Carlyle Group LP (NASDAQ:CG) has been downgraded by Citigroup from Buy to Neutral following a shortfall posted by the buyout firm in its economic net income and mixed post quarter call. William R Katz and the team at Citi lowered Carlyle’s 12-month price target by $3 to $29.

Carlyle Group

Carlyle missed EPS expectations

Recently, Carlyle Group announced its second quarter earnings, posting earnings per share that were much less than expectations. The buyout firm reported earnings of 39 cents per share. The firm’s economic net profit was $156 million, compared to last year’s loss of $57 million. Carlyle posted revenue of $508 million compared to $61 million last year.

Reasons for Citi’s downgrade of Carlyle Group LP (NASDAQ:CG)

Citi analysts attribute three reasons for assigning a Neutral rating on Carlyle.

The analysts feel elevated fundraising costs are likely to pressure FRE margins beyond the second half of 2013, besides pressurizing more structurally going forward, given a changing mix. Citi analysts also feel such spend is not generating disproportionate organic growth.

Secondly, William R Katz and team feel U.S. Private Equity capital deployment is tougher in the short term, while cyclical could pressure overall deal activity.

Thirdly, the analysts feel the valuation is not overly compelling on SOTP and DEDM bases.

Citi reduces Carlyle Group LP (NASDAQ:CG)  net income estimates

William R Katz and the team at Citi also reduced their 2013-15 Economic Net Income estimates to $2.62, $2.65 and $2.97. This was lower than their earlier estimates of $3.02, $3.34 and $3.65 respectively. Some of the reasons attributed by analysts include higher Economic Net Income tax rate and higher G & A expense, since the analysts believe fundraising costs could continue to be elevated beyond 2013 as Carlyle Group plans to increase its retail presence.

Citi analysts also observe that Carlyle management is now forecasting lower capital deployed in 2013 as opposed to 2012, in view of more challenging investing environment. The analysts feel the buyout firm could find it tougher to achieve prospective 20 to 25 percent IRR target.

Carlyle management anticipate Distributable Earnings will increase toward the end of 2013 as they expect higher realization of performance fees from carry and hedge funds followed by reasonable growth in 2014. Citi analysts thus note Distributable Earnings outlook from Carlyle management may accelerate into 2014.

Citi analysts also recall Carlyle Group LP (NYSE:CG) management’s view of the more challenging investing environment for the U.S. buyout business. However, Citi analysts feel though Europe appears to be an attractive place to deploy ‘dry powder’, overall deal sizes tend to be lower in Europe as compared to the U.S.