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Carlyle in Line to Benefit as Citigroup Expands Model

David Rubenstein, co-founder of Carlyle Group, at the World Economic Forum (WEF) in Davos. Photographer: Scott Eells/Bloomberg
David Rubenstein, co-founder of Carlyle Group, at the World Economic Forum (WEF) in Davos. Photographer: Scott Eells/Bloomberg

May 3 (Bloomberg) -- Citigroup Inc., one of the lead underwriters on Carlyle Group LP’s initial public offering, expanded the way it values managers of hedge funds and private equity, a change made before the IPO that may make the Washington-based firm’s shares more attractive.

An analyst team led by William Katz issued a report explaining the new valuation approach on April 23, while Carlyle executives were traveling to pitch prospective investors on yesterday’s IPO. The report didn’t address Carlyle, as Katz’s team hasn’t initiated coverage of the company. It reassessed four of Carlyle’s publicly traded peers and said investors were undervaluing them.

Carlyle, which started trading today after pricing its stock at $22 a share, has been trying to get Wall Street and investors to focus on its ability to distribute profits from buyouts, while downplaying the use of valuations that put more weight on income tied to fees. If other banks follow Citigroup, the shift may benefit Carlyle, which has struggled to match rivals such as Blackstone Group LP in producing management fees.

“Our analyst added a supplemental valuation model to his existing sum-of-the-parts valuation technique for his entire coverage universe of alternative asset managers,” said Sophia Stewart, a spokeswoman for New York-based Citigroup. “There were no meaningful changes to his target prices. The change addressed a significant appetite for an additional valuation methodology by investors in the stocks he currently covers.”

Buyout Dependent

Carlyle’s fee-related earnings, which exclude the firm’s cut of profits from buyout investments, have lagged behind those of Blackstone and KKR & Co. during the past three years. Carlyle depends on private equity for more than half of its revenue, compared with almost 18 percent at Blackstone.

Investors see earnings tied to management fees, usually 1.5 percent to 2 percent of assets under management, as a steadier income stream. Beyond the ability to exit holdings and generate reliable performance fees, investors are concerned that rising taxes and pressure from private investors to lower fees may hurt industry profits, according to the Citigroup analysts.

Chris Ullman, a spokesman for Carlyle, declined to comment. The firm didn’t seek the model change from Citigroup, said a person with knowledge of the matter.

New Model

Securities firms are supposed to maintain separation between banking and research, known as the “Chinese Wall.” Still, analysts help bankers vet prospective corporate clients and price IPOs, and for specific transactions can suspend research coverage while they work with bankers on a stock sale or merger. In 2002, 10 securities firms paid $1.4 billion to settle allegations by then-New York Attorney General Eliot Spitzer that they used research to improperly promote stocks.

Citigroup’s new distributable earnings discount model is driven mainly by an asset manager’s ability to generate cash by exiting investments through sales or IPOs. Publicly traded buyout managers are undervalued because investors are assuming the “realization cycle will never improve,” Citigroup wrote in its note.

Carlyle executives, in their pre-IPO roadshow, said payouts from deals will remain strong.

Carlyle will exit 62 percent of its $62 billion in “carry fund” investments over the near term and cash “is going to come flying out” of the company, Chief Operating Officer Glenn Youngkin said at a pre-IPO presentation in New York on April 26, according to a person present who asked not to be named because the event wasn’t public. Its carry funds include buyout, growth capital and distressed-debt pools while excluding hedge funds, structured credit and funds of funds, according to the firm’s regulatory filings.

Investor Skepticism

Last year, Carlyle distributed a record $18.8 billion to its private backers.

Potential investors in the stock, who would share in those profits, have expressed skepticism that the pace of exits is sustainable, according to people with knowledge of the roadshow.

Citigroup’s new metric uses forecasts of asset growth to project future distributions and puts less emphasis on earnings tied to management and performance fees, an area in which Blackstone, the world’s largest private-equity firm, excels. The bank lowered its 12-month price prediction for Blackstone to $18.50 from $19.

Carlyle generated distributable earnings of $881.6 million in 2011, adjusted for the effects of the IPO and the acquisition of AlpInvest Partners NV, according to data compiled by Bloomberg. The comparable figure at Blackstone was $696.7 million.

Fee Earnings

Citigroup’s older analysis focused on earnings and included unrealized fees, and has little to do with cash generation. Citigroup’s new price targets reflect a blend of both methodologies.

Under the sum-of-the-parts method, investors assign a low multiple on buyout profits, the 20 percent of gains from investments, because they’re unpredictable, especially in an economic slowdown when it’s difficult to sell. The stocks are trading at multiples of two to five times those earnings on that basis, according to Citigroup the note.

“When we speak with investors as to why they assign such a low multiple the responses are the same: 1) complexity; 2) volatility; 3) uneven realization outlooks,” the analysts wrote.

Banking Relationship

Carlyle and Citigroup, which is joined by JPMorgan Chase & Co. and Credit Suisse Group AG as the IPO’s lead underwriters, have a long history doing business. When Carlyle’s publicly traded credit fund fell victim to the housing crisis in 2007, Citigroup led a group of banks that extended a $875 million credit line in an unsuccessful effort to help rescue the fund.

Citigroup and JPMorgan helped the firm secure a second investment from Mubadala Development Co., part of the Abu Dhabi government, in 2010. The firm paid out most of the proceeds from the Mubadala deal to its owners that year.

After Carlyle filed to go public last September, the three lead underwriters, which are also the firm’s lenders, agreed to increase the revolving credit line to $750 million from a prior limit of $150 million. According to a copy of the borrowing agreement, revised again in December, the banks will no longer require the management and carried interest fees that Carlyle and its partners pledged as collateral once the IPO is completed and Mubadala is repaid.

Carlyle originally sought $23 to $25 a share in the IPO. The stock rose 0.3 percent to $22.07 at 1:35 p.m. in New York in the first day of trading.

To contact the reporter on this story: Cristina Alesci in New York at

To contact the editor responsible for this story: Christian Baumgaertel at

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