Carlyle's Way
Making a mint inside "the iron triangle" of defense, government and industry
By Dan Briody
January 8, 2002
Red Herring
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
reënter 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 Garaïalde, 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.
Write to Dan Briody.
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