Apart from their location on the 39th floor of San Francisco’s Transamerica Pyramid, the offices for The Carlyle Group’s venture capital arm give no sign of who their tenants are. There is a notable lack of opulent furnishings or photographs of the Washington, D.C. insiders who populate Carlyle’s ranks. When you spend so much time working for a U.S. president that you can call him Ron or George (in private anyway), you don’t feel the need to hang photos of yourself glad-handing the “Pres.”
Like his surroundings, Bob Grady doesn’t put on airs of self-importance. The head of Carlyle’s venture capital group and a member of the group’s executive committee, Grady greets visitors with a spring in his step and an affable demeanor. Without knowing him, you’d never suspect that the 45-year-old has the kind of resume that requires several pages to cover adequately – and that’s without the usual superfluous modifiers and hyperbole.
The resume’s bullet points include Harvard College, Stanford MBA, chief of staff for a Congresswoman and a governor, and then a White House speechwriter. The list goes on, of course, with stints as deputy assistant to the President, Stanford faculty member, and managing director of Robertson Stephens.
That’s the unadorned picture up to when Grady joined Carlyle in 2000. It would be an insufferable record of achievement if so many of his peers at Carlyle didn’t have similarly strong resumes and names like Baker, Bush, Carlucci, Gerstner, Major, Ramos and Rubenstein. Men like these have the wherewithal even under 50 to have retired as gentlemen farmers at their ranches in Jackson Hole, Wyo., but something has kept Grady in the game
Apart from the IPOs and the dozens of deals he did for Robertson Stephens, he was also involved in the firm’s venture capital efforts. Perhaps that is what attracted him to join and co-manage Carlyle’s first venture fund, which was raised by Ed Mathais, David Rubenstein, and Mitch Reese.
That first fund of $210 million, was raised mostly from high net worth individuals, with a few blue-chip institutional LPs thrown in. However, Reese left in 2000 to found his own venture fund, leaving Grady as the sole manager of the group’s venture arm.
After recruiting the entire San Francisco-based staff, Grady raised a larger second fund, CVP II almost entirely from institutional LPs. At over $600 million, CVP II was one of the largest technology funds raised last year and it is on track to have invested $200 million by the end of this year. grady says that it will be fully invested by 2006.
Carlyle’s U.S. funds complement a $600 million European venture fund and two Asian venture funds ($159 million raised in 1999 and $180 million raised in 2001), which Grady oversees as Carlyle’s global head of venture capital.
What Grady has learned since joining the firm three years ago is that Carlyle itself has grown considerably over the last 15 years. Carlyle employs about 500, including 270 professionals who work in the group’s various funds.
With regard to funds, Carlyle is into just about everything: It operates multiple buyout and real estate funds in Asia, Europe, Japan and the United States, in addition to energy funds (it’s currently raising its second energy buyout fund), turnaround funds (it’s investing its first) and high-yield funds (it’s investing its fourth such fund).
All told, Carlyle manages more than $16 billion in 21 different active funds with 550 LPs, making Carlyle one of the five largest private equity firms in the world.
Carlyle made an effort in 2001 to enter the asset management business. It raised a hedge fund-of-funds and a secondary fund to buy investment interests from LPs. But this past summer the firm announced that it was selling the hedge fund to its managers. It’s still considering its role in the secondary market. The missteps are the first public recognition that Carlyle can’t do everything, at least not to the standards that it demands of itself. The bar is set high: Carlyle has produced an average of 35% IRR on realized transactions and returned about $5.4 billion to its LP’s over 15 years.
All of which brings us to the interesting question of where, exactly, Grady is driving Carlyle’s venture capital group.
The firm’s interests are demonstrated by its deals, says Grady, in terms of stages of investing (a blend of early-, mid- and late-stage), sectors (storage, security, defense/aerospace, communications, automotive, imaging, health care devices and software), and geography (Europe, Asia, Japan and North America).
Reflecting on the perception that Carlyle is a creature of the privileged class that benefits from deals its high powered members garner through their social network, Grady unapologetically agrees that aerospace and defense are important to the company. But he says that the sectors make up only 6% of the group’s overall investments, while the remaining 94% of all deals the company has done are with technology, real estate, energy, industrial and health care companies.
Grady characterizes the deals his group does as having four key factors. First, many Carlyle deals involve complex legal and regulatory issues, which are anathema for the average VC firm.
Second, Carlyle leads most of its deals and its staffers sit on the boards of all the companies it backs.
Third, it’s drawn to deals with physical assets, developed products and customers.
And finally, Carlyle likes deals to which it has the ability to add value through its connections and experience.
What do such deals look like? Grady speed talks through several he feels represents the description that he has given.
Let’s start with the classic deal that epitomizes the big, complex just plain smart and wildly profitable kind of transaction that Carlyle likes.
When Global Crossing and other companies got into trouble building fiber optic networks across the globe with billions of inflated Internet-era dollars, they began selling their assets. Carlyle bought one piece of that business (from an Australian conglomerate) in Bankruptcy Court that has become WCI. WCI owns fiber cable within Alaska, and between Alaska and the lower 48 states, that cost $300 million to build. It’s one of only two such cable networks. Carlyle bought the assets for $28 million (from Grady’s CVP II) and is now growing that business to something that will make real money when its time to sell.
And it’s just in time to carry telephonic and data traffic over secure fiber cables for the U.S. government’s missile shield installations that have quietly gone into place across the far North.
Then there is the build-and-sell arena of medical technology. Carlyle just participated in a $26.5 million Series B round for Endius, a company that provides less-invasive techniques for spinal surgery. Grady explains that Carlyle likes to invest in medical device companies over other areas of life sciences, such as drug discovery, because medical devices have good demographics. Translation: Lots of Baby Boomers need high-tech remediation of age-related medical problems.
More importantly, Grady points out that devices are more predictable than drugs, have a well-defined process of invention, development and sale to device manufacturers/distributors, while at the same time they have less-arduous regulatory hurdles to overcome. The risk in devices, he says, is in marketing and execution, things his group excels at.
A good representation of Carlyle’s investments is found in imaging technology, including Indigo Systems of Santa Barbara (chips, sub-systems and cameras for infra-red applications), SMaL Camera Systems (chips, sub-systems and optics for low cost digital cameras) of Boston, and Canesta (3D sensors and display technologies).
The cluster of investments has applications for the automotive, aerospace and military/security markets. Carlyle likes vertical markets, where it sees deals that most other VCs never get a peek at, Grady says.
For example, Indigo just won a contract to supply $12 million worth of cameras for the pre-production run of the Joint Strike Force Aircraft that Lockheed Martin will supply to the military as the mainstay of the first half of the 21st century fighter. The plane will need many hundreds of thousands of units of infrared detectors over the life of the fighter program. That means Indigo has a leg up and good connections for a contract worth $990 million to a supplier over the life of the plane. It’s nice to have former defense secretaries on the payroll.
Meanwhile, SMaL Camera just announced that it has won a key deal with a top-six auto manufacturer that will help expand that company’s business over the next four years beyond the murderously competitive market for low-cost consumer digital cameras. Deals like SMaL Camera and Indigo demonstrate why Carlyle is so successful over time. VCs stress that one of the best things they bring to their portfolio companies is a deep Rolodex of contacts and resources.
What is considered a sin of the military-industrial complex in some circles (former government employees working with ex-employers on government contracts) is a license to print money in the eyes of limited partners. In the VC game its almost more important whom you know than what you know to make deals happen. And Carlyle happens to have a rich Uncle Sam that it knows well like no other private equity firm in the country.
In the world of venture capital there are always ups and downs, and Carlyle is no exception. While the last two years have been very difficult for most VC firms, however, Grady says that Carlyle has been busy and pleased with its VC investments.
Having said this, Grady furrows his brow. “Over the last three months,” he says, thinking of the May through July period, “the market has swung up. There have only been a handful of IPOs, but they were good-quality IPOs.”
At the same time, a number of venture firms are preparing to raise new funds in 2004, firms that have not been bidding on deals for awhile and that “appear to have decided that they need to make some high-profile deals that will dress-up their portfolios for the future fund-raising efforts that are sure to come,” he says, staring out of his office window, which overlooks the Golden Gate Bridge. As a result, Grady says, by August there was a sense of craziness that the VC industry hasn’t seen in a while.
“Companies that we’re evaluating are telling us that they need a decision in two or three days, telling us that they have four or five term sheets, all priced very high,” he says.
That sense of competitiveness once again borders on silliness, and as a result Carlyle has been outbid for deals in several cases. Carlyle, Grady says with certain satisfaction, has measured those deals against the business plans submitted by the pitching companies and found without exception that the companies have not met their projected business goals or results.
“These are the kind of investments that got VCs into so much trouble in the late 90s,” he concludes.
It is exceedingly clear just how methodical, industrious and smart these guys are. It’s not that they’re that much smarter than others. It’s just that they define what they do to an extraordinary degree and have a similar degree of discipline in the practice of what they do. Grady says that the group simply does not invest outside of its domains. And when you’ve got Grady, who’s got an inside-angle on so many fruitful political and business domains, why look anywhere else?