Thursday, March 27, 2014

Money and Culture at Carlyle

Money and Culture at Carlyle

Yesterday Michael Cavanagh left his post as co-leader of JP Morgan’s investment bank in order to become co-President of Carlyle Group.  Mr. Cavanagh has worked with Jamie Dimon, Chairman of JP Morgan, since Mr. Dimon was at Citigroup well over a decade ago.  He followed Mr. Dimon to Bank One and remained a confidant during the merger between Bank One and JP Morgan.  According to various press reports, Mr. Cavanagh’s departure came as a surprise to Mr. Dimon and was prompted in part by the increasingly strict regulatory environment confronting banks.
State College Quant (1999)
In my view Mr. Cavanagh’s departure has a great deal to do with money.  Carlyle Group, is as a diversified alternative money manager, enables Mr. Cavanagh to reach a new level of compensation and wealth.  As I’ll explain in a bit, I think the transition to Carlyle may prove to be more difficult as Mr. Cavanagh moves into a brand new culture.

Mr. Cavanagh was doing quite well for himself at JP Morgan.  As the bank’s CFO, his compensation and stock ownership were reported in JP Morgan’s annual proxy statements.  In 2010, he was made about $10 million after two relatively lean years in which his total compensation was $7.6 million and $6.1 million respectively.  He also owned or was entitled to about 1.4 million shares through various stock and option programs, which would be worth about $85 million today.  In 2010, he became CEO of Treasury and Security Services and then ascended to co-head the investment bank.  Although his compensation and holdings are no longer reported, we can be sure he made a lot more money and received more stock incentives in his new roles.

In fact, the heads of JP Morgan’s Retail Financial Services, Investment Bank, and Investment Office were making significantly more money and building up more equity than Mr. Cavanagh when he was still CFO.[1]  He needed to sit atop a profit center within the bank in order to reach the next level of remuneration.  We can get some idea about how much he made because the co-head of the Investment Bank, Daniel Pietro, was listed in the 2012 proxy statement with total compensation of $17 million.[2]  

In order to see what Mr. Cavanagh could make at Carlyle, we need to take a look at Glenn Youngkin’s compensation and holdings, because he is the other co-President.   As we examine the sources of Mr. Youngkin’s wealth and compensation, we’ll also see some possible signs of what might undermine their partnership at the helm of Carlyle.  In 2013 Mr. Youngkin made $10.6 million, which was down 39% from the $17.2 million he made in 2012 and down even further from his total compensation of $21.3 million in 2011.[3] Mr. Youngkin’s total compensation appears to be falling because his carried interest payments from his previous role running buy-out funds are slowly winding down.   Without those payments, Mr. Youngkin only took home about $2.5 million per year.  While this looks like a far cry from what Mr. Cavanagh earned at JPM Morgan, it doesn’t begin to describe how Mr. Youngkin makes his money.

Mr. Youngkin also owns some 5.7 million shares in Carlyle worth about $187 million. These shares pay hefty annual distributions.  Last year the distribution was $1.97/share or roughly $11.2 million.  By the way, the three founders of Carlyle earned about $230 million from their distributions. 

Mr. Youngkin has also been a long-time investor in Carlyle’s funds.  In the last two years he has received $48.7 million in distributions from various funds.  Investing in your own funds is particularly lucrative, because private equity executives don’t pay management fees or carried interest.  In other words, they probably make 25% to 35% more than their clients on the same investments.

While we can expect Mr. Cavanagh to get a hefty salary and a slug of stock appreciation units for signing on at Carlyle, he can’t possibly replicate the sources of Mr. Youngkin’s income any time soon.  Moreover, Mr. Cavanagh continues to invest heavily in Carlyle’s products.  In the past two years he’s invested $24.7 million in various Carlyle offerings, while committing to invest $92.0 million over the next several years.  Carlyle has hired a host of other executives in the past several years, and none of them have the financial wherewithal to invest the way the founders and Mr. Youngkin invest in Carlyle’s products. 

In the past two years, the founders of Carlyle have committed $1.8 billion to various funds.  This commitment appears to be important to Carlyle’s culture and distinguishes the firm from other publicly traded private equity firms.  Henry Kravis, George Roberts, and Leon Black aren’t making nearly the same commitment at KKR or Apollo Global.[4] 

While there’s plenty of money to lure new executives to Carlyle, including Mr. Cavanagh, I’m betting that the old guard and the new guard will chafe over time.  The founders and other long-term executives at Carlyle have worked together and made their fortunes in a certain manner.  The recruits have twenty or thirty years working with very different incentives.

You’d think that everyone should be extremely happy because they are making so much money, no matter the source.  In money management, no one remains happy for long when it comes to money.

[1] For example, Ina Drew made $15 million as Chief Investment Officer, Charles Scharf earned $12 million as CEO of Retail Financial Services and James Stalely made $17 million as CEO of the Investment Bank. at page 16.
[2] at page 23.  The 2013 proxy statement will be available to about two weeks.
[4] Blackstone doesn’t provide this type of data in its proxy.  Steve Schwarzmann received $78 million in distributions in 2013 from existing funds, but we don’t know how much he committed to new funds.

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