Value Added: Investment opportunities through the eyes of a Carlyle Group co-founder
By Thomas Heath,
The Carlyle Group is gearing up its annual investor conference in downtown Washington this week on the heels of a buying binge that constitutes a big bet on the U.S. manufacturing sector.
The investors gathering at the meeting represent the pension funds, foundations, universities, sovereign wealth funds and rich people who give Carlyle their money in hopes of making more with it.
The business of private equity is, by definition, one of adding value, because firms buy companies with the intention of selling them at a profit.
The Washington-based private-equity giant lately has invested billions in basic, old-line industries such as railroads, refineries, pumps and paint companies, while many of its competitors have remained relatively quiet.
Carlyle’s moves are especially surprising, given that U.S. manufacturing dipped in August for the third month in a row, a sign that the economy — and production in particular — may be slowing.
William E. Conway Jr., 63, a co-founder of Carlyle and chairman of its investment committee, took a contrarian point of view in a wide-ranging telephone interview in which he discussed his thought process behind the focus on factories.
He also talked about other sectors he likes and ones he doesn’t, the current mess in Europe and what keeps him up at night.
Carlyle’s stock price isn’t keeping him awake. The shares have marched 19 percent upward since their initial public offering in May.
The bottom line for Conway, and for closely watched Carlyle, is that the firm’s vast portfolio of companies serves as a sort of instant heart monitor of the U.S. economy, and, far from flat-lining, the numbers are telling him that the United States is the most attractive market in the world in which to invest.
“We track that growth through data in our portfolio companies, which helps us make smart new investments and best manage current investments,” said Conway, a data hound who scrounges through obscure metrics in search of “ahas.”
“We, in some ways, have better data than economists and some government people. That data tells us things like cargo-shipping rates, leisure-car rentals from Hertz and commercial building-supply sales. Based on that data, we continue to see real growth. We have real growth on the order of 2 percent.”
Not exactly robust, but Conway said the United States is riding big business advantages that may create lots of future wealth — if the decision-makers on Capitol Hill ever get their act together.
He cited two big reasons to back up his thinking.
“One is the domestic energy revolution, which you could call shale gas,” he said, adding that it is cheap, plentiful and used to heat homes as well as power industry. “It’s going to make our lives a lot better and a lot better for the rest of the world.
“The second big thing we have going on that makes the U.S. attractive and doing deals is reindustrialization, which has two big parts. The first part is the operating costs, which includes cheap energy. The second is increasingly competitive labor costs, due in part to the weaker dollar. Japan and parts of Europe and China are very competitive, but perhaps a little less competitive because of the dollar’s relative weakness.”
Conway said the United States continues to have the strongest, deepest and most flexible financial markets in the world, which also makes it a magnet for investment and creates the climate for growth.
“The U.S. is still the center of technological innovation. We have the best university system in the world. The best hospital system in the world. Best medical labs. I like the U.S. for all those reasons.”
The cost of borrowing money is also very low, which Conway sees as an opportunity not to be missed.
“The last six deals we’ve done, the average cost of borrowing was 6 percent,” said the former chief financial officer of MCI Communications. “That may sound like a lot, but when I was CFO of MCI in the early 1980s, we were paying 15 percent for debt.”
Conway said the business model for private equity is changing. Twenty years ago, private equity was built largely on financial engineering, which flipped companies for more than was paid for them.
Those days are largely a thing of the past. Because of intense competition, Carlyle must find companies it can fix, reposition, grow and then sell — hopefully at a huge profit, like it did with Dunkin’ Donuts (300 percent profit) and like what it hopes to do through its recent acquisition of DuPont’s auto paint business and Getty Images’ photography archives.
“Carlyle doesn’t have a monopoly on genius,” Conway said. “When I see Carlyle is doing things and our competitors aren’t doing as much, that causes me to say, ‘What do we know?’
“We know we have expertise inside Carlyle. We think we know how to make these businesses better. This is a very important point. When we started 25 years ago, you could buy businesses very cheaply and make money on the first day because you bought it cheaply. In this era, you have to make the company better.”
Conway said he also finds Europe intriguing, and likes China, Brazil and other emerging markets.
“People are just afraid of Europe and what’s going to happen to the euro. Europe is ripe. Everybody is sitting around saying, ‘I’m afraid so I’m going to invest in U.S. Treasurys. I’m not investing in Europe.’ Everyone is scared. Europe is an enormously wealthy continent. They have problems, but you travel around and there is so much wealth. We are seeing some pretty intriguing opportunities.”
Carlyle recently bought a cable company in Spain and bought the financial services firm TCW Group from the Paris-based Societe Generale bank for $700 million in cash.
I asked Conway which sectors he is avoiding.
“I would say the tougher ones are telecom and technology. We’ve made a lot of money for years in telecom. It was some of our best deals. But telecom is tougher. It’s more of a commodity. It’s not a question of do you have a cellphone, but it’s how many do you have?”
Finally, I wanted to know what is keeping him up at night.
“Two things,” he said. “One, China is slowing down. Eight percent growth is now 6 percent. Does it go to 5, 4 or where?
“The second thing is the U.S. political situation. The two parties are in so much disagreement on everything. There are few people in the center who can try to get something done. I’ve lived a long time with uncertainty. I want certainty. You tell me what the rules are, should I bring my hockey stick or should I bring a football?”
For now, he is bringing money. And he is investing it in the U.S. manufacturing sector.
“The proof will be what happens over the next three to four years.”
Shareholders will be watching.
To read previous Value Added columns, go to postbusiness.com.