Lee McCabe Analyzes Carlyle’s Business Model and Its Public Market Perception

In a recent LinkedIn post, Lee McCabe discusses the fundamental business model of private equity firms, using Carlyle as a key example to illustrate the ongoing relevance of the traditional private equity cycle, even as larger competitors diversify. McCabe emphasizes that while many alternative asset managers have evolved to include more stable revenue streams like insurance and credit, firms like Carlyle remain more closely aligned with the classic private equity structure.

McCabe highlights the core components of this traditional model: growing management fees, the cyclical nature of carried interest (carry), and the significant impact of exit environments and fundraising success. He notes that this structure, while not flawed, presents a different profile to public markets compared to the more diversified giants.

“Carlyle sits closer to the older model. Management fees grow. Carry comes and goes. Exits matter. Market windows matter. Fundraising matters.”

The journalist points out that the predictable, recurring nature of fee-related earnings (FRE) is what public markets tend to favor. McCabe explains that these earnings, projected to reach approximately $1.2 billion by 2025 for Carlyle, offer a steady and understandable revenue stream.

The Cyclicality of Carried Interest

In contrast to FRE, McCabe details the more volatile aspect of traditional private equity: carried interest. This performance-based revenue is inherently cyclical, spiking during favorable exit environments and declining when market windows close.

“The dashed line is the more traditional private equity bit. Realized performance revenues spike when the exit environment is good, then fall back when it is not. Which is exactly what carry does. It is not broken. It is just cyclical.”

According to McCabe, this cyclicality is a natural characteristic of the business, comparable to how portfolio company resilience is often perceived optimistically until refinancing needs arise.

Strategic Tension in Public Market Valuation

McCabe posits that the central strategic question for Carlyle, and firms like it, is not about the efficacy of their operational model, but rather how public markets will value them in the long term. He suggests there’s a tension between firms adhering to the classic private equity model and the larger platforms that are increasingly valued on more stable, financial-infrastructure-like earnings.

The Distinction Between Giants and the Rule

Lee McCabe argues that the largest alternative asset managers represent the exception rather than the rule in the industry. While these giants have successfully built diversified, less cyclical revenue streams, many other firms, like Carlyle, continue to operate closer to the traditional private equity playbook.

“The question is whether public markets will keep rewarding firms that look like classic private equity when the largest platforms are increasingly valued on earnings streams that look less like carry and more like financial infrastructure.”

McCabe concludes that understanding this distinction is crucial for investors and industry observers alike. The perception and valuation of firms like Carlyle are intrinsically linked to their adherence to the more traditional, albeit cyclical, private equity model, which differs significantly from the evolving strategies of the industry’s largest players.