Ratings and research agency Fitch Ratings has downgraded The Carlyle Group to ‘BBB+’ from ‘A-’, citing an expected slowdown in the private equity firm’s fee-related earnings.
Fitch wrote in its downgrade report that Carlyle won’t be able to produce sufficient fee-related EBITDA (FEBITDA) as the firm gears up for a major fundraising cycle beginning in 2017. The report said those cycles often begin with a fall in FEBITDA resulting from an uptick in fundraising costs before management fees have been activated.
“In order to enter the fundraising cycle, they will have a lot of costs,” Fitch senior director and primary analyst Meghan Neenan told Private Equity International. “That will reduce their FEBITDA in 2017. But once they have their projected $100 billion raised and start earning fees, that will reverse course, and leverage will come down.”
Indeed, Fitch wrote that Carlyle’s leverage is relatively high at 5.39x as of 30 September, compared with its peers, said Neenan. It is also well above Fitch’s ‘BBB’ category benchmark for alternative investment managers, which ranges between 2.5x and 4.0x, according to the report.
However, when Carlyle does begin to experience increasing fees, Fitch believes it will be able to reduce its leverage multiple to the ‘BBB’ benchmark range, the report said.
Another reason for the downgrade is Carlyle’s liquidity profile, which Fitch says compares unfavourably with its peers. This is down to its balance sheet co-investments in its own funds, according to Neenan, which stem from the point it became a publicly traded firm.
“Prior to going public, Carlyle funded most co-investments to its funds from its employees and partners,” she said. “Once they went public, shareholders wanted a piece of the pie, so the firm’s balance sheet now has skin in the game with co-investing. They essentially need to fund their co-investments with cash on the balance sheet. KKR already has a significant portfolio on its balance sheet to do that, but Carlyle’s legacy portfolio is not as big, and building that up would take time.”
The report also noted that Carlyle’s management fees decreased by 10.8 percent for the first three quarters of 2016, compared with the same period in 2015. And although the firm’s earnings from carried interest are relatively high among its peers thanks to strong exit activities, net realised performance fees were down 30.2 percent for the 12 months ended 30 September, Fitch said.
“This action is not a surprise as Fitch is focused on fee-related earnings and fee-earning assets under management,” a Carlyle spokesman told PEI. “We produced strong distributable earnings in the third quarter and expect our fee-related earnings and fee-earning AUM to grow again in 2018 with the commencement of the $100 billion in fundraising in 2017.”
At the same time, Fitch maintained its ‘A’ rating for KKR and ‘A+’ rating for Blackstone, citing ample liquidity, relatively low leverage, sizeable fee-related AUM and incentive income-generating capacities for both firms.