Melvin: Digesting KKR Earnings for Q3

Tim Melvin on KKR Earnings and What to Expect from the PE Shop

KKR earnings came out this week. If you read the headlines surround the recent earnings report form KKR and Company (KKR), you would think the world had ended for the private equity and alternative investment firm. While earnings did drop 23% year over year, this was implied because the company did not sell many assets to generate incentive fees in the quarter. The media loved the topic, but it didn’t come up n the analyst and investors call in any significant way at all.

CFO Bill Janetschek did talk about fee-generating monetization’s that are expected over the next few quarters saying, “let me give you a little color on monetization activities as we stand here today. Transactions that have closed or have been signed and are expected to close should contribute $925 million in realized carried interest and realized investment income in Q4 2019 or early 2020. Of that $925 million, we expect $375 million to close in Q4. And it’s only the end of October.”

KKR and Monetization Trends

Janetschek also discussed the year to date monetization trend and the types of gains they had realized when they sold telling analysts that “Through the first nine months of 2019, Private Market is deployment is $10 billion, up 8% year-over-year. Now let’s turn to monetization activity in the quarter. As reported in our monetization update in late September, activity this quarter was driven by both strategic transactions and secondary sales. We had just over $500 million of realized carried interest and investment income this quarter. We had our final exit in the quarter in both PRA Health and National Vision, at a blended multiple of five times our cost.”

Private equity is not a smooth business.

Returns tend to be high but very lumpy. Some quarters will see more monetization than others, and there will be times when it is easy to deploy money and others where it is difficult to find companies and assets available at prices KKR is willing to pay.

It is the long-term results that matter, and as Craig Larson, Head of Investor Relations for KKR, pointed out KKR has excelled at delivering long term returns. Mr. Larson told analysts that “Most importantly, the earnings power of the firm continues to grow nicely as can be seen by the charts on the left-hand side of the page. Our AUM is now $208 billion, while the book value is $18.22 per adjusted share. As you know, we’re big believers in the power of compounding, and we’ve seen that power through our book value. Over the last year, book value per share grew 9%, well ahead of equity and fixed income indices. And over the last three years, we’ve compounded book value per share 15% each year all while paying out dividends alongside of this.”

Craig Larson on Limited Partner Returns

He also pointed out the strong return they continue to deliver for their limited partners noting that “Beginning with private equity, the private equity portfolio in its entirety appreciated 12% over the trailing 12 months. This compares favorably to the MSCI World that appreciated 2.4% on a total return basis. Where we saw a notable performance was in our flagship private equity funds, as you see on the page. The blended performance across these funds these are our more recent vintages that have been investing for at least two years was quite strong appreciating 26% driven by Asia III. Our flagship real estate and infrastructure funds appreciated 21% and 9%, respectively, while the commodity environment pressured our benchmark energy fund. Energy Income and Growth declined 15% on an LTM basis but performed well ahead of the benchmark. And credit our alternative and leverage strategies have both appreciated 4% on a blended basis.”

KKR CEO Scott Nuttall on the Macro View

CEO Scott Nuttall talked about what KKR sees going on in the world right now, saying that” I’d say we see basically an industrial recession we think now in the U.S. and Europe to a great extent. Consumer and services look okay, but we’re watching the data closely. So, to be clear, we are expecting whatever’s coming to be kind of a more of a normal recession. But we’re seeing a bit of a rolling recession right now; we believe really starting with the industrial sector U.S. and Europe. Asia is a bit of a different story. So, we do see an opportunity coming out of all of this.”

He added, “As we think about how to invest in it, what we’re seeing is there’s more volatility in the market, there’s more dispersion in the market. So, we continue to see a have/have-not market, and to some extent, a have/have-not economy. And so, as a result of that, where we’re spending time is where the market is undervaluing companies. So, we’re finding complexity is punished, any change in outlook is punished, and the market overall is quite skittish.”

KKR Earnings Views from Larson

When asked about the difficulty of getting money to work when deal multiples are actually a little above pre-crisis levels at 11 times EBITDA in terms of purchase price multiples Craig Larson replied saying “I think one of the things that’s interesting to look at public equity deployment is looking we continue to see more dislocation, more opportunity and better risk/reward outside of the U.S. And part of that is exactly what you’re talking about which is valuation-related. So, if you look at total returns over the last five years, returns for S&P is more than two times that of the MSCI Asia Pacific. And so overall, we see greater value overall in the region. If you look year-to-date in terms of investment activity again it’s interesting but dollars invested in Asia together with Europe are actually over 2.5 times that of the U.S. And again, I think what you’re seeing is given overall valuation levels a pretty disciplined approach as it relates to U.S. investments most specifically.”

The Bottom Line

Paying attention to what a firm that controls more than $200 billion of assets with the ability to lever than up over half a trillion and delivering outstanding long term returns to Limited Partners and shareholders alike is seeing in the world and investing in right now strikes me as far more valuable than contemplating one quarter’s results.

 

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