Executive Insight: Brooke Coburn of Carlyle on Middle Market Investing

My co-author this week is Brooke Coburn, Managing Director and Co-Head of Carlyle Growth Partners and Carlyle Equity Opportunity Fund.

Brooke Coburn

Brooke Coburn

The Carlyle Group is one of the largest and most successful alternative asset managers in the world. With nearly USD 200 billion in assets managed across 130 funds and 156 fund of funds it is daunting just trying to figure out where to start in learning from their best in class experience. I decided to approach the middle market team and highlight their story as, I believe, investors in the Middle East can learn the most from their approach and experience.

Carlyle’s middle market team is currently investing two funds: Carlyle U.S. Equity Opportunity Fund, L.P. I & II. Recent investments include Service King, one of the largest automotive collision repair centers in the U.S.; ECi Software Solutions, a provider of industry-specific technology; Traxys Group, a financial and logistical provider in the mining industry; AxleTech International Holdings, Inc., a manufacturer of automotive supplies; and PrimeSport, a global sports travel and events-management company. Carlyle defines the US middle market as companies that have revenues in the region of USD 100MM to USD 600MM, which comprises more than 100,000 companies and is the largest segment, and most fragmented, of the US economy. Although the revenue numbers are much lower in the UAE, the SME segment remains equally as important.

Carlyle’s value creation for its investors, which necessarily comes from creating value for its portfolio companies, begins with deal origination. In a small or cohesive market there are middlemen, investment banks and brokers who simply market potential investee companies to the highest bidders. But in a fragmented market, and one in which partial sellers are selective in their partners, Carlyle has a massive advantage.

Carlyle’s deal origination advantage is developing a trusting network of partners, investors and clients who act as a proprietary information network that matches Carlyle with suitable portfolio companies.

For example, Carlyle today owns more than 200 portfolio companies worldwide. Add to that the alumni network of more than 400 former CEOs of Carlyle companies and it becomes clear how powerful Carlyle’s proprietary information network is.

This advantage took years to develop and is impossible for competitors to match without investing years as well. In effect, Carlyle, by deciding not to take any reputational shortcuts, gave up short term gains for a long-term sustainable advantage. This corporate personality trait matches the Middle East investor’s emphasis on personal trust and prioritising a relationship over a transaction.

After origination comes post-investment value creation. Again, Carlyle brings a sustainable advantage here with its large global portfolio of companies, deep industry insights and access to best in class experience. A live example will help to highlight Carlyle’s strategy.

A potential target company was introduced to Carlyle by one of its investors. The owner of the target company was looking to sell a majority stake, but had not hired bankers yet to advise him. The combination of Carlyle’s reputation and a mutual known third party persuaded the owner to bypass the bankers and speak to Carlyle directly.

The next step for Carlyle was to map the target business into the portfolio of businesses that Carlyle currently owns, in effect, find synergies. The word “synergy” has lost a lot of its luster in the investment world, as it was continually misused by financiers looking to sell a story. Carlyle firmly brings the idea of synergy back to where it belongs: a proactive, operational approach to managing portfolio businesses.

In this case Carlyle brought a lot to the table. Automotive is a core sector for Carlyle, having invested in it for decades. Carlyle’s industry expertise includes the likes of Dan Ackerson, formerly CEO of General Motors. Potential synergies came from Carlyle portfolio companies Hertz and Axalta.

Carlyle’s post-acquisition value creation comes from internal assets and stakeholders as well as external ones. Key to the acquisition of the target was bringing on board co-investors with automotive sector experience. At the executive level, Carlyle introduced a seasoned CFO who had previously worked with Carlyle and knew how to work closely with the firm as a shareholder, as well as help manage the surge in growth that Carlyle’s investment signaled. In addition, Carlyle maintains a network of retired executives who mentor and coach the target’s executive team when needed.

Creating such a value proposition is of course quite resource-intensive and this requires strict discipline on the part of the Carlyle team. They therefore aim to make only two or three investments per year.

What does all of this mean for the Middle East? Those with the closest parallels are the family groups with large portfolios of companies. The aim is not to emulate Carlyle, as they have different objectives overall, but there is certainly a lot that one can learn from a world-class business.

Probably the greatest difference in operating strategy is deal origination. Carlyle is looking for successful operating businesses that it can help to grow. The average family business in the Middle East is looking for new agencies or new concepts to deploy as a business using internal resources.

Carlyle’s success certainly makes a case for buying successful businesses. The points that regional businesses would have to consider are whether the risk reduction of buying an operating business is worth the price premium over investing from scratch. Equally important is whether the family business is capable of adding value post acquisition.

This brings us to the second fundamental lesson and that is Carlyle’s extensive and frequent use of its networks of external resources. Indeed, Carlyle finds these networks so valuable that it invests in them, maintains them and grows them on a constant basis. In contrast, however, in the Middle East such networks are maintained but solely as a form of lobbying with the government and other businesses. It is rare to see a family business in the Middle East investing in operating networks as Carlyle does. This needs to change.

A simple but powerful example is the creation of portfolio company boards. The protocol in the region is to solely appoint executives of the parent to the boards of subsidiaries. A key takeaway from Carlyle’s success is to maintain a network or a pool of external experienced directors who could be appointed to the boards of subsidiaries as appropriate.

More importantly, given the current environment, is maintaining a network of seasoned executives. In the aftermath of the global financial collapse, many good executives found themselves out of a job. Pioneering businesses would be well served to place such executives under an option contract.

The final lesson that I will discuss out of the many that one can learn from Carlyle is the idea that an investor can create massive operational value post acquisition. The prevailing idea that an investor is simply creating liquidity for the current owners by providing a form of growth financing leaves a lot of value on the table. Taking a more proactive approach of providing operational support without taking full ownership is novel for the Middle East but remains a key business concept in developed markets and forms part of the foundation for a strong economy.

As you can see, there is much that the Middle East can learn from the remarkable achievements of Carlyle’s middle market team. At the core of their success is harnessing the resources of the global firm and the network of industry veterans on their team. It’s a powerful combination that can help Middle East investors to create even more value.

This article was originally published in The National.