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Coverage Initiation: KKR & Co. L.P.
Private equity firm, and Value Line newcomer, KKR & Co. L.P. (KKR) traces its roots to Bear Stearns, where Jerome Kohlberg, Jr., Henry R. Kravis, and George R. Roberts ran the corporate finance department in the 1960s and 1970s. These men focused on buying private companies that were too small to go public. Their first noteworthy leveraged buyout was that of Orkin Exterminating Co. in 1964. A series of mostly successful transactions was conducted into the early 1970s. But with Bear Stearns uninterested in creating a leveraged buyout fund, the department managers left the company in 1976 to form Kohlberg Kravis Roberts & Co.
In 1977, KKR, with First Chicago Bank, the Hillman Family and a few individual investors, completed the $94 million (including debt) buyout of A.J. Industries. One year later, the firm had $30 million in available capital. Operations expanded in the 1980s, supported by funding from the Oregon State Treasury Pubic Pension Fund. Several $1 billion plus deals were executed, including the purchases of Wometco Ents., Beatrice Cos., Safeway Stores and Duracell.
Jerome Kohlberg left the firm in 1987, leaving Messrs. Kravis and Roberts to run things. In 1988, KKR finalized a landmark transaction, buying RJR Nabisco in a hostile deal for $31.1 billion. The pension funds of Coca-Cola (KO - Free Analyst Report), Georgia-Pacific, and United Technologies (UTX - Free Analyst Report), the MIT and Harvard endowments, and the New York State Common Retirement Fund provided capital for the deal. During the 1990s, managing RJR Nabisco’s debt proved a challenge. KKR had to boost its equity contribution to $3.2 billion, restructure and sell some of that company’s assets, and conduct initial public offerings (IPOs) of common stock. At the same time, IPOs of other companies bought in the 1980s were completed. Many of these deals were profitable, some not so.
In the early 1990s, KKR sought to consolidate assets in the publishing industry through its K-III Communications operation. More than $1 billion in assets were amassed, and K-III went public in 1996, and changed its name to Primedia (PRM). KKR held stakes in Primedia until 2005, and lost money as that company’s share price declined. Around mid-decade, the KKR 1996 Fund was established with $6 billion in capital. Various buyouts were completed. KKR endeavored to again consolidate assets, this time in the movie theater sector, with the purchases of Act III Cinemas and Regal Cinemas. Management planned to combine these businesses with United Artists Theaters, which was to be acquired by partner Hicks, Muse, Tate & Furst. Unfortunately, the deal fell through frustrating the partners’ ambitions.
KKR performed well during the period leading up to the 2005-2007 buyout boom. With the help of several partners, Blackstone Group (BX) among them, the firm scored the $6.6 billion takeover of Toys R Us in 2004 and the $11.3 billion buyout of SunGard in 2005. Notable deals concluded during the boom included HCA, Dollar General, Alliance Boots, and First Data. The biggest transaction, done with backing from TPG Capital and Goldman Sachs (GS), was the buyout of TXU for $44.4 billion.
In 2005, KKR completed the IPO of KKR Financial (KFN), then a real estate investment trust, which now trades on the NYSE as a limited liability company. KFN invests in residential and commercial mortgage loans, mortgage-backed securities, and corporate debt and equity. Separately, in 2006, KKR listed common shares of KKR Private Equity Investors (KPE), a fund of funds. KKR intended to list its own shares in 2008, but the global financial downturn forced a delay. In 2009, KPE was absorbed into KKR, and the combined company traded on Euronext Amsterdam. This year, KKR delisted from that exchange, and began trading on the NYSE on July 15, 2010.
KKR has about 600 employees in 14 offices across North America, Europe, the Middle East, Asia, and Australia. The company has three segments. Private Markets is KKR’s private equity business, focused on capital appreciation. As of June 30, 2010, the segment had 16 funds, with $59.5 billion in capital commitments and $41.0 billion of assets under management (AUM), and six-month economic net income (ENI) of $350 million. Public Markets is a fixed-income operation, dealing in leveraged loans, high-yield bonds, mezzanine debt, special situations assets, distressed assets, and rescue, debtor-in-possession and exit financings. At mid-2010, this segment had $13.4 billion of AUM and year-to-date ENI of $28 million. Capital Markets & Principal Activities is comprised of KPE, and arranges debt and equity financing. In the first half of this year, the segment produced $730.5 million of ENI.
Since 2004, KKR has expanded its AUM at an average compounded annual growth rate of 26.2%, from $15.1 billion to $54.4 billion. As of June 30, 2010, Private Markets had $11 billion in capital and Public Markets had $1 billion in funds available to invest. As the macroeconomy recovers and confidence returns to the capital markets, we look for a solid expansion of KKR’s operations in the next 3 to 5 years. Over the company’s history, these two segments have outperformed their market benchmarks. In the first six months of 2010, Capital Markets has increased its ENI by 81%.
Recent business activity includes the purchase of a 23.44% stake in Colonial Pipeline, a Georgia-based owner of a 5,529-mile petroleum products distribution system, for close to $1 billion. This deal, done with partner National Pension Service of Korea, gives KKR increased exposure to the global energy infrastructure market. Too, KKR has made a $1.72 billion overture to Australian fund manager Perpetual Ltd, which has some $30 billion in AUM. The firm also appears interested in Foster’s Group’s (FBRWF.PK) wine business, worth roughly $3 billion. Additionally, KKR is in talks to buy Seagate Technology (STX), possibly for as much as $12 billion.
In the first three months of their trading history on the NYSE, KKR units performed fairly well, rising about 3.6%. At a price of $11.00, a unit yields 2.9%, based on an annualized distribution of $0.32. We believe that KKR will produce attractive investor returns to 2013-2015. At the end of the 2010 June quarter, the company’s finances were strong, with more than $2 billion in available liquidity and a debt-to-total capital ratio of less than 5%.
At the time of this article’s writing, the author did not have positions in any of the companies mentioned.