Carlyle's Way
Making a mint inside "the
iron triangle" of defense, government, and industry
by Dan Briody
Red Herring, January 8, 2002
http://web.archive.org/web/20021204214851/redherring.com/index.htm
Like everyone else in the United States,
the group stood transfixed as the events of September 11 unfolded.
Present were former secretary of defense Frank Carlucci, former
secretary of state James Baker III, and representatives of the
bin Laden family. This was not some underground presidential bunker
or Central Intelligence Agency interrogation room. It was the
Ritz-Carlton in Washington, D.C., the plush setting for the annual
investor conference of one of the most powerful, well-connected,
and secretive companies in the world: the Carlyle Group. And since
September 11, this little-known company has become unexpectedly
important.
That the Carlyle Group had its conference
on America's darkest day was mere coincidence, but there is nothing
accidental about the cast of characters that this private-equity
powerhouse has assembled in the 14 years since its founding. Among
those associated with Carlyle are former U.S. president George
Bush Sr., former U.K. prime minister John Major, and former president
of the Philippines Fidel Ramos. And Carlyle has counted George
Soros, Prince Alwaleed bin Talal bin Abdul Aziz Alsaud of Saudi
Arabia, and Osama bin Laden's estranged family among its high-profile
clientele. The group has been able to parlay its political clout
into a lucrative buyout practice (in other words, purchasing struggling
companies, turning them around, and selling them for huge profits)--everything
from defense contractors to telecommunications and aerospace companies.
It is a kind of ruthless investing made popular by the movie Wall
Street, and any industry that relies heavily on government regulation
is fair game for Carlyle's brand of access capitalism. Carlyle
has established itself as the gatekeeper between private business
interests and U.S. defense spending. And as the Carlyle investors
watched the World Trade towers go down, the group's prospects
went up.
In running what its own marketing literature
spookily calls "a vast, interlocking, global network of businesses
and investment professionals" that operates within the so-called
iron triangle of industry, government, and the military, the Carlyle
Group leaves itself open to any number of conflicts of interest
and stunning ironies. For example, it is hard to ignore the fact
that Osama bin Laden's family members, who renounced their son
ten years ago, stood to gain financially from the war being waged
against him until late October, when public criticism of the relationship
forced them to liquidate their holdings in the firm. Or consider
that U.S. president George W. Bush is in a position to make budgetary
decisions that could pad his father's bank account. But for the
Carlyle Group, walking that narrow line is the art of doing business
at the murky intersection of Washington politics, national security,
and private capital; mastering it has enabled the group to amass
$12 billion in funds under management. But while successful in
the traditional private-equity avenue of corporate buyouts, Carlyle
has recently set its sites on venture capital with less success.
The firm is finding that all the politicians in the world won't
help it identify an emerging technology or a winning business
model.
Surprisingly, Carlyle has avoided the
fertile VC market in defense technology, which now, more than
ever, comes from smaller companies hoping to cash in on what the
defense establishment calls the revolution in military affairs,
or RMA. Thus far, Carlyle has passed up on these emerging
technologies in favor of some truly awful Internet plays. And
despite its unique qualifications for early-stage funding of defense
companies, the firm seems to have no appetite for the sector.
Despite its VC troubles, however, the
Carlyle Group's core business is set for some good times ahead.
Though the group has raised eyebrows on Capitol Hill in the past,
the firm's close ties with the current administration and its
cozy relationship with several prominent Saudi government figures
has the watchdogs howling. And it's those same connections that
will keep Carlyle in the black for as long as the war against
terrorism endures.
For the 11th-largest defense contractor
in the United States, wartime is boom time. No one knows that
better than the Carlyle Group, which less than a month after U.S.
troops began bombing Afghanistan filed to take public its crown
jewel of defense, United Defense, a company it has owned for nearly
a decade. That this company is even able to go public is testament
to the Carlyle Group's pull in Washington.
United Defense makes the controversial
Crusader, a 42-ton, self-propelled howitzer that moves and operates
much like a tank and can lob ten 155-mm shells per minute as far
as 40 kilometers. The Crusader has been in the sights of Pentagon
budget cutters since the Clinton administration, which argued
that it was a relic of the cold war era--too heavy and slow for
today's warfare. Even the Pentagon had recommended the program
be discontinued. But remarkably, the $11 billion contract for
the Crusader is still alive, thanks largely to the Carlyle Group.
"This is very much an example of
a cold war-inspired weapon whose time has passed," notes
Steve Grundman, a consultant at Charles River Associates, a defense
and aerospace consultancy in Boston. "Its liabilities were
uncovered during the Kosovo campaign, when the Army was unable
to deploy it in time. It is exceedingly expensive, and it was
a wake-up call to the Army that many of its forces are no longer
relevant."
But the Carlyle Group was having none
of that. While it is impossible to say what U.S. secretary of
defense Donald Rumsfeld was thinking when he made the decision
to keep the Crusader program alive, people close to the situation
claim to have a pretty good idea. Mr. Carlucci and Mr. Rumsfeld
are good friends and former wrestling partners from their undergraduate
days at Princeton University. And while Carlyle executives are
quick to reject any accusations of them lobbying the current administration,
others aren't so sure. "In this particular effort, I felt
that they were like any other lobbying group, apart from the fact
that they are not," said one Washington, D.C., lobbyist with
intimate knowledge of the Crusader negotiations, noting the fine
line between lobbying and having a drink with a old friend.
According to Greg McCarthy, a spokesperson
for Representative J.C. Watts Jr. (R: Oklahoma), whose district
is home to one of the Crusader's assembly plants, the Carlyle
Group's influence was indeed felt at the Pentagon. "Carlyle's
strength was within the DoD, because as a rule someone like Frank
Carlucci is going to have access," says Mr. McCarthy. "But
they have other staff types that work behind the scenes, in the
dark, that know everything about the Army and Capitol Hill."
Perhaps even more disconcerting than Carlyle's
ties to the Pentagon are its connections within the White House
itself. Aside from signing up George Bush Sr. shortly after his
presidential term ended, Carlyle gave George W. Bush a job on
the board of Texas-based airline food caterer Caterair International
back in 1991. Since Bush the younger took office this year, a
number of events have raised eyebrows.
Shortly after George W. Bush was sworn
in as president, he broke off talks with North Korea regarding
long-range ballistic missiles, claiming there was no way to ensure
North Korea would comply with any guidelines that were developed.
The news came as a shock to South Korean officials, who had spent
years negotiating with the North, assisted by the Clinton administration.
By June, Mr. Bush had reopened negotiations with North Korea,
but only at the urging of his own father. According to reports,
the former president sent his son a memo persuasively arguing
the need to work with the North Korean government. It was the
first time the nation had seen the influence of the father on
the son in office.
But what has been overlooked was Carlyle's
business interest in Korea. The senior Bush had spearheaded the
group's successful entrance into the South Korean market, paving
the way for buyouts of Korea's KorAm Bank and Mercury, a telecommunications
equipment company. For the business to be successful, stability
between North and South Korea is critical. And though there is
no direct evidence linking the senior Bush's business dealings
in Korea with the change in policy, it is the appearance of impropriety
that excites the watchdogs. "We are clearly aware that former
President Bush has weighed in on policy toward South Korea and
we note that U.S. policy changed after those communications,"
says Peter Eisner, managing director at the Center for Public
Integrity, a watchdog group in Washington, D.C., which has an
active file on the Carlyle Group. "We know that former President
Bush receives remuneration for his work with Carlyle and that
he is capable of advising the current president, but how much
further it goes, we don't know."
While the Center for Public Integrity
looks for its smoking gun, others in Washington say hard evidence
is unimportant. "Whether the decisions made by the former
president are a real or apparent conflict of interest doesn't
matter, because in the public's eye they're equally as damaging,"
says Larry Noble, executive director and general counsel of the
Center for Responsive Politics. "Bush [Sr.] has to seriously
consider the propriety of sitting on the board of a group that
is impacted by his son's decisions."
And the controversy is expected only to
increase as Carlyle's investments in Saudi Arabia are scrutinized
during the war on terrorism. Mr. Eisner says that very little
is known about Carlyle's involvements in Saudi Arabia, except
that the firm has been making close to $50 million a year training
the Saudi Arabian National Guard, troops that are sworn to protect
the monarchy. Carlyle also advises the Saudi royal family on the
Economic Offset Program, a system that is designed to encourage
foreign businesses to open shop in Saudi Arabia and uses re-investment
incentives to keep those businesses' proceeds in the country.
But the money flowing out of Saudi Arabia
and into the Carlyle Group is of even more interest. Immediately
after the September 11 attacks, reports surfaced of Carlyle's
involvement with the Saudi Binladin Group, the $5 billion construction
business run by Osama's half-brother Bakr. The bin Laden family
invested $2 million in the Carlyle Partners II fund, which includes
in its portfolio United Defense and other defense and aerospace
companies. On October 26, the Carlyle Group severed its relationship
with the bin Laden family in what officials termed a mutual decision.
Mr. Bush Sr. and Mr. Major have been to Saudi Arabia on behalf
of Carlyle as recently as last year, and according to reports,
the Federal Bureau of Investigation is currently looking into
the flow of money from the bin Laden family. Carlyle officials
declined to answer any questions regarding their activities in
Saudi Arabia.
But for all the questions, Carlyle has
stayed clean in the eyes of the law. Lobbying laws in Washington,
D.C., are ambiguous at best, requiring only that former politicians
observe a one-year "cooling-off period" before they
renter the lobbying scene on behalf of industry. It is playing
within this gray area that has given the Carlyle Group some of
the best returns in the business.
After David Rubenstein, a former aide
in the Carter administration, and William Conway Jr., former chief
financial officer of MCI Communications, hooked up at New York's
Carlyle hotel in 1987 to form the company, the Carlyle Group spent
two lost years investing in a hodgepodge of companies. It wasn't
until 1989, when the company brought in Mr. Carlucci, fresh off
his two-year stint as U.S. secretary of defense, that Carlyle
got serious in government. In 1991 the company made a name for
itself by facilitating a $590 million purchase of Citicorp stock
for Prince Alwaleed bin Talal. Shortly thereafter, Carlyle snatched
up defense contractors Harsco, BDM International, and LTV, turning
the companies around and selling them to the likes of TRW, Boeing,
and Lockheed Martin.
The Carlyle Group has diversified its
holdings since then, investing in everything from bottling companies
to natural-food grocers. In the process, it has become one of
the biggest, most successful private-equity firms in business,
with annualized returns of 35 percent. (Judging by the early numbers
from some of their funds, however, like many other private-equity
funds, 2001 will be a considerably less profitable year for Carlyle.)
"They are the new breed of private equity, acting more like
a large mutual fund of private companies," says David Snow,
editor of PrivateEquityCentral.net, a Web site that tracks private-equity
firms. The numbers are impressive: Carlyle employs 240 people,
as opposed to the 10 or 12 typical of most private-equity firms.
It has ownership stakes in 164 companies, which collectively employ
more than 70,000 people. George Soros invested $100 million in
the group's funds; the California Public Employees' Retirement
System is in for $305 million.
Carlyle has succeeded by raising money
first, then finding the talent to manage it. For instance, it
raised a fund for buying out telecom companies and hired William
Kennard, the former U.S. Federal Communications Commission chairman,
to run it. Accused early on of being nothing more than a bunch
of Washington grip-and-grinners, Carlyle has proven its critics
wrong. At a Salomon Smith Barney private-equity conference last
March, a panel of professional investment managers were asked
who the best fund managers are. Carlyle cofounder Mr. Conway was
one of two managers chosen.
With its size and success, questions about
the firm's ability to grow revenue has arisen. Carlyle has placed
its bets for future growth on the VC markets, which it entered
in 1996. But to date, it has found that venture capital is a game
with far different rules than that of corporate buyouts. "They
may be very established in private equity, but it seems to me
that they don't really know the venture capital business,"
says one VC who has done deals with Carlyle. "In buyouts,
you take over a company and fight the management, but in venture
capital it's the opposite. You want to work with people."
Carlyle executives admit as much. As a
result, the Carlyle Europe Venture Partners fund has been slow
to commit its capital. So far, it has spent just more than 20
percent of its $660 million, and 3 of its original 17 investments
have already folded. None has gone public or been acquired. As
Jack Biddle, cofounder of Novak Biddle Venture Partners, dryly
puts it, "I haven't been involved in a lot of venture deals
where the participation of a president mattered that much. In
venture capital, it's all about the technology."
For a firm that has made its money in
highly regulated, politically charged industries, picking business-to-business
plays is hardly second nature. While Carlyle has investments in
highly regulated sectors like telecom and banking, it has avoided
defense entirely, instead focusing on tech industries that have
already gone flat. The firm's European fund alone boasts six B2B
companies, two optical-networking companies, and Riot-E, a wireless
media play. Jacques Garaalde, managing director of the Europe
fund concedes that expectations have been shifted. "Clearly,
we can't make 100 times returns on B2B, but there are some situations
in which we can make 3 times."
But the struggles in its VC business may
be offset, at least temporarily, by the expected windfall from
the war on terrorism. The federal government has already approved
a $40 billion supplemental aid package to the current budget,
$19 billion of which is headed straight to the Pentagon. Some
of the additional government spending is likely to find its way
into Carlyle's coffers.
The Bush administration isn't afraid to
mix business and politics, and no other firm embodies that penchant
better than the Carlyle Group. Walking that fine line is what
Carlyle does best. We may not see Osama bin Laden's brothers at
Carlyle's investor conferences any more, but business will go
on as usual for the biggest old boys network around. As Mr. Snow
puts it, "Carlyle will always have to defend itself and will
never be able to convince certain people that they aren't capable
of forging murky backroom deals. George Bush's father does profit
when the Carlyle Group profits, but to make the leap that the
president would base decisions on that is to say that the president
is corrupt."
Additional reporting by Lawrence Aragon,
Mark Chediak, Julie Landry, Christopher Locke, Eric Moskowitz,
Mark Mowrey, and Michael Parsons.
Carlyle Group
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