KKR & Co. Inc. quarterly report, Q2 FY2020

KKR & Co. Inc. — Q2 2020 Form 10-Q

Reporting period: Three and six months ended June 30, 2020. Amounts below are U.S. dollars. GAAP results consolidate investment funds and collateralized financing entities (CFEs), including assets and liabilities that are generally not available to KKR and are non-recourse to it; the filing also presents non-GAAP measures that exclude these entities.

Business context and financial performance

KKR is a global alternative investment manager with private markets, public markets, capital markets and principal investment activities. It earns management and transaction fees, carried interest and investment income. At June 30, 2020, AUM was $221.8 billion, fee-paying AUM $160.3 billion and uncalled commitments $66.8 billion.

Metric	Q2 2020	Q2 2019	Six months 2020	Six months 2019
GAAP total revenue	$1.332bn	$1.180bn	$330.5m	$2.367bn
Net income (loss) attributable to KKR	$707.0m	$522.7m	$(573.6)m	$1.232bn
Common-stock EPS, diluted	$1.24	$0.93	$(1.06)	$2.20
After-tax distributable earnings, non-GAAP	$325.6m	$327.3m	$680.9m	$641.4m

Q2 GAAP revenue and earnings improved year over year as investment values rebounded, while fees and other revenue fell to $393.5 million from $519.4 million, mainly on lower transaction fees. Capital allocation-based income was $938.5 million in Q2, versus $660.4 million a year earlier. For the first half, GAAP revenue and profit fell sharply: capital allocation-based income was a loss of $443.6 million, and net investment losses were $2.464 billion, versus gains of $2.242 billion in 2019. The first-half loss primarily reflected COVID-19-related market depreciation and reversals of previously recognized carried interest.

Non-GAAP distributable operating earnings were $449.1 million in Q2 and $921.3 million for the first half; the corresponding margins were approximately 50.4% and 50.2%, calculated as distributable operating earnings divided by distributable revenues. After-tax distributable earnings were nearly flat year over year in Q2 and rose 6% for the first half. These non-GAAP measures are not substitutes for GAAP results.

Balance sheet, cash flow and liquidity

At June 30, total assets were $62.1 billion, investments $54.4 billion, total liabilities $32.7 billion and total equity $29.4 billion. KKR common-stockholders’ equity per outstanding share was $16.94, down from $18.44 at year-end 2019. Non-GAAP book value per adjusted share was $17.73, down from $19.24.
GAAP debt obligations were $28.7 billion, up from $27.0 billion at December 31. This total includes substantial fund and CFE borrowing; $17.7 billion was attributable to consolidated VIEs whose creditors generally have no recourse to KKR’s general assets. KKR reported compliance with material debt covenants.
Cash and cash equivalents were $2.45 billion. Cash including amounts held at consolidated entities and restricted cash totaled $3.74 billion, but fund-held cash is generally unavailable for KKR’s general liquidity needs. KKR also reported $1.0 billion available under its corporate revolver.
For the first half, operating cash flow was $(2.74) billion, investing cash flow $(75.6) million and financing cash flow $3.32 billion; cash, cash equivalents and restricted cash increased $501.2 million. Consolidated operating cash flow includes investment purchases and sales by funds and CFEs, so it is not a direct measure of corporate cash generation.
Non-GAAP book liabilities were $5.77 billion, including $3.86 billion of KKR debt excluding KFN and $949 million of KFN debt. The filing does not provide a single directly comparable “corporate-only” GAAP debt figure.

Material changes and operating trends

Market recovery drove Q2 gains: net gains from investment activities were $1.481 billion, including $1.811 billion of unrealized gains. The first half nevertheless recorded $2.196 billion of unrealized losses.
Q2 private-markets AUM rose to $124.8 billion from $114.1 billion at March 31, supported by new fundraising and higher portfolio values. Public-markets AUM rose to $96.9 billion from $93.0 billion over the same quarter, though first-half public-markets AUM declined from $99.1 billion at year-end.
First-half fee and other revenue declined $117.9 million year over year, largely because transaction fees fell $232.6 million; management fees rose $47.9 million. Capital markets transaction fees were $129.6 million versus $219.3 million in the first half of 2019.
KKR issued $500 million of 3.625% notes due 2050 and an additional $250 million of 3.750% notes due 2029 during 2020. First-half debt proceeds were $7.01 billion and repayments $4.73 billion.
KKR completed an internal reorganization on January 1, 2020, acquired KKR Capstone, and reclassified certain share classes effective May 8. These changes affect structure and presentation; KKR states Capstone had already been consolidated for GAAP purposes.

Outlook, risks and unusual items

Management said it could not reasonably predict the ultimate impact of COVID-19. Risks include further portfolio markdowns, defaults and impairments, delayed exits, fundraising constraints, lower transaction activity, liquidity pressure at portfolio companies and borrowers, and operational and cybersecurity risks from remote work. Q2 market recovery does not remove the risk of renewed declines.
Fair value estimates are particularly judgment-sensitive: 54.9% of investments measured at fair value were Level III at June 30. KKR cautioned that actual liquidation values may differ materially and future valuations could change substantially.
KKR recorded an $88.3 million impairment charge in Q2 on an equity-method investment after reducing its growth outlook and estimated fair value.
KKR agreed to acquire Global Atlantic, a life and retirement insurer, in a transaction announced in July and expected to close in early 2021, subject to approvals and other conditions. Global Atlantic’s June 30 GAAP equity, excluding accumulated other comprehensive income, was approximately $4.4 billion. KKR expects a mix of cash, possible seller rollovers, minority co-investors and new debt and/or equity; required financing and rollover amounts were not yet known. The acquisition could reduce available liquidity, and regulatory conditions or integration costs could limit expected benefits.
At June 30, KKR had $6.155 billion of unfunded commitments to active funds, plus $200 million of investment-purchase commitments and $461.3 million of capital-markets underwriting and financing commitments. Approximately $100 million of carried interest was subject to clawback at reported fair values, including $60 million attributable to KKR; a zero-value liquidation scenario would imply approximately $2.5 billion of clawback in total, of which $1.5 billion would be KKR’s obligation.
KKR disclosed a new $100 million contingent guarantee for a revolving facility of a managed public-markets fund; no amount had been funded, and KKR considered funding remote. A Kentucky-related lawsuit and regulatory inquiries remain potential legal risks; management said it could not estimate a loss range for the matters discussed.
No specific earnings guidance was provided. The board declared a $0.135 common dividend for payment in September 2020; future common dividends remain discretionary. KKR increased its repurchase authorization to $500 million, repurchased no common shares in Q2 and retired 1.73 million equity awards during the quarter.

Important facts for investors to verify

How much of KKR’s reported cash and debt is attributable to KKR itself versus consolidated funds, CFEs and KFN, and what cash is actually available for corporate uses.
Whether portfolio marks and carried-interest accruals are realized, especially given the large Level III valuation exposure and the first-half reversal in investment income.
Global Atlantic’s final purchase consideration, seller rollover and co-investor participation, financing mix, regulatory conditions, closing timing and effect on liquidity and leverage.
Fundraising, fee-paying AUM, transaction activity and realizations, including the extent to which Q2’s market rebound persists or reverses.
Potential funding of commitments, clawbacks, guarantees and legal contingencies, along with the sustainability of dividends and repurchases.