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Firm of the Year –

Given the combination of bargain basement valuations and high amount of uninvested capital, the LBO market’s $44 billion of deal volume in 2002 was hardly unexpected. Indeed, with most analysts agreeing that the stock market was at or near its bottom, it was only natural-heck, even fiscally responsible-for buyout firms to open their wallets.

But capitalizing on this confluence of events was easier said than done. Most auctions were highly competitive-especially for cream-of-the-crop investments-and the restrictive senior debt market required firms to contribute uncomfortably high equity. All the while, private equity funds were attempting to succor a limited partner community that may have felt suckered after several consecutive quarters of negative returns.

Against that backdrop, The Carlyle Group’s accomplishments last year look all the more impressive. The Washington, D.C.-based firm was involved in several large LBOs in 2002, contributing $1.2 billion of equity across several sectors and in numerous spots on the globe. Meanwhile, the firm upgraded its all-star team by hiring Louis Gerstner, the former IBM chief, as its chairman.

There’s no question Carlyle’s greatest asset in doing deals-and, more importantly, in winning them-is its $4 billion of uninvested capital in buyout funds across the globe, an amount it retains in part because the firm cut back sharply on acquisitions when stock prices were high. With so much cash at its disposal, it has been tough for most firms to outbid Carlyle.

Keeping Busy

A prime example of the firm’s dominance in the market is Carlyle’s successful bid for the biggest buyout deal since RJR Nabisco: Qwest Communications’ $7.05 billion spinoff of its QwestDex yellow pages directories business. Carlyle closed part of the deal last year, for QwestDex East, for $2.75 billion. The remaining $4.3 billion is the expected price for QwestDex West, a deal that’s expected to close in the second or third quarter of this year. Welsh, Carson, Anderson & Stowe is participating in both QwestDex transactions.

Carlyle won both transactions in part because it was willing to eat the entire serving, whereas other bidders weren’t hungry for a whole meal. “The size of the deal narrowed the field, and since people knew [divestitures from] Sprint and BCE were coming, which were more digestible, this deal evolved into a two-horse race,” says Jim Attwood, managing director of Carlyle’s U.S. Buyouts Global Telecommunications and Media Group. “Since we were the only ones bidding for the entire company (not just half), it was essentially just us bidding for it.”

Equally important was getting the deal for a fair price. “If you look at the price we paid (7.9 times EBITDA, compared with Sprint at 8.7 times and BCE at greater than 9 times), on a pure multiples perspective we are very pleased,” says Attwood. “And when you consider the tax step-up ($2.5 billion of value over 15 years) we feel like we paid 6.5 times EBITDA for this deal, after the tax benefits.”

But Carlyle didn’t empty its entire wallet for one transaction. The firm made acquisitions of Vivendi Universal Publishing ($1.06 billion), Rexnord Corp. ($913 million), Casema ($697 million), Edscha ($182 million), WPI Cable ($31 million), Boto International, CSX Lines ($300 million) and Qinetiq PLC (a 33% stake in the defense-related UK firm, for GBP150 million).

Carlyle also exercised caution in 2002, as evidenced by its decision to drop out of the deal for TRW’s auto-parts division. The original deal called for Carlyle and The Blackstone Group to each commit $500 million in equity to the deal, but Carlyle pulled out for unexplained reasons. Since Carlyle also had the Edscha deal in the works (a European auto-parts manufacturer), it could have put Carlyle in control of the global auto-parts market, yet the firm showed no apparent hesitation in dropping the bid. (Blackstone recently closed the deal, with some assistance from Northrop Grumman, who purchased TRW and plans to split off the auto-parts unit to Blackstone.)

Studying Abroad

The deals for Edscha and Qinetiq show Carlyle’s continued commitment to Europe, where it has invested 90% of its _1 billion Carlyle European fund since its launch in 1998. According to Glenn Youngkin, managing director of European buyouts for Carlyle, the firm has completed six transactions with a cumulative value of _3.5 billion since July 2002.

One advantage for Carlyle is having a sizable on-the-ground team in Europe. “[With] a buyout team of approximately 40 investment professionals spread across France, Germany, Italy, Spain and the UK, this is a larger team than most of our competitors and allows us to examine more opportunities in greater detail,” says Youngkin.

Youngkin adds that the team of investment pros is augmented by an advisory board of senior European executives. “We are then able to combine this local view with a global perspective on the development of global industries like telecommunications, automotive, and aerospace, in order to exploit global opportunities for business growth.”

Asian Experience

Meanwhile, Carlyle hasn’t forgotten about Asia, where it invests Carlyle Asia Partners (CAP), a dedicated $750 million fund focused on investments in financial services, manufacturing, telecom/media and consumer businesses. “We view ourselves as one of the leading private equity investors in Asia and will continue to be very active,” said Xiang-Dong (X.D.) Yang, Carlyle’s managing director of Asian buyouts.

Those aspirations were threatened last year when the firm made a bid for Boto International, a manufacturer of artificial Christmas trees and outdoor furniture. The deal faced a group of irate shareholders who tried to stop the deal, arguing that it undervalued the core Christmas-tree business and was a ploy to turn Boto into a corporate shell. Carlyle could’ve walked away from the deal, to avoid sullying its reputation. But instead it tinkered with the deal structure, eventually revising the terms to leave 25% of Boto in public hands. In the end, the total transaction value was $150 million, financed with $104 million debt underwritten by HSBC and $46 million of equity, for a multiple of approximately 5.5 times EBITDA. Of the equity portion, Carlyle put in $34 million for a 75% stake.

“We offered a fair and reasonable price for the Boto business, so we thought it best to have the shareholders decide if they wanted to take our deal,” Yang said. “Boto represented an ideal LBO candidate for us…and since Boto exports its products predominantly to customers in the U.S. and Europe, it can benefit from Carlyle’s global network and knowledge.”

How important was the deal’s success? According to Yang, after the Boto deal Carlyle was approached by several people about new Asian opportunities, enough for the firm to consider further expansion in the region. “We are actively looking at some of these situations. We have a number of active deals in Korea and China,” Yang says. “In the next three to five years, we would like to more than double our fund under management in Asia and open offices in China, among other [offices] under consideration.”

One important investment thesis for the fund is to invest in manufacturing companies that are based in China and export to the rest of the world. “China is, in our view, the most efficient basic manufacturing location in the world,” Yang adds. “Boto is a very good example of this.”

Full-Service Shop

Unquestionably, the wide range of sectors and geographies represented prove Carlyle has evolved dramatically from its early days as a defense-focused buyout shop. The firm has lofty ambitions, aiming to become the first truly full-service private-equity manager, with 23 buyout, venture, real estate, and asset-management funds in North America, Europe, and Asia. That’s an objective only a select few private equity firms can even dream about, much less accomplish.

But those ambitions don’t appear to be distracting Carlyle from its primary responsibility: doing right by its limited partners. “We have maintained a strong relationship with Carlyle over the past [seven] years, and have been very pleased with the firm’s performance,” said William D. Crist, President of California Public Employees’ Retirement System (CalPERS) Board of Administration.

Another step in Carlyle’s development was last November’s hiring of Louis Gerstner Jr., the former CEO of IBM, as the firm’s chairman. Gerstner replaced Frank C. Carlucci, defense secretary during the Reagan Administration, and was brought on to the part-time advisory position to apply the same strategic and culture-building skills that helped him rescue IBM. Given the importance of portfolio management in this down economy-and at a time when exits are few and far between-Gerstner’s expertise couldn’t be more timely.

Yet Gerstner will not be changing the basic direction set by Carlyle’s co-founders: David M. Rubenstein, a lawyer and domestic-policy adviser to President Jimmy Carter; William E. Conway Jr., once the CFO of MCI; and former Marriott executive Daniel A. D’Aniello.

Meanwhile, the company will continue to leverage its existing network of famous advisors, including former Secretary of State James A. Baker III, former President George H.W. Bush, former Securities & Exchange Commission Chairman Arthur Levitt Jr. and former British Prime Minister John Major. Currently, Baker is a senior counselor at Carlyle, providing strategic advice on Carlyle business matters and giving speeches at Carlyle events. Bush is a senior advisor to the Carlyle Asia Advisory Board, and his exclusive role is to give speeches at Carlyle events. Levitt is a senior advisor to Carlyle who advises management on strategic business matters and also advises Carlyle Asset Management Group on its business and investing activities, while Major is chairman of Carlyle Europe.

Looking ahead, there’s no signs of Carlyle stopping in 2003. As of press time, the firm had already closed five LBO transactions globally, totaling more than $500 million.