When Cedar Rapids, Iowa-based Rockwell Collins (NYSE:COL) announced over the weekend that it's buying aviation networks company ARINC from The Carlyle Group (NASDAQ:CG), my first reaction was to shrug.
Rockwell Collins is paying only $1.39 billion for AIRINC, after all. Measured against ARINC's $600 million in anticipated 2013 revenues, that works out to a valuation of 2.3 times sales -- essentially even with the 2.2 sales valuation of Rockwell's shares. As a result, the deal looks fair to Rockwell -- end of story.
But on second thought, maybe this is just the end of one story. A more interesting read may be what this sale means to Carlyle.
As a longtime follower of the defense contracting industry, I've heard a lot about Carlyle over the years. The company used to own Vought Aircraft, after all, a key supplier for Boeing 787 aircraft -- before selling it to another Boeing supplier, Triumph Group. But honestly, I paid little attention to Carlyle itself because the company was private, and its stock could not be bought. That changed last summer, when Carlyle did its IPO and became "investable" in its own right. Now seems as good a time as any to take a closer look at the company and see if it's a bargain.
So let's do that.
Value: in the eye of the beholder
Valuing a publicly traded private equity firm like Carlyle is far from the easiest task an individual investor might undertake. From a traditional "profits are good, more profits are better" approach, the stock looks anywhere from slightly overpriced at 48 times earnings, and a 30% annualized projected growth rate, to ... vastly, unconscionably overpriced, once you factor in the company's $13.5 billion net-debt load, and its resulting $14.7 billion enterprise value. The fact that Carlyle's earnings are so feast-or-famine -- spiking when the company sells a big investment, subsiding when it doesn't -- makes relying on this growth rate especially risky.
Fortunately, there are better ways to evaluate Carlyle's suitability for an investment. Valued at the traditional "2% of assets under management" metric for asset managers, for example, the stock actually looks attractive. 2% of its $170.2 billion in AUM, after all, implies a fair valuation of not today's $1.2 billion market cap, but of something closer to $3.4 billion.
Carlyle's discount to intrinsic value looks all the more apparent when you consider that rival Blackstone Group (NYSE:BX) fetches a valuation of $12.7 billion (6% of assets under management), while Kohlberg Kravis Roberts (NYSE:KKR) costs $5.6 billion (7.4% times AUM). But why?
The fact that Carlyle carries so much more debt than do Blackstone or KKR, relative to their market caps, may help to explain why Carlyle sells at a discount. Or it could be that Carlyle's percentage of "fee-earning" AUM (72%) is lower than the 80% levels we see at Blackstone and KKR. Viewed the other way around, the fact that Blackstone has more than tripled the size of its assets under management over the past five years, while Carlyle didn't even double its AUM, could explain why investors prefer the former over the latter. Blackstone's financial advisory business, which generated a tidy $367 million in revenues in 2012, may be another attraction.
Whatever the reason for its existing, though, there is a discount at Carlyle, and it's a big one.
Is the discount at Carlyle big enough to justify buying the stock? I honestly don't know. I will tell you that the fact that Carlyle did a secondary offering of its own shares just two months ago makes me cautious. If your primary reason for wanting to own this stock is that you think Carlyle is a savvy buyer and seller of stocks, then the fact that Carlyle's currently selling off its own stock should make you nervous.
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