Private Equity: An Expert Tells How It's Done
In 1987, Dan D'Aniello left the Marriott Corp. to start the Carlyle Group, along with cofounders David Rubinstein and Bill Conway. Since then, Carlyle has become one of the world's biggest private-equity firms, with more than $46 billion under management. Carlyle owns all or part of nearly 200 companies, usually holding its stake for four to six years before cashing in. Overall return to investors exceeds 25 percent per year. D'Aniello spoke recently with Deputy Business Editor Rick Newman about Carlyle's purchase of Dunkin' Brands and trends in private equity.
As you know, a lot of people are worried about the growing role of private equity in the economy. Help explain private equity, in plain English.
Private equity is an asset class that allows for companies that are underperforming, or undermanaged, or not part of the core strategy of the owner to be put through a transition that allows us to improve their future, value, utility, and the products and services they offer. Private equity is like the body shop of the capital markets. Then, once you've fixed it, you need to ask, where's the vigorish?
Our mission is to produce returns in excess of what the market might provide. For private equity to earn a premium return, we must manage against heightened risks. And we promise absolute returns, not relative returns.
Explain some of the ways Carlyle adds value to companies.
There are different routes to profitability, such as acceleration of growth or improving the productivity of the assets. Then, once you've stabilized a company, you can ask a higher price. We also tend to put less debt on a company so management can focus on the business and not on statistics. We want the CEO working for the shareholders, not the banks.
So what does private equity offer that a big corporate owner, for example, might not?
You have to ask: Is private equity the right investor? It's more than just money that a private-equity firm can bring. It brings expertise. Business runs on trust, and when you can understand the strategy of a company and you believe management can execute sufficiently against that strategy, that's a powerful incentive to invest. Here again, the power of private equity is that occasionally management teams can get lost in a bigger organization.
Another key element for private equity is the alignment of incentives. We don't make money unless the company makes money and our investors make money. It's all aligned. In a public company, the stock might go up or down but not necessarily based on your actions. That's one of the incentives for management teams to go private. In the private world, reality is where we work, rather than perception. Public perception can add or take away value overnight. Like in the dot-com world. But not in the private world. Your range of movement in dealing with the business issues of a company in the private world is much broader. You don't have to worry about perception, just reality.
What makes a good target?
There must be a reasonable expectation of stability within two to three years. And the private-equity firm must have the capability of fixing specific issues. We also find companies sometimes where the owners are a little bit distracted. Dex [U.S. directories business]: distracted. Avio [Italian jet engine company]: distracted. KDDI [Japanese mobile phone company]: distracted.
So how do you determine when it's time to get out–your "exit strategy"?
Three things create value: paying down debt, increasing earnings, and you can also play the market for the optimal terms. Private equity has a clock on its money, which is, it has to turn the capital.
Time is the enemy of returns. The ways to exit are to do an IPO, sell to a strategic, or do a secondary buyout with another firm. Many times the preferred exit is an IPO. To do that, we have to establish the growability of the company and stabilize new markets. Growth: If people see it happen, then it becomes a very attractive public target.
Some people think there's a bubble in the private-equity market. If there is a bubble and it bursts, what will that look like?
The smart people in private equity are gearing up for a slowdown. The marginal firms will go away. Financial engineering, which is what private equity used to offer, has become a commodity. Firms today need expertise in the businesses they invest in and the infrastructure to deliver. The bulge-bracket PE firms may breathe a bit more, but a lot of them will go away, like the midmarket firms without a lot more than financial engineering. A lot of those will go away.
What you need today, it's connecting people with other people who can bring value on the factory floor. That's what reduces volatility to our investors. And we have a "one Carlyle" policy. We hold no barriers with regard to our resources and skills. We share expertise globally.
How big can these deals get? You mean, could there be a $70 billion deal?
I think there actually could. The appetite for coinvestment remains. On one deal, we were looking for $50 million in coinvestment. Within three weeks, we had $350 million worth of demand.
So why don't you do a massive pro bono project and buy one of the U.S. auto firms and re-engineer it until it's competitive?
Not an auto company! [Laughs.] Autos and airlines, we're a little bit reticent. If they catch a cold, we catch pneumonia.