Rolling in War Bucks

How the state public employees' retirement system and the politically connected Carlyle Group profit from defense

It is, of course, hardly extraordinary when the owners of defense companies profit from war. There is something a wee bit unusual about this case of war profit-making, though. In this case, the entity that reaped profits from the U.S. defense buildup and the Iraq War was a company employing a host of political luminaries, many of whom served in past Republican administrations or have connections to the current Republic administration.

But that's not quite the whole of the development I found noteworthy.

Yes, the Carlyle Group arranged for a group of investors to buy into United Defense and, apparently, make money. The actual identities of many of those investors have not been publicly revealed; in fact, some of those identities are obscured in partnerships based in the secrecy-happy offshore tax haven of the Cayman Islands.

All the same, there is one known beneficiary of war involved in the interesting/dismaying developments of this summer. It is the California Public Employees Retirement System.


Because calling someone a "beneficiary of war" could seem impolite, let me put on my best Sunday suit and restate the matter: Carlyle and its strategic business partner, CalPERS, apparently made a lot of money this summer, and some of the profit might be reasonably attributed to war in Iraq. Here is how the moneymaking came about.

Carlyle's involvement with United Defense Industries began in 1997, in a transaction the firm's Web site describes this way: "United Defense was formed when Carlyle acquired the partnership interests of FMC Corporation and Harsco Corporation for $850 million in October 1997. Following a leveraged recapitalization during the summer of 2001, United Defense went public in an initial public offering completed in December 2001. 'United Defense has been a successful investment due to great execution,' says Carlyle's [managing director] Allan Holt. 'The management team has faced an ever changing defense environment and reacted quickly and appropriately.'"

That United Defense would profit in the post-9/11 environment of increased security spending seems axiomatic, given the broad range of military products and services the company provides. Among other endeavors, the firm is the prime contractor for the Bradley Fighting Vehicle, the Army's chief armored personnel carrier; an automated gun system for the U.S. Navy; a missile launch system for the Navy's surface ships; and the next generation of motorized artillery for the Army. The firm has a division that constitutes, according to the Carlyle Web site, "America's largest non-nuclear ship repair and modernization company." And United Defense has been selected to help develop ground combat vehicles for the Army's Future Combat Systems, a central component in Secretary of Defense Donald Rumsfeld's multibillion-dollar plan to use technology to "transform" some portions of the U.S. military into lighter, quicker striking forces.

A prospectus filed ahead of this summer's United Defense stock sale makes it clear that the likelihood of increased U.S. defense spending and continued U.S. war fighting makes the company's financial future seem bright. In a section titled "Industry Overview/Market Opportunity," the prospectus notes that defense spending will grow about 4 percent in the next fiscal year and is expected to continue to increase. Beyond those general trends, the prospectus says, the defense sector generally, and United Defense in particular, is likely to prosper because of "greater repair and maintenance requirements due to significant wear and tear on both naval vessels and armored vehicles from the United States' involvement in extended deployments as well as active military conflicts, such as the recent war in Iraq."

Carlyle's investment in United Defense has already paid, literally and figuratively, dividends. In addition to the $270 million raised in the August sale, the Bloomberg News Service reported, "Carlyle has sold almost $500 million in shares of [United Defense] in public offerings since 2001, pocketed about $350 million in dividends before the company went public, and still owns about $350 million of stock, according to Securities and Exchange Commission filings."

CalPERS's involvement with Carlyle began in 1996, with a commitment to put $80 million in a private equity fund called Carlyle Partners II. In 2000, the retirement system pledged to invest $150 million in Carlyle Partners III. A CalPERS press release from early 2001 says the retirement system was so happy with its Carlyle relationship that it would purchase a $175 million piece (or 5.5 percent) of the Carlyle Group itself and commit to place another $250 million in Carlyle equity funds. The press release says CalPERS had an option to invest an additional $425 million with Carlyle over two ensuing years.

The Carlyle Web site lists United Defense as one of the holdings in the portfolio of Carlyle Partners II, the first Carlyle partnership in which CalPERS invested. In an SEC document filed in August, a Carlyle-related management firm reports that it sold 10,569,808 United Defense shares for $25 each on behalf of an entity that includes both Carlyle Partners II and Carlyle Partners III, also a recipient of CalPERS funds. According to SEC documents, at least two other Carlyle partnerships -- Carlyle International Partners II and Carlyle International Partners III -- were also part of that entity. The latter partnerships have an interesting provenance. They were formed in the Cayman Islands. Yes, the Cayman Islands favored by many who wish to keep their business affairs secret. The Cayman Islands known as havens for some firms (including the ones CalPERS board member Angelides has roundly criticized) that seek to limit the amounts they pay in U.S. taxes.

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