William Conway, managing director and co-founder of the Carlyle Group, was talking recently about the media coverage of his bank and the cast of ex-Presidents and former officials, including George H.W. Bush, James Baker III and Frank Carlucci, on its payroll. "One of the words that has recently cropped up as an adjective around us--and I love this adjective--is the 'secretive' Carlyle Group," he said in an interview in his offices overlooking Pennsylvania Avenue in downtown Washington. "What's the secret? I don't think we have many secrets. The reality is, we're a group of businessmen who have made an enormous amount of money for our investors by making good investments over the past fifteen years."
To give Conway his due, Carlyle has done exceedingly well for the 435 pension funds, banks and investment funds--40 percent from overseas--that have entrusted their money to one of the world's largest private equity funds. Under the leadership of Carlucci, a former CIA deputy director who was Defense Secretary in the Reagan Administration, Carlyle has become the nation's eleventh-largest defense contractor, a major arms exporter to Saudi Arabia and Turkey, one of the biggest foreign investors in South Korea and Taiwan, and a key player in global telecommunications, wireless, real estate and healthcare markets. Since 1987 it has invested $6.4 billion in 233 transactions, with a rate of return of 36 percent on its completed investments. Carlyle currently has $12.5 billion invested.
"Their basic nature is not to be a long-term investor but buy low and sell high," said Philip Finnegan, an analyst with the Teal Group, a Beltway company that tracks the aerospace industry. "They always look for an exit strategy in whatever they buy. They have a sense of the stability of the business because of the accumulated expertise they have."
That's where Carlyle's global network of statesmen and former officials comes in. Bush is Carlyle's senior adviser on Asia and makes his money by giving speeches at Carlyle's investment conferences. Baker, who was Bush's Secretary of State, is Carlyle's senior counselor and a member of the firm's Asia, Europe and Japan advisory boards. John Major, the former British prime minister, was named chairman of Carlyle Europe last year. Carlyle's advisory boards are peppered with corporate executives from Boeing, BMW, Toshiba and other big multinationals, and men of influence like former Bundesbank president Karl Otto Pohl, former Thai prime minister Anand Panyarachun and former US ambassador to Japan (and former Speaker of the House) Thomas Foley. Carlyle's new asset management group is run by Afsaneh Beschloss, the former treasurer and chief investment officer of the World Bank.
By hiring enough former officials to fill a permanent shadow cabinet, Carlyle has brought political influence to a new level and created a twenty-first-century version of capitalism that blurs any line between politics and business. In a sense, Carlyle may be the ultimate in privatization: the use of a private company to nurture public policy--and then reap its benefits in the form of profit. Although the fund claims to operate like any other investment bank, it's undeniable that its stable of statesmen-entrepreneurs have the ability to tap into networks in government and commerce, both at home and abroad, for advance intelligence about companies about to be sold and spun off, or government budgets and policies about to be implemented, and then transform that knowledge into investment strategies that dovetail nicely with US military foreign and domestic policy.
How the Carlyle System Works
A good analogy to the Carlyle system is a Japanese tradition known as amakudari (literally, "descent from heaven"). Under this system, senior officials from Japanese ministries retire, only to be instantly hired as senior advisers by the companies and industry groups they were paid to regulate. "What we're really talking about is a systematic merging of the private and public sectors to the point where the distinctions get lost," said Chalmers Johnson, president of the Japan Policy Research Institute and author of two acclaimed books on the Japanese system of governance. "The Carlyle Group is a perfect example. It's the use of former government officials for their access to government bureaucracies to determine contractual relations. It's inside knowledge--knowing where the government is going to spend money and then investing in it."
In turn, Carlyle executives influence policy--sometimes profoundly. On March 12 Carlucci, who is chairman of the US-Taiwan Business Council, a coalition of US multinationals doing business in Taiwan, invited Tang Yao-Ming, Taiwan's Defense Minister, to attend a closed-door summit of US and Taiwanese defense officials sponsored by the council and key US military contractors, including Carlyle's United Defense Industries. Tang's visit, which was capped by a meeting with US Deputy Defense Secretary Paul Wolfowitz, marked the highest-level defense contacts between Taipei and Washington since diplomatic relations were severed in 1979--and paralleled President Bush's push to expand arms sales to Taiwan, where Carlyle has significant investments. Carlyle people also testify frequently before government panels: senior adviser Arthur Levitt, the former chairman of the Securities and Exchange Commission, has been ubiquitous before Congressional hearings on Enron.
Carlyle's investment philosophy, as described in its brochures, is to focus "on industries we know and in which we have a competitive advantage," in particular "federally regulated or impacted industries such as aerospace/defense." Its capital is siphoned into fourteen funds, seven focused on US industries and real estate, four on Europe and three on Asia. The $1.3 billion Carlyle Partner II fund is the majority owner of United Defense, maker of the Bradley Fighting Vehicle and other weapons systems, and owns Vought Aircraft, the world's largest supplier of commercial and military airline parts. Carlyle's largest acquisition took place two years ago in South Korea, when its $750 million Asia Buyout Fund invested $145 million to buy a controlling stake in KorAm Bank. Through United Defense, Carlyle owns Bofors Defense, a Swedish manufacturer of naval guns and other weapons. In its latest deal, finalized March 13, Carlyle is investing $50 million in Conexant Systems, a spinoff from defense giant Rockwell International, to manufacture silicon wafers for wireless communications and Internet supply markets around the world.
The Conexant deal illustrates the extraordinary mix of business acumen and contacts that makes Carlyle tick. Carlyle's entry into wireless is being led by William Kennard, who regulated the wireless industry as chairman of the Federal Communications Commission before being hired as managing director of Carlyle's global telecommunications group. Carlyle's investment will help Conexant expand its already sizable market in China, where its wireless division recently won approval to supply a key cell-phone technology to state-owned China Unicom, the second-largest telecom provider in the world's largest wireless market. In a convenient twist, China Unicom's national network is operated by Canada's Nortel Networks under a contract signed during a visit to Beijing by Carlucci, who was Nortel's chairman from 2000 to 2001.
A classic example of how Carlyle's political connections work was the Pentagon's decision last year to develop United Defense's Crusader mobile artillery system. The decision to fund the Crusader, which could eventually cost $11 billion, came after years of strenuous objections from senior military planners, who said it was outdated, too heavy and of little use in contemporary warfare. But United Defense's modifications to the system--and a lobbying campaign by a handful of lawmakers who received a total of $300,000 in donations from a United Defense political action committee--apparently made the difference.
Then came September 11 and its aftermath. With the Crusader contract in hand and President Bush's war in Afghanistan well under way, Carlyle decided the time was ripe to sell some of its United Defense holdings on the stock market. The initial public offering on December 14 raised $237 million for Carlyle. In January United Defense, whose board of directors includes Carlucci and John Shalikashvili, former chairman of the Joint Chiefs of Staff, said its fourth-quarter profits had risen 62 percent, due in large part to sales of the Crusader, which received $472 million in the Pentagon's latest budget.
Those events raised a few eyebrows, particularly at a time when the media were dishing out daily revelations about Enron's political influence in Washington. Columnist Paul Krugman described the Pentagon's policy switch on the Crusader as a "very nice gift" from Rumsfeld to Carlucci, whom Rumsfeld brought into government, and an example of "crony capitalism," the Asian model of capitalism scorned by US economists and the International Monetary Fund [for more on Carlucci, see "Company Man" at www.thenation.com]. Conway, who is chairman of United Defense, scoffed at the speculation. "Frank [Carlucci] is not going to lobby somebody in the Defense Department about a program for Carlyle," he said. As for the timing of the IPO, which was organized after the hijack attacks, "no one wants to be a beneficiary of September 11," he said.
Friends in High Places
Bush Sr., who chairs the annual meeting of Carlyle's Asian Advisory Board, has not hesitated to communicate with his son regarding policies that could affect Carlyle and other US investors in the region--particularly South Korea, where Carlyle could soon have an investment stake of more than $2 billion. Last spring, after President Bush stuck a knife in Kim Dae Jung's sunshine policies by saying North Korea couldn't be trusted, Bush Sr. sent the President a memo written by Donald Gregg, his former National Security Adviser who once served as CIA station chief in Seoul, urging the new Administration to ease its hard-line policies.
A few weeks later, in a decision the New York Times described as "the first concrete evidence of the elder Bush's hand in a specific policy arena," George W. said he was willing to talk to the North "anytime, anyplace." But the President's "axis of evil" speech on January 29, which North Korea took to be a near-declaration of war, ended any hopes of rapprochement and led Pyongyang to cancel a February visit by Gregg and several other former diplomats. Bush Jr. tried to soften his rhetoric during his late February visit to Seoul but was met instead by the largest anti-American demonstrations of his career. Conway, however, was sanguine about the investment climate in Korea. Bush's axis speech "doesn't add to my level of concern," he said.
In Europe, Carlyle's strategy is to invest in companies seeking to become Europewide and global players. Conway, who attends the annual meetings of the European board, which are chaired by Britain's Major, described the advisory boards as an expansive process where advisers strategize about how to create and nurture companies with a global reach. At the last meeting of the European board, the consensus was that "all these companies that have been more single-country companies are going to have to expand onto the European stage and ultimately a global stage," he said. "Frankly, if they don't, they'll have a tough time competing with the Americans and the Asians." To implement the strategy, Carlyle acquired and combined three companies, from Italy, Germany and the United States; in another case, it combined two German and Canadian auto firms.
In buying Bofors, Carlyle and United Defense crossed into an extremely sensitive policy area. To smooth the process, a member of Carlyle's European board "helped us on that even though it was an acquisition by a US company of a Swedish company," said Conway. "Most people, when you talk about defense assets, tend to get a little bit sensitive, just as we do in this country."
Sensitivity is one lesson Carlyle has learned the hard way. Last September, less than three weeks after the attacks on the twin towers and the Pentagon, the Wall Street Journal disclosed that the bin Laden family of Saudi Arabia had committed at least $2 million to one of Carlyle's funds. Carlyle quickly returned the money. Conway, in the bank's first public comments on the incident, said the decision to part ways with the bin Ladens was made at the senior partnership level. "Anything that had the word bin Laden in it, you just didn't want to be associated with it," he said. "Its not that the people we were dealing with had done anything wrong." But in the end, "we said, 'Gee whiz, we'll buy you out at fair market value and get on with our life.'"
The Carlyle Group is owned by forty-nine managing partners, who hold 94.5 percent of Carlyle's private stock. (They include Baker and Major, whose Carlyle holdings are worth at least $200 million if the stock is equally divided.) The remaining 5.5 percent is held by the California Public Employees Retirement System [see "CalPERS and Carlyle," page 15]. The investors in Carlyle's various funds include US investment banks Goldman Sachs and Salomon Smith Barney; investment authorities in Abu Dhabi, Kuwait and Brunei; giant insurers like American International Group and the labor-oriented Union Labor Life; public pension funds in Ohio, Florida, Michigan and New York; and the corporate pension funds of American Airlines, Boeing, BP Amoco, GM and the World Bank.
Carlyle has distinguished itself from competitors like Kohlberg Kravis Roberts and Donaldson, Lufkin & Jenrette by branding its name on its fourteen investment funds, as Fidelity does with mutual funds. David Snow, editor of PrivateEquityCentral.net, an industry newsletter that recently named Carlyle its "deal team of the year," said the innovation was the inspiration of David Rubenstein, the lone Democrat among Carlyle's founding partners. "They've taken the name they built in defense and are stamping it on funds with different expertise," he said. "That's the direction the private equity industry is moving in." Carlyle's practice of hiring influential statesmen and politicians has also inspired imitation. Al Gore, for example, was recently hired by Metropolitan West Financial of California to start a private equity practice, and Forstmann Little, a fund co-managed by Erskine Bowles, President Clinton's former Chief of Staff, lists Newt Gingrich and Henry Kissinger among its advisers.
Carlyle doesn't provide investment figures by industry. But its focus on military and government-regulated industries is illustrated by the breakdown of Carlyle's Partner II fund, its primary vehicle for US manufacturing, which has 24 percent of its capital in defense-related companies, 23 percent in commercial aerospace and 24 percent in telecommunications and energy. Similarly in its Asia fund, 52 percent of Carlyle's investments are in financial services, where governments are deeply involved in restructuring the region's banks; 17 percent are in telecommunications; and 31 percent are in cable TV, industries that are being privatized and are under strict government supervision.
Carlucci, the mastermind of the bank's defense investments, came on board in 1989 after serving in the Reagan Administration. Carlyle says that Carlucci has never lobbied the government. He does, however, get invited to government events of great use to Carlyle simply because he is Frank Carlucci. According to recently declassified documents from the Office of the Secretary of Defense, Carlucci met with Rumsfeld twice last year--not as a representative of Carlyle but as a former Defense Secretary and National Security Adviser. The meetings, on February 9 and October 19, were organized by Rumsfeld to discuss defense issues and the war on terrorism, and included other luminaries from the national security establishment, including Kissinger and Caspar Weinberger (Shalikashvili was there too).
Rumsfeld's correspondence and Carlucci's subsequent comments underscore the utility of such meetings to Carlyle. After the February event, Carlucci and Rumsfeld agreed to follow up with discussions on how "to cut the cost of defense infrastructure and reinvest the savings in modernization and other priority programs"--key issues for United Defense. Ten days after the October 19 session, which included Wolfowitz, Carlucci offered an assessment of the situation in Afghanistan that exactly reflects the Bush Administration's endless-war scenario. "We as Americans have to recognize that [terrorism] is more or less a permanent position," Carlucci told a New York audience of business executives and labor leaders that included AFL-CIO president John Sweeney. "We're going to have to live with this kind of phenomenon for the rest of our lives."
Where Carlucci has led Carlyle's foray into defense, Bush Sr. and Baker have helped the bank forge deep ties with the Middle East. Just after his son was sworn into office, Bush was invited by Saudi ambassador Prince Bandar bin Sultan bin Abdulaziz to speak to potential US investors in Saudi Arabia at a two-day conference in Houston. Bandar, who is close to the Bush family, was not relying purely on friendship, however: The Washington Post recently disclosed that Bandar has invested in Carlyle, along with his father, Prince Sultan, the Saudi defense minister. (Bush Jr. also has a Carlyle connection: In the early 1990s he was on the board of Caterair, a Carlyle company that provided in-flight food services to airlines but never made a profit.)
Through a 51 percent joint venture with the Saudi government, Carlyle's United Defense provides tactical training and maintenance for the thousands of Bradley Fighting Vehicles purchased by the Royal Saudi Land Forces after the Gulf War. Carlyle had a long relationship with Saudi Arabia through BDM Corporation and Vinnell Corporation, which train the Saudi National Guard and were sold to TRW in 1998. In the early 1990s Carlyle advised Al-Waleed bin Talal--the Saudi prince whose $10 million donation to the World Trade Center victims' fund was rejected by Rudy Giuliani--on his US investments, including a $600 million bailout of Citicorp, now Citigroup.
Last April, Bush Sr. led a Carlyle delegation to Turkey, where Rubenstein negotiated a joint venture with the Koc Group, Turkey's largest conglomerate, which has holdings in energy, telecommunications and defense. During a dinner with Turkish business executives, Bush reminded the audience of Turkey's support during the Gulf War and promised to "help Turkey as we did in the past." FNSS, a joint venture between United Defense and the Nurol Group, is Turkey's largest manufacturer of armored vehicles and exports to Malaysia and other nations.
Over the past three years, in addition to visiting Turkey, Bush has been to South Korea, Saudi Arabia, Australia, France, Thailand and Hong Kong on Carlyle's behalf. In his speeches to investment conferences, said Conway, Bush "talks about the world, what he sees, what he thinks. Period." Carlyle's newly hired spokesperson, Chris Ullman, would not discuss Bush's compensation or his schedule, but added that Bush "does not and has never represented Carlyle before other governments or government officials. He has made no business deals for Carlyle."
Investors, however, recognize that the Bush name--and the many contacts Bush developed as President, CIA director and ambassador to the UN--carry tremendous weight as he travels around the world on behalf of Carlyle. "Nothing beats the ability to have George Bush call up some contact he's known for the last twenty years to comment on the worthiness of a particular deal," said Pat Macht, a spokesperson for CalPERS, after consulting with investment managers about Bush's role in Carlyle. That is particularly true in Asia, where personal relationships are key to business deals and Bush chairs the annual meeting of Carlyle's Asian Advisory Board.
Carlyle started its $750 million Asia fund three years ago to invest in countries trying to recover from the Asian financial crisis. Under pressure from the IMF and the US Treasury, the structure of Asian capitalism has been changing from family-controlled conglomerates, such as the Korean chaebols Daewoo and Hyundai, to leaner companies run by professional managers, hired in many cases by foreign owners. Governments, meanwhile, have abandoned social policies that once guaranteed a portion of the work force lifetime jobs and made it difficult to fire workers. That's even true in Korea, where militant unions have given the country a bad reputation in the eyes of foreign investors.
"Contrary to popular belief, major layoffs are being done in Korea," Jonathan Colby, a former aide to Kissinger who is one of Carlyle's managing directors for Asia, told a recent Asian investors conference in New York. With Asian banks holding billions of dollars in bad loans, "being able to tap private equity is crucial to long-term growth in Asia," Ray Hood, director of Asian investments for State Street Bank, said at the same event. For companies like Carlyle, Asia "is where the rewards will be in the next few years. Investment returns will be a complete steal."
In Japan, Carlyle is positioning itself alongside Goldman Sachs, Newbridge Capital, the Ripplewood Group and other US investment banks in buying up nonperforming loans and distressed assets, which are valued at more than $1 trillion. "Just as in Korea you can make some investments by taking a piece of the chaebols, I think the same thing is true in Japan, where you have these overleveraged, underperforming companies," said Conway.
These investment strategies mesh with policies of financial deregulation, structural reform and privatization, which have been publicly endorsed by President Bush, whose Administration is deeply concerned that a collapse of Japan's financial system could imperil the US-Japan security alliance. Last July, when Japanese Prime Minister Junichiro Koizumi visited Bush to seek his help in resolving Japan's financial woes, Japanese reporters blinked in astonishment as George W. explained at some length the importance of restructuring bad loans and banks from his experience as an oil executive and Texas governor during the S&L disaster.
So far, Carlyle's Asia fund has made four acquisitions: KorAm Bank, whose value has almost doubled since it was purchased in 2000; Taiwan Broadband, that country's fourth-largest cable company, in which Carlyle has invested $187 million; Mercury Communications, a telecom manufacturer recently spun off from the bankrupt Daewoo Group, for $49 million; and Pacific Department Stores, a joint venture with a Taiwan group that operates a chain of retail stores in mainland China, for $43 million.
Carlyle's Japan fund recently agreed to make its first acquisition, a 90 percent stake, worth $28 million, in the security trucking subsidiary of the bankrupt Daiei Group, Japan's largest retailer. Carlyle Asia is about to close its third acquisition in Korea, where Carlyle and J.P. Morgan have reportedly offered $1.2 billion to buy Kumho Industrial, the world's tenth-largest tire maker and a major exporter to the United States and China. China, in fact, may be where Carlyle is heading in the long term. "We are very focused on South Korea today, but China is our priority market of tomorrow," Michael Kim, Carlyle's managing director in Seoul, told the Daily Deal in January.
All of this is good news for Carlyle's family of investors, who seem nonplussed by the questions swirling around the firm. "I don't see what the issue is with Carlyle, except that there are some people who just don't like President Bush," said Michael Flaherman, chairman of the CalPERS investment committee. But as America has learned from the Enron fiasco, the mix of big business and politics can lead to disastrous investments, poor public policy and further erosion of the democratic process. The Carlyle system, where former Presidents, prime ministers, diplomats and industry regulators capitalize on their careers to make money for themselves and their clients, may be perfectly legal. Yet as Japan's experience over the past decade shows, even the most vaunted economies can sink--and sink fast--when the line between public interest and private profit disappears. Outside of the conservative Judicial Watch and the muckraking Center for Public Integrity, there has been little public interest in the Carlyle system of capitalism and where it is going. Congress, meanwhile, is too busy seeking Carlyle's advice even to ask the question. The people who run Carlyle may hate the word secrecy, but their words and actions make it impossible to know where the policy-making ends and the money-making begins.