Business Context and Reporting Period
Company: KKR & Co. Inc. (KKR)
Filing Type: Form 10-Q (Unaudited)
Reporting Period: Quarter and six months ended June 30, 2010
Overview: KKR is a global alternative asset manager operating through three segments: Private Markets, Public Markets, and Capital Markets and Principal Activities. The reporting period follows a significant reorganization and combination transaction completed in October 2009, which consolidated KKR's asset management business with KKR Private Equity Investors (KPE). KKR listed on the NYSE on July 15, 2010, shortly after the period end. The financial statements consolidate KKR's funds on a gross basis, with third-party investor interests reflected as noncontrolling interests.
Key Financial Metrics
| Metric (in thousands) | Three Months Ended June 30, 2010 |
Six Months Ended June 30, 2010 |
|---|---|---|
| Fees Revenue | $87,070 | $193,101 |
| Total Expenses | $430,586 | $893,894 |
| Net Gains from Investment Activities | $1,031,568 | $3,318,121 |
| Total Investment Income | $1,224,959 | $3,988,895 |
| Net Income (Consolidated) | $850,160 | $3,243,367 |
| Net Income Attributable to KKR & Co. L.P. | $29,907 | $143,743 |
| Earnings Per Unit (Basic & Diluted) | $0.15 | $0.70 |
| Total Assets | $33,816,937 | $33,816,937 |
| Debt Obligations | $1,292,639 | $1,292,639 |
| Cash and Cash Equivalents | $491,857 | $491,857 |
Note: Consolidated Net Income is significantly higher than Net Income Attributable to KKR due to the consolidation of funds where the majority of economic interest belongs to noncontrolling interests.
Material Changes vs. Prior Period
- Revenue Growth: Fees increased 69% year-over-year for the quarter ($87.1M vs. $51.5M) and 113% for the six months ($193.1M vs. $90.6M). This was driven by higher transaction fees (including a $5.5M non-recurring break-up fee) and increased capital markets activity.
- Expense Surge: Total expenses rose 341% for the quarter and 341% for the six months compared to 2009. The primary driver was non-cash equity-based compensation charges ($296M for the quarter) and allocations to the carry pool, resulting from the post-transaction compensation structure.
- Investment Income Volatility: Net gains from investment activities decreased 54% for the quarter ($1.0B vs. $2.2B) due to lower unrealized gains compared to the prior year. However, for the six-month period, investment income increased 151% ($4.0B vs. $1.6B) driven by higher realized gains and unrealized appreciation.
- Debt Reduction: Debt obligations decreased to $1.29 billion from $2.06 billion at year-end 2009, reflecting paydowns under credit agreements.
Guidance, Outlook, and Risks
Management Commentary: Management highlights a disciplined investment process and alignment with investors. The firm reported $54.4 billion in Assets Under Management (AUM) as of June 30, 2010. Fee-paying AUM decreased slightly to $41.6 billion due to foreign exchange adjustments and redemptions in liquid credit accounts, offset by new capital raised.
Outlook: KKR intends to make quarterly cash distributions representing substantially all cash earnings of the asset management business. The firm expects to fund future capital commitments with available cash and proceeds from realizations.
Risks and Contingencies:
- Clawback Obligations: KKR has a contingent clawback obligation of $61.5 million based on fair values as of June 30, 2010 (up to $689.2 million if funds were liquidated at zero value). Principals remain responsible for pre-transaction clawbacks up to $223.6 million.
- Net Loss Sharing: A contingent obligation of approximately $21.8 million exists based on fair values (up to $1.1 billion if liquidated at zero value) to fund 20% of net losses in certain funds.
- Legal Proceedings: KKR is involved in various litigation, including antitrust investigations by the DOJ, shareholder derivative actions regarding PRIMEDIA, and class actions regarding KKR Financial Holdings (KFN). Management believes these actions are without merit.
- Valuation Risk: Approximately 70.6% of investments are Level III (unobservable inputs), requiring significant management judgment. A 10% decrease in fair value of private equity investments would materially impact net gains.
Investor Verification Checklist
- Noncontrolling Interest Allocation: Verify the split between consolidated net income and the portion attributable to KKR & Co. L.P. (approx. 30% of Group Partnerships), as consolidated figures are inflated by fund assets.
- Equity Compensation Impact: Assess the sustainability of earnings given the significant non-cash equity-based charges ($321M for six months) recorded in 2010 versus 2009.
- Carried Interest Realization: Monitor the realization of carried interest, which is recognized on an unrealized basis but subject to clawback provisions if future fund performance declines.
- Debt Covenants: Confirm continued compliance with debt covenants, particularly regarding the borrowing base of the Principal Credit Agreement.
- Legal Exposure: Track the status of the DOJ antitrust investigation and the KFN-related litigation for potential financial impact.