as ESG/Impact Investing and (private market) Infrastructure. competitive as ever, causing declines in fee margins and Millennials are the driving force for this sustainable capital to flow towards the largest fund managers. Some movement. The increasing importance of ESG investments managers have responded by restructuring fee schedules, that these individuals as a group are driving this strong shutting down underperforming funds, and launching new momentum. ESG investments are those that meet certain 5 products . Over the past 15 years, the popularity of active ethical and sustainability standards. According to a recent core assets has declined significantly. Although a lot of the Morgan Stanley survey, 84% of Millennials cite investing money has flowed out of active assets into passive assets, with a focus on ESG impact as a central goal3. Millennial this has benefited only a handful of asset managers. growth will drive innovation in the industry and be a Companies with deep industry expertise and diversified significant factor in future AUM growth. Figure 1 depicts management teams are better prepared for the future in increasing inflows from into ESG assets aiming to create a today’s environment. From an AUM perspective, solutions positive impact without impacting returns. ESG inflows are and passive investments have been the fastest growing on pace for upwards of $16 Billion even with investor product category over the past 10 years. Growth in assets uncertainty due to COVID-19. under management is a primary driver of revenue gains for the asset management industry. The asset management industry includes Traditional Asset Managers, Alternative Asset Managers and Discount Brokers. Key Industry Drivers China is becoming very important for asset management firms, ahead of Europe, attracting more flows than the US over the next decade. Asset managers increasing targeting towards millennials with ESG/SRI (Socially Responsible Investing), communicating the importance of stewardship and governance, including the positive impact this has on society. Millennials are twice as likely to purchase from a Figure 1: Source 3 brand because of the company’s social and/or Amid a slowing global economy and geopolitical environmental impact millennials are showing strong uncertainty, the alternative assets industry has continued to interest in sustainable investing with 84% of Millennial 2 grow. Figure 2 shows private asset class AUM increasing to investors are interested in sustainable investing . record highs of $6.7tn in the six major alternative asset classes as investors poured capital into alternatives Active management must continue to make its case against searching for yield. Even with uncomfortably high asset passive solutions and alternative investments (especially prices at this time last year, investors are maintaining their private assets). faith with alternatives. We see two key revenue pools driving AUM growth in the future: (1) Asia, specifically EM/China and (2) alternatives We believe alternative asset managers are better positioned for the future because of alpha opportunities in private markets. With Private Capital dry powder at a record $2.3 trillion dollars4, managers will be able to create highly- structured investments at distressed valuations in response to COVID-19. We believe overall AUM for alternatives will accelerate and keep its title as the fastest growing segment. We expect that strong performance to continue, with the result that alternatives will widen their lead as the largest source of the industry’s revenue by 2023. Private equity, already a major and fast-growing investment vehicle, will Figure 2: Source 4 2 The global economic shockwaves caused by the COVID- 19 pandemic will cause disruptions on alternative asset management firms who rely on excessive leverage. FY 2020 will be a very difficult year for alternative investments, but managers will be able to invest heavily into distressed areas of the economy at low valuations. Institutional investors have increased allocations to alternatives in lieu of lower correlations to other asset classes. Over 12,000 institutional investors allocate funds into at least one private capital asset class4. Current Private Market Landscape Figure 4: Source 4 Early Signs of Contraction Dry Powder Early signs of contraction were shown in Asia already. Everybody is looking to China’s recovery efforts because it The record $2.3 trillion dollars of dry powder is causing was the first country to get hit with the virus. The rest of the deal volumes to drop. Managers have $2.6 trillion globally world is on its hind foot and psychological scars of the in cash or other marketable securities willing to invest in crisis will make a quick recovery difficult. The effects distressed assets at extremely low valuations following COVID-19 had on Asia will be indicative of what is to COVID-19. This will allow companies to come to market come in North America. Private markets have seen the and strike deals at a rapid pace. fewest number of funds closed since Q1 2012 and the worst quarter of Asia-focused fundraising in 7 years4. Declines in Fundraising The start of 2020 was met with headwinds for the global economy as it faced the fallout from the COVID-19 pandemic. Both the number of funds and amount of capital raised fell compared with Q4 2019 by 32% and 29% respectively. Total capital inflows in the private equity space is consistent with the overall market. Figure 5: Source 4 Real Asset Illiquidity Concerns The real assets industry is showing weakness as global recession fears continue to grow. Real estate fundraising levels declined over the first quarter of 2020 drastically. Deal activity has also declined across all property sectors and regions. Private real estate fundraising declined even further in the first quarter of 2020. Total capital raised was just $18 billion, while these figures should rise as more data becomes available, the totals are far from Q1 2019, when capital raised totaled $51billion. Deal activity fell below the recent quarterly average. In total, 1,797 deals Figure 3: Source 6 were completed globally for a total value of $73 billion. This compares with 2,417 deals for a combined value of Increased Fund Competition $101bn in Q1 20197. Global real estate’s recent run of underwhelming performance is likely to continue in 2020 The number of private equity funds in the market stands at on lower deal volume and fundraising. Deal activity has 3,620 globally with so many firms in search of capital. This declined significantly because of the increasing need for makes it an increasingly competitive fundraising liquidity. Liquid investments are at a premium in this environment. There is a record number of total funds in the current marketplace, forcing extreme outflows in real estate market, standing at 5,300 funds targeting $1.6 trillion in funds. Illiquid investments are taking the most beating as 6 assets . investors flock to safer, liquid assets. 3 2019 Total AUM by Segment 45.2 B 20.16% 86.4 B 38.54% 49.1 B 21.90% 43.4 B 19.36% Corporate Private Equity Real Assets Figure 6: Source 7 Global Credit Investment Solutions Private Debt Figure 7: Source 10: Carlyle 12.31 Supplement Private debt fundraising was also lackluster during the first Corporate Private Equity is a multi-fund, industry and quarter of 2020.