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In SoCal's Bond Triangle, the Carlyle Group hits some trouble

The Carlyle Group, a huge private-equity firm, has hit snag with its purchase of a majority stake in TCW, one of the big bonds finds headquartered in California.
The Carlyle Group, a huge private-equity firm, has hit snag with its purchase of a majority stake in TCW, one of the big bonds finds headquartered in California.
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Reuters ran a dense "exclusive" Monday about some financial gyrations that are making potential trouble for private-equity colossus the Carlyle Group's deal to buy a chunk of TCW, one of the biggest bond funds in the world and a part of what I call the Southern California Bond Triangle. It also includes PIMCO and DoubleLine Capital.

PIMCO is the biggest bond fund in the world, with $1.8 trillion under management. TCW has around $135 billion on its books. DoubleLine has been growing at a furious pace since CEO Jeff Gundlach established it after a controversial departure from TCW. It has taken on nearly $50 billion in under three years. 

You could also throw Pasadena-based WAMCO in there, creating a Bond Quadrangle. WAMCO has around $450 billion under management and has tried in recent years to regain its competitive mojo versus PIMCO.

That's over $2.5 trillion in assets, all clustered here in Southern California - more than $500 million more than the annual economic output of the the entire state and a figure equivalent with about 15 percent of the yearly GDP of United States.

The entire scene is, predictably, highly competitive. That's especially true recently as speculation has emerged that when PIMCO's co-Chief Investment Officer Bill Gross retires, investors may move their funds elsewhere. The Carlyle Group clearly smells a big opportunity for TCW to grow its business — although my sources in the bond world tell me that the name of the game continues to be about investment return rather than vacuuming up all the available money.

On that front, TCW has been picking up the pace, with double-digit returns on funds that were positioned to benefit from the Federal Reserve's round of mortgage-backed-securities buying late this year — so-called "QE3," the third round of "quantiative easing" the central bank had undertaken in the aftermath of the financial crisis. (PIMCO and DoubleLine also racked up nice returns.)

Here's Reuters:

Carlyle...sees TCW's cash flow margins — a measure of how well a company transforms sales into cash — as 35 percent lower than the industry standard, according to the document.

Private equity is known for seeking to increase the value of its assets though cuts in expenses. It is unclear whether a possible slump in the cash flow as a result of the dispute with EIG would prompt Carlyle to seek even more cost savings from TCW.

TCW plans $14.6 million in cost cuts, including through fee-sharing, reductions in headcount, executive compensation and products, to increase its cash flow margins to 24 percent from 20 percent now, according the document. That is still below the 31 percent median cash flow margins of TCW's peers [according to legal documents].

The problem for Carlyle is that EIG Energy Partners, another private-equity firm, has been sending profits to TCW. EIG was "spun out of TCW" in 2011, Reuters reports. EIG is trying to prevent Carlyle from buying 60 percent of TCW. Meanwhile. Carlyle could see its nearly $800 million deal to acquire a majority stake in TCW roiled by this revelation.

In any case, TCW probably needs a revamp. It's owned, for now, by Société Générale, a French bank. But SoGen is dealing with the ongoing Eurozone crisis and, as I wrote when the Carlyle deal was announced, couldn't have picked a better time to jettison TCW (TCW staff is buying the rest of the firm). Its business has been iffy as WAMCO has been somewhat resurgent and DoubleLine has been booming. Only a deal to buy Metropolitan West Asset Management, with its $30 billion in assets under management, kept TCW in the action, prior to the QE3 bonanza.

Fixed-income management hasn't traditionally been thought of as particularly thrilling, compared with swashbuckling equities trading. Stocks are more exciting than bonds! But in SoCal, it looks as if things are about to get a lot more interesting.

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