Carlyle Group’s owners aren’t waiting for an initial public offering to take some money off the table. In transactions nine months before it filed for an IPO, the private equity firm saddled itself with debt to pay founders William Conway Jr., Daniel D’Aniello, David Rubenstein, and other owners a $398.5 million tax-deferred dividend. First it borrowed $500 million from Abu Dhabi’s Mubadala Development in December 2010, saying it would use part of the proceeds to expand investment products. Then it paid out almost 80 percent of the money to existing owners, according to regulatory filings. Separately, the Washington-based firm also negotiated bank credit giving it the option to distribute an additional $400 million prior to the IPO, according to lending agreements filed with the Securities and Exchange Commission last month.
“Why would you do that?” asks Matthew Pieniazek, president of Darling Consulting Group, a Newburyport (Mass.) adviser to banks. He suggests Carlyle’s owners may have wanted some insurance against the vagaries of a public offering. “IPOs are not guaranteed,” he says. “They were willing to give up some of the upside for the certainty of” a distribution. Chris Ullman, a spokesman for Carlyle, declined to comment. In October 2011, Carlyle used bank loans to repay half the money it borrowed from Mubadala. On March 1, it borrowed $263.1 million to retire the remaining $250 million in Mubadala debt, according to a March 15 regulatory filing.
Because the dividends are financed with debt, under IRS regulations for partnerships the owners can defer paying taxes on the distribution until the debt is retired, says Allan Weiner, a partner at the Washington office of law firm Kelley Drye & Warren. For tax purposes, paying off Mubadala with borrowed money would not count as retiring the debt. “They are essentially creating a distribution without paying taxes,” Weiner says.
The recent financial moves are similar to the “dividend recapitalization” that private equity managers use to extract cash from companies they buy. Dunkin’ Brands Group (DNKN) borrowed $1.25 billion in 2010 to pay $500 million to owners Carlyle, Bain Capital, and Thomas H. Lee Partners. Dunkin’ went public last year in a $486 million share sale. Six months after Carlyle and Clayton, Dubilier & Rice led the buyout of Hertz (HTZ) in 2005, the car rental company used a $1 billion loan to pay a dividend to its new owners.
Carlyle, founded in 1987, is the second-biggest private equity firm, with $148 billion in assets as of Sept. 30, including stakes in companies such as NBTY, the vitamin maker, and ratings company Nielsen Holdings (NLSN). Its three founders received a combined $413 million last year, mostly from distributions. Apart from the founders and Mubadala, its owners include the California Public Employees’ Retirement System, or CalPERS, which bought a 5.5 percent stake in 2000.
Some of the firm’s first investors came from the Middle East and included the Saudi royal family and owners of the Saudi Binladin Group, the Jeddah-based construction company founded by Osama bin Laden’s father, Mohammed. Carlyle returned the Binladin money after the Sept. 11 terrorist attacks.
The firm has weighed an IPO since at least 2007 when larger competitor Blackstone Group (BX) went public. As financial markets began to collapse, Carlyle tabled its IPO plans and instead agreed to sell a 7.5 percent stake to Mubadala, an investment vehicle owned by the Abu Dhabi government, for $1.35 billion in September 2007. Mubadala made the second investment in Carlyle in December 2010, buying $500 million in debt convertible into Carlyle stock at a 7.5 percent discount to the IPO price. Carlyle refinanced half of that debt in October 2011, a month after it filed to go public and secured a bigger credit line from its banks.
The money Mubadala lent in 2010 helped Carlyle distribute $787.8 million in cash to its top executives that year, up from $215.6 million in 2009 and $253.9 million in 2008, according to regulatory filings. While Carlyle didn’t give a reason for the dividend payout, one possibility is that the executives needed cash. The founders and other senior professionals had agreed to contribute a total of $1.2 billion to the firm’s buyout and other funds as of Sept. 30, 2011, according to the IPO documents. Such commitments can sometimes prove burdensome for private equity executives, says David Miller, a tax attorney at Cadwalader, Wickersham & Taft in New York. “It was not infrequent during the recession that private equity managers had to draw on credit lines because they had commitments” to put money into buyout funds, Miller says.
In addition, when Carlyle’s buyout funds sell companies they own, the firm’s partners must recognize income for tax purposes, even though they may not immediately get any of the actual cash. They must wait until outside investors in Carlyle funds have gotten all of their capital back, plus a return of 8 percent to 9 percent before they receive any money, according to the firm’s IPO filing. “Managing the cash in a private equity arrangement is a little more of a challenge than in a typical hedge fund that has liquid assets,” says Jim Browne, partner at Strasburger & Price, a Dallas law firm that specializes in general tax planning. Carlyle’s owners seem to have found a solution to that problem.