KKR & Co. L.P. — FY2017 Form 10-K
Reporting period: Fiscal year ended December 31, 2017. The filing is for KKR & Co. L.P. (NYSE: KKR), a global alternative investment manager—not a separate “KKR & Co. Inc.” The filing was signed February 23, 2018. KKR reports four segments: Private Markets, Public Markets, Capital Markets and Principal Activities.
Financial performance and key metrics
| Metric | FY2017 | FY2016 |
|---|---|---|
| Fees and other (GAAP) | $3.282 billion | $1.908 billion |
| Total expenses (GAAP) | $2.337 billion | $1.695 billion |
| Total investment income (GAAP) | $1.839 billion | $762.6 million |
| Net income attributable to common unitholders | $984.9 million | $287.1 million |
| Diluted earnings per common unit | $1.95 | $0.59 |
| Economic net income (ENI; non-GAAP, segment basis) | $2.435 billion | $794.4 million |
| Fee-related earnings (FRE; non-GAAP) | $866.6 million | $537.4 million |
| After-tax distributable earnings (non-GAAP) | $1.560 billion; $1.91 per adjusted unit | $1.528 billion; $1.89 per adjusted unit |
Revenue and earnings comparisons reflect substantial growth, driven by higher carried interest, transaction fees and investment gains. FY2017 GAAP investment gains included $1.165 billion of net unrealized gains; the year’s $1.203 billion total net investment gain also included $38.3 million of realized gains. Carried interest recognized in GAAP fees and other rose to $1.741 billion from $803.2 million. Results are volatile and include unrealized marks; consolidated statements also include certain funds and financing entities, with third-party interests separately presented.
- Cash flow: Operating cash flow was negative $3.630 billion, investing cash flow was positive $57.7 million, and financing cash flow was positive $2.940 billion. Operating cash flow is heavily affected by investment purchases and sales at consolidated entities and is not a clean measure of cash generated by KKR’s management business.
- Liquidity and debt: GAAP cash and cash equivalents were $1.877 billion; GAAP debt obligations were $21.194 billion. These GAAP figures include consolidated funds/CLOs. On a segment basis, cash and short-term investments were $3.215 billion and debt obligations were approximately $2.765 billion for KKR and KFN, with $373.8 million of KFN preferred shares also reported. KFN’s obligations are generally non-recourse to KKR beyond KFN assets. KKR also had an undrawn $1.0 billion corporate revolving facility maturing in 2019.
- Balance sheet: GAAP assets were $45.835 billion, liabilities $25.172 billion and KKR & Co. L.P. partners’ capital $7.186 billion. Segment book value was $11.674 billion, or $14.20 per outstanding adjusted unit; this is a non-GAAP presentation and is not directly comparable with GAAP partners’ capital.
- Assets under management: Private Markets AUM was $97.5 billion and FPAUM $61.7 billion; Public Markets AUM was $70.9 billion and FPAUM $55.8 billion. Private Markets AUM increased $23.7 billion and Public Markets AUM increased $15.2 billion year over year. Private Markets had $47.4 billion and Public Markets $9.1 billion of uncalled commitments.
- Activity and distributions: KKR raised $38.7 billion of new AUM, invested $18.4 billion of capital and syndicated $4.7 billion in 2017. The regular common-unit distribution rose to $0.17 quarterly from $0.16; the $0.17 distribution for the December 2017 quarter was declared in February 2018.
Material changes versus the prior period
- Private Markets ENI increased to $1.296 billion from $667.0 million, mainly on higher carried interest and fees. Its AUM grew to $97.5 billion from $73.8 billion.
- Public Markets ENI increased to $325.6 million from $228.3 million. AUM rose to $70.9 billion from $55.7 billion, despite redemptions and distributions, supported by fundraising, value gains and transactions.
- Capital Markets ENI rose to $330.1 million from $132.2 million as transaction fees and activity increased. The business completed 193 transactions versus 117 in 2016.
- Principal Activities reported ENI of $483.7 million versus a $233.1 million loss, reflecting a return to net investment gains. First Data’s share-price increase contributed approximately $238 million to 2017 segment ENI.
- GAAP comparisons are affected by the 2016 adoption of a consolidation accounting standard that deconsolidated most investment funds; the filing states prior periods were not retrospectively adjusted. This makes some reported revenue and balance-sheet comparisons less comparable.
Outlook, commentary, risks and unusual items
- KKR says earnings are highly variable and does not intend to provide earnings guidance. It cites strong 2017 investment, fundraising and transaction activity, but does not provide quantified forward guidance.
- Management’s market discussion noted economic growth and positive equity and credit markets in 2017, while warning that rising U.S. rates, market volatility, weaker credit conditions, currency moves and commodity prices could affect valuations, financing, realizations and fundraising.
- The Tax Cuts and Jobs Act produced a provisional $97.9 million 2017 tax expense, including deferred-tax remeasurement and a transition tax estimate. KKR said the accounting was incomplete and could change. Management also disclosed that it was evaluating a possible conversion from partnership to corporation; a conversion could affect taxes, distributions, costs and unitholders.
- KKR completed the PAAMCO/KKR Prisma combination in June 2017, retaining a 39.9% interest in PAAMCO Prisma, and acquired an additional 5% interest in Marshall Wace in November. A proposed strategic BDC partnership with FS Investments remained subject to approvals and closing conditions.
- Carried interest is subject to fund hurdles, netting holes and clawbacks. The estimated clawback obligation was $19.2 million assuming relevant funds were liquidated at year-end fair values; it would have been $1.921 billion if those investments were liquidated at zero value.
- A lawsuit filed in December 2017 in Kentucky alleges fiduciary and other duty violations relating to separately managed accounts for Kentucky Retirement Systems and names KKR, its co-CEOs and other parties. KKR said it could not estimate a loss range for relevant proceedings; management had not concluded that resolution would materially affect the financial statements.
- Valuation risk is significant: 53.9% of fair-value investments were Level III, relying on unobservable inputs and management judgment. Independent valuation firms reviewed certain investments, but not all Level III valuations were independently reviewed quarterly.
- The independent auditor issued an unqualified opinion and reported effective internal control over financial reporting as of December 31, 2017.
Most important facts for investors to verify
- Reconcile the drivers and sustainability of GAAP earnings, ENI, FRE and distributable earnings, particularly unrealized valuations and carried interest.
- Review liquidity on a segment basis, corporate and KFN debt maturities, capital commitments, underwriting exposures and the extent to which consolidated fund debt is non-recourse.
- Assess Level III valuation assumptions, concentrated balance-sheet investments and sensitivity to market, interest-rate, currency and energy-price changes.
- Track fundraising, FPAUM conversion into fees, redemption levels, investment deployment and realization activity; distinguish recurring fees from transaction and performance income.
- Monitor the tax-law impacts, any partnership-to-corporation decision, the tax receivable agreement, pending litigation, clawback exposure and the status of the proposed FS Investments partnership.
- Consider dilution and governance: KKR Holdings held approximately 40.9% of the KKR Group Partnerships at year-end, and common-unit holders have limited voting rights under the partnership structure.