ZGram - 3/12/2002 - "Did anybody say 'incestuous'?

[irimland@zundelsite.org]

ZGram

March 3, 2002

Good Morning from the Zundelsite:

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The Big Guys Work For
The Carlyle Group

By Melanie Warner Fortune.com

3-11-2
 

Are you the sort of person who believes in conspiracies--the 
Trilateral Commission secretly runs the world, that sort of thing? 
Well, then, here's a company for you. The Carlyle Group, a 
Washington, D.C., buyout firm, is one of the nation's largest defense 
contractors. It has billions of dollars at its disposal and employs a 
few important people. Maybe you've heard of them: former Secretary of 
State Jim Baker, former Secretary of Defense Frank Carlucci, and 
former White House budget director Dick Darman. Wait, we're just 
getting warmed up. William Kennard, who recently headed the FCC, and 
Arthur Levitt, who just left the SEC, also work for Carlyle. As do 
former British Prime Minister John Major and former Philippines 
President Fidel Ramos. Let's see, are we forgetting anyone? Oh, 
right, former President George Herbert Walker Bush is on the payroll 
too.

The firm also has about a dozen investors from Saudi Arabia, 
including, until recently, the bin Laden family. Yes, those bin 
Ladens. Is it any wonder that Internet sites with names like 
paranoiamagazine.com are rife with stories about Carlyle's shadowy, 
corrupt global network? And it's not just wackos. "Be careful," a 
tech entrepreneur in Silicon Valley wrote in an e-mail when he 
learned I was doing a story on Carlyle. "The rabbit hole runs really 
deep on this one.''

Leaving aside the conspiracies for a moment, what exactly does the 
Carlyle Group do? Start with the basics: It's one of the world's 
largest and most powerful private-equity investment firms, meaning it 
buys and sells privately held companies and divisions of large public 
companies for big profits. Founded in 1987 (and named after the 
favorite New York hotel of the firm's first investors, the Mellon 
family), Carlyle has raised a total of $14 billion from investors in 
just the past five years--more than any other private-equity firm has 
attracted in the same period, except the Blackstone Group and CSFB 
Private Equity. Profits, too, have been pretty terrific. Not counting 
the standard 20% cut that goes to Carlyle's partners and managing 
directors, the firm's average annual rate of return has been 36%.

It's quite a success story, and to understand how Carlyle pulled it 
off, FORTUNE spent a month and a half peeking down that rabbit hole. 
One conclusion seems clear: While most of the conspiracy theories are 
amusingly overblown, this is a firm that's been built on the backs of 
Bush and other big shots who have lent Carlyle their names, their 
golden networks of friends in high places, and their insights into 
how government works. It wasn't until Carlucci joined, for instance, 
that Carlyle really took off. Founded by David Rubenstein, a lawyer 
who worked as an aide in the Carter White House, Bill Conway, a 
former CFO at MCI, and Dan D'Aniello, a former finance executive for 
Marriott, Carlyle early on invested in a motley assortment of 
deals--buying an airline-catering business, a health-food chain, and 
a biotech firm, for example. In 1990, Carlucci got the trio 
interested in the $150-billion-a-year U.S. defense industry, making 
introductions to companies that would turn into some of Carlyle's 
most lucrative investments. Rubenstein quickly realized the wisdom of 
recruiting a former Secretary of Defense and followed it up with a 
former Secretary of State, then a former White House budget director, 
and on and on.

The revolving door has long been a fact of life in Washington, but 
Carlyle has given it a new spin. Instead of toiling away for a trade 
organization or consulting firm for a measly $250,000 a year, former 
government officials can rake in serious cash by getting equity cuts 
on corporate deals. Several of the onetime government officials who 
have hooked up with Carlyle--Carlucci, Baker, and Darman, in 
particular--have made millions. Carlyle isn't the only organization 
doing it: Metropolitan West Financial in Los Angeles recently hired 
Al Gore to help with tech deals and make introductions overseas, for 
example. But Carlyle, which pioneered the idea, seems more adept at 
it than any other firm.

Unlike other private-equity groups, Carlyle concentrates on companies 
funded by the government, such as defense contractors, or those 
affected by government regulation, such as telecommunications firms, 
and then hires people with relevant government experience. As the 
company once put it in a brochure, "We invest in niche opportunities 
created in industries heavily affected by changes in governmental 
policies." Doing so, of course, raises the ultimate rabbit-hole 
question: Is Carlyle's approach just a smart twist on good old 
business networking or a step over the line into an ethical twilight 
zone in which the public trust is broken?

Half a mile from the White House, inside nondescript offices sparsely 
adorned with generic depictions of ships and ducks, co-founder 
Rubenstein sits with his hands folded on a table so shiny you can see 
your reflection. Next to him sits Chris Ullman, Carlyle's first-ever 
full-time PR person. Habitually wary of media attention, Rubenstein 
and his partners agreed to rare interviews with FORTUNE. That's 
because since Sept. 11 the firm has been under unusual fire. First 
there was the bin Laden thing. Shafig bin Laden, one of Osama's many 
brothers and a Carlyle investor, was in attendance at a Carlyle 
conference at a Washington hotel on that infamous day. As the media 
were quick to point out, this meant that George H.W. Bush was working 
for a firm that was helping to make the bin Ladens money. Even though 
the wealthy Saudi family has reportedly cut all ties to Osama, the 
press lambasted Carlyle.

The firm has since given the bin Ladens back their money, some $2 
million, but controversy lingers. Sept. 11 and its aftermath also 
created the appearance of further conflicts of interest--namely, that 
while his son is in the Oval Office directing the war effort and 
proposing the largest increase in defense spending since Ronald 
Reagan, Bush is working for a firm that, through various investments, 
has become the nation's 14th-largest defense contractor. "It destroys 
the office of the presidency no less, in my view, than having sex 
with an intern," says Larry Klayman, director of the watchdog group 
Judicial Watch. On top of all that, there's the unfolding Enron saga 
and the likely passage of the campaign-finance-reform bill, which 
suddenly make it look bad for businesses to have too many friends in 
Washington.

It's no surprise, then, that Rubenstein is anxious to downplay the 
roles of Carlyle's famous people and to dispel the aura of mystery 
surrounding the firm. "The word I hate most is 'secretive,' " says 
Rubenstein, whose wry countenance and shock of white hair suggest a 
less rubbery version of Steve Martin. Rubenstein insists that all 
Bush does for Carlyle is give speeches to investors and that it is 
silly to think of him whispering in his son's ear about how to help 
Carlyle's companies.

On the whole, Rubenstein says, the big names at Carlyle do a lot less 
than most people think. "We don't lobby the government," he says, 
echoing a claim made by other partners interviewed by FORTUNE. He 
insists that if Carlyle is at all remarkable, it's because of the 
firm's innovative approach to private equity, its great returns, and 
its global ambitions--not because it happens to employ a few famous 
people. "Out of the 500 people at the firm, we have maybe eight or 
nine who served in government. The rest are your typical Harvard, 
Stanford, or Wharton MBAs, who do all the same things they do at 
other firms,'' says Rubenstein. (In fact, the number of former 
government big shots is 12, but who's counting?)

The conspiracy theorists like to imagine that Bush, Baker, and Major 
are jetting around the world cutting deals and making money for 
companies owned by Carlyle, but after nearly two dozen interviews 
with CEOs of current and former Carlyle companies and people familiar 
with Carlyle's business, it seems clear that this really isn't 
happening. What Bush & Co. actually do is far less pernicious but 
clearly valuable to Carlyle--they help raise money. Every year 
Rubenstein sets up scores of lunches and dinners around the world 
intended to woo new investors and gratify existing ones. As you might 
imagine, people like Bush, Baker, and Major are a huge draw. "If you 
call and say you're doing a dinner with Jim Baker or with George 
Bush, and could they please attend, chances are people are going to 
show up," explains a former employee, who, like all ex-Carlyle 
staffers I talked to, didn't want his name used. In the mid-'90s, for 
instance, Baker introduced Rubenstein to members of the royal family 
in Saudi Arabia and Kuwait; since he left Parliament last year, Major 
has been opening doors to big money in Europe and Canada. The allure 
of a former President is particularlyirresistible. At Carlyle's 
annual investor meetings, CEOs and money managers line up to have 
their pictures taken with Bush.

For his camera mugging and speech giving, Bush is paid "in line with 
market rates,'' says Rubenstein. That would mean about $100,000 per 
speech, so if Bush makes five or six speeches a year, as Rubenstein 
claims, then the former President is earning at least $500,000 
annually from Carlyle, not including the money he makes investing in 
deals. Rubenstein declines to specify which companies Bush has put 
money into, except to say that as a rule, they have nothing to do 
with the U.S. government.

There's no doubt that without these stars Carlyle would not have been 
able to raise as much money as it has. The firm's impressive returns 
and Rubenstein's seemingly inexhaustible energy and willingness to 
spend 300 days a year traveling have certainly played a role, but 
it's the bigwigs who draw crowds and really leave an impression. 
Their names on Carlyle brochures and their faces at Carlyle events 
give the firm a patina of power and credibility. "David's a brilliant 
fundraiser," says a source formerly associated with Carlyle. "What 
he's done so masterfully is traffic on the impression that the 
connections they have from these guys can bring them many valuable 
deals."

In the case of Carlucci, that impression happens to be true. The 
deals he's brought in total close to $2 billion in profits. There 
were Magnavox and GDE, makers of top-secret electronics gear, and 
Vought, an aircraft-parts manufacturer, all of which Carlyle bought 
and sold within two years, netting $300 million, $109 million, and 
$140 million, respectively.

Carlyle today is mostly associated with the defense industry, and one 
of the things Rubenstein and his partners would like to get across is 
that they invest in other things too. In fact, the firm owns stakes 
in everything from European automotive-parts manufacturers to Silicon 
Valley startups and Japanese DSL companies; roughly 25% of its 
profits last year came from real estate. But if you follow the money, 
it leads straight back to defense, which is where the greatest chunk 
of Carlyle's profits have come from. Today defense accounts for about 
10% of the firm's total investments, but in the early days it was 60%.

The firm's biggest score to date also involved a military 
contractor--United Defense, which went public in November, turning 
Carlyle's $130 million investment into $900 million. But the story of 
United Defense's latest coup also shows why Carlyle will probably 
never be seen as just another shrewd investment firm.

Last spring, when United Defense was feverishly pitching the 
Crusader, one of its new products, to the Department of Defense, 
Jacques Gansler, then in charge of acquisitions at the Pentagon, got 
a call from across the Potomac. It was Frank Carlucci, and according 
to Gansler, he wanted to know how Gansler felt about the Crusader, a 
controversial self-propelled artillery system that many inside the 
Pentagon felt was out of sync with plans for a lighter, more mobile 
Army. "I think he [Carlucci] wanted to make sure I was personally 
involved and that it wasn't going to be one of these things that got 
pushed down the bowels of the system,'' says Gansler, who has known 
Carlucci since the Reagan Administration and occasionally sees him at 
D.C. social events. As it turned out, Gansler was no fan of the 
Crusader and told Carlucci as much, ending that conversation. But 
Gansler thinks that had he been a fan, Carlucci "definitely would 
have wanted to make sure I was involved.'' It wasn't the first time 
Carlucci had had a conversation with a member of the Pentagon brass 
on behalf of a Carlyle company. In the early '90s, when Carlyle owned 
GDE, Carlucci drove over to Bethesda, Md., and met with, among 
others, Major General Raymund O'Mara, who was head of the Defense 
Department's Defense Mapping Agency, then a big GDE customer.

Carlucci acknowledges both conversations but asserts that neither 
constitutes lobbying. In O'Mara's case, he points out that GDE 
already had business from the mapping agency; in the case of Gansler, 
Carlucci says his call did nothing to advance the Crusader's cause. 
Nor, he says, did any of his interactions with Secretary of Defense 
Donald Rumsfeld during that time. The two men have known each other 
since their days on Princeton's wrestling team. The Rumsfelds have 
been to the Carluccis' for dinner and on several occasions have 
offered their ski house in Taos, N.M., to Carlucci and his wife, 
Marsha. It certainly would be easy for Carlucci to strike up a 
conversation over cocktails about the Crusader or some other 
Carlyle-related matter, but Carlucci says he never does that. "In 
light of our friendship, I'm particularly cautious about not 
discussing Carlyle business with him. In fact, I have never mentioned 
the word 'Crusader' in his presence," he says. All this may well be 
true. Yet it certainly can't hurt if it's known throughout the 
Pentagon that you are good friends with the Secretary of Defense. The 
Crusader, incidentally, is on the 2003 defense budget, making it 
likely that the Pentagon will ultimately buy 480 of the artillery 
systems for $5 billion.

There's no question that Carlyle does occasionally make calls to the 
government on behalf of its companies. They may not be hard-sell 
lobbying calls, but making introductions to influential people is 
often just as effective. One company Carlyle funded recently through 
its venture fund hopes to tap into the firm's government connections. 
Indigo Systems, a maker of infrared-camera technology in Santa 
Barbara, has an interest in seeing the laws restricting exports of 
U.S.-made infrared technology lifted or amended. Indigo's technology 
goes into tiny cameras that manufacturers are starting to place in 
cars. These cameras "see'' objects out of the range of the headlights 
and display them on a digital monitor. "The automotive industry is 
not centered on the U.S. today, and if our product is going to become 
a standard item on cars, I've got to have access to a global 
marketplace,'' says CEO Tim Fitzgibbons. During the five months it 
took Indigo and Carlyle to put together a deal, the two sides talked 
about ways Carlyle could help open doors within the government. "If 
somebody at Carlyle says to whoever is chairing a committee, 'We wish 
you would listen to these guys, we're invested in them, and they've 
got a good point,' then that says a lot. As opposed to me landing in 
D.C. and trying to get appointments, which is damn near impossible,'' 
says Fitzgibbons. Indigo's camera technology also has lots of 
security applications, and the company would like to get a slice of 
next year's $38 billion federal budget allocated for homeland 
security. "Carlyle certainly can't influence the outcome, but they 
can at least get us an audience,'' says Fitzgibbons.

Besides opening doors, fundraising, and marketing, there is another 
advantage to getting ex-government honchos to join your firm, and 
that's investment insight. Carlucci didn't help companies like 
Magnavox, GDE, and Vought win any defense business, but he brought 
these firms to Carlyle because of connections he'd made with defense 
contractors while at the Pentagon. And as a former Defense Secretary 
just a few years out of the job, he knew how to evaluate the 
companies. It was the end of the Cold War and Pentagon budgets were 
way down, but Carlucci knew big money was still going to be spent on 
certain programs. He figured that highly classified electronic 
equipment--such as the boxes for analyzing radar imagery and the 
battlefield radios made by Magnavox, as well as the digital mapping 
technology for cruise missiles made by GDE--was going to be very 
valuable as the Pentagon tried to make the Armed Forces smarter. 
Later, when Carlyle invested in Elgar Electronics in 1996, Carlucci 
looked favorably on something that scared off other investors. Says 
Elgar CEO Ken Kilpatrick: "Other people questioned what would happen 
if our business of selling automatic testing equipment to the Navy 
would go away. But Carlyle understood that the Navy was committed to 
this program and that it was just in the middle of it." Carlyle sold 
Elgar in 1998 for a profit of $100 million.

Carlucci downplays the extent of his insight by saying that top 
analysts like Loren Thompson at the Lexington Institute know just as 
much as he does about defense spending, and maybe more. Certainly 
people like Thompson are quite knowledgeable and have networks of 
contacts at the Pentagon, but they don't belong to the same 
high-level coterie that a former Secretary of Defense does. They 
don't, for instance, go to lunches like the one Rumsfeld gave a 
little over a year ago where former Pentagon heavyweights like 
Carlucci, William Cohen, Caspar Weinberger, William Perry, and Dick 
Cheney all chatted and mingled. "Cabinet-level people are a small 
fraternity who all stay in touch,'' says a former Carlyle staffer. 
"Once they've reached that global 50,000-foot view, they tend to stay 
there.''

Though defense has been Carlyle's most fruitful area to date, 
Carlucci and the firm's current head of defense investing, Alan Holt, 
don't have plans to do many deals this year. Wars are such an obvious 
bonanza for defense contractors that prices get bid up, and Carlyle 
thinks they're too high now. Fortunately, there are lots of other 
opportunities on the horizon. Carlyle recently launched its first 
energy fund in partnership with Riverstone Holdings; it is also in 
the process of putting together an asset-management group, headed by 
the former treasurer of the World Bank, that will invest in other 
private-equity funds. With the help of former SEC chief Levitt, 
Rubenstein is setting up a financial services fund. There's also 
telecom, which has the biggest team of people devoted to it of any 
area at Carlyle. "There are dramatic restructurings in the telecom 
and media business going on right now, and the one thing they have in 
common is that they're all driven at some point by government 
action,'' says former FCC boss Kennard--who, like Levitt, is a 
Democrat, which shows that Carlyle can be bipartisan.

Rubenstein started recruiting Kennard to be a managing director in 
Carlyle's telecom group as soon as he left the commission last year, 
and ultimately won out over lots of other bidders. He was quite a 
catch. Kennard knows everyone who's anyone in telecom and has 
extensive contacts at regulatory agencies around the world. Could 
telecom be Carlyle's new defense? Rubenstein doesn't like to put in 
it those terms, but he's hoping for big returns. Looking at what 
Carlyle and its star-studded team have been able to do in the past, 
would you bet against him?


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