Business context and reporting period
KKR & Co. L.P. is a global investment firm spanning private equity, real assets, credit, hedge funds and capital markets. This unaudited Form 10-Q covers the quarter and six months ended June 30, 2014; comparisons are with the corresponding 2013 periods. Results consolidate managed funds and CLOs, so reported assets, debt, income and cash flows include substantial amounts attributable to noncontrolling investors.
Major changes to the business include the April 30 acquisition of KKR Financial Holdings (KFN), funded with 104.3 million KKR common units, and the February acquisition of Avoca Capital. KFN provided more than $2 billion of permanent equity capital; KKR’s ownership of the KKR Group Partnerships increased.
Key financial metrics
Amounts below are in millions, except per-unit data. Figures are consolidated GAAP unless identified otherwise.
| Metric | Q2 2014 | Q2 2013 | Six months 2014 | Six months 2013 |
|---|---|---|---|---|
| Fees | $249.4 | $166.4 | $552.3 | $317.6 |
| Net gains from investment activities | $1,971.9 | $98.5 | $3,944.0 | $2,368.4 |
| Total expenses | $585.3 | $292.0 | $1,058.5 | $731.4 |
| Income before taxes | $2,058.7 | $285.8 | $4,084.5 | $2,393.3 |
| Net income attributable to KKR & Co. L.P. | $178.2 | $15.1 | $388.3 | $208.6 |
| Diluted net income per common unit | $0.43 | $0.05 | $1.06 | $0.72 |
| Economic net income (non-GAAP; total segments) | $501.6 | $144.4 | $1,131.8 | $792.2 |
Quarterly GAAP investment income also included dividends of $272.9 million, interest income of $215.9 million and interest expense of $66.0 million. Fee-related earnings, a non-GAAP measure, were $93.7 million in Q2 2014 versus $98.2 million in Q2 2013. Management’s distribution calculation showed total distributable earnings of $701.0 million for Q2 and $1,147.8 million for the first half; these measures are not GAAP earnings or a guarantee of distributions.
For the six months, operating cash flow was $1,867.1 million, investing cash flow was $147.7 million and financing cash flow was negative $816.9 million; cash and cash equivalents increased by $1,197.8 million to $2,504.2 million. These cash-flow figures include consolidated funds and CLOs and are not a direct measure of cash generated by KKR’s management business.
At June 30, total assets were $65.6 billion and total liabilities were $13.9 billion. Debt obligations were $10.6 billion, including $7.4 billion of consolidated CLO debt. KKR reported $3.4 billion of segment cash and short-term investments, including approximately $0.9 billion of short-term investments; GAAP cash and cash equivalents were $2.5 billion. CLO debt is secured by the related CLO assets, and KFN debt is generally non-recourse beyond KFN. KKR said it expected available liquidity to cover working-capital requirements for at least 12 months.
Private Markets AUM was $59.4 billion and fee-paying AUM was $46.2 billion; Public Markets AUM was $38.5 billion and fee-paying AUM was $33.5 billion at June 30. KKR’s segment balance-sheet book value was $10.4 billion, or $12.52 per adjusted unit. These are management-defined, non-GAAP measures.
Material changes versus the prior comparable period
- Q2 fees increased 50% year over year, mainly from newly consolidated oil and gas revenue, higher management fees and transaction activity. First-half transaction fees benefited from 16 fee-generating Private Markets investments totaling approximately $10.5 billion in transaction value, compared with 12 totaling $3.3 billion in 2013.
- Q2 investment gains rose sharply, driven chiefly by private equity realizations and fair-value changes. Private equity generated $1.9 billion of net gains in Q2; KKR cited gains in the 2006 Fund, European Fund III and North America Fund XI, with gains on Alliance Boots and Biomet among notable portfolio contributors. First-half private-equity net gains were $3.6 billion.
- Higher carried interest and investment gains contributed to higher compensation, including carry-pool allocations. Expenses also rose with acquired operations, oil and gas costs, professional fees and increased litigation accruals. Q2 GAAP expenses more than doubled year over year.
- Q2 GAAP net income attributable to KKR increased to $178.2 million from $15.1 million. The comparison reflects stronger investment results and an increased KKR ownership share of the KKR Group Partnerships; most consolidated net income remained attributable to noncontrolling interests and appropriated capital.
- Debt rose substantially from year-end, primarily reflecting KFN and consolidated CLO debt, as well as KKR’s May issuance of $500 million of 5.125% senior notes due 2044. The acquisitions also changed the comparability of operating results and balance-sheet measures.
Outlook, commentary, risks and unusual items
- The filing provides no quantified earnings or revenue guidance. Management described uneven global growth, elevated economic and market uncertainty, tightening credit spreads and volatile transaction activity. It noted that lower transaction or realization activity could reduce fees, carried interest and distributions; it also said committed capital decreased in the quarter, the first decline in several quarters.
- Investment valuations are a central risk: 68% of investments measured at fair value were Level III, using significant unobservable inputs. Management cautioned that valuation assumptions may differ materially from eventual realization values and that market, interest-rate, credit-spread, foreign-exchange and commodity movements can affect valuations and results.
- Fair-value changes and carried interest can reverse. Carried interest is recognized as if funds were liquidated at reporting-date values; no carry was subject to clawback using those values, but a zero-value liquidation scenario would imply a $1.9 billion clawback. Certain funds also had a potential $431.7 million net-loss-sharing obligation in a zero-value scenario.
- KKR cited a $75 million estimated aggregate loss for matters where a loss was considered probable and reasonably estimable, up from $37.5 million; the estimate is judgmental and outcomes may differ. KKR signed a July 28 agreement to settle the private-equity antitrust litigation, subject to court approval, and did not expect the payment to materially affect results. Other litigation, including Primedia and KFN shareholder matters, remained pending; management said ultimate outcomes could be unpredictable.
- Acquisition accounting produced gains of $14.9 million for KFN and $13.0 million for Avoca, primarily related to fair values of CLO assets and liabilities. Acquisition-related costs were expensed. KFN’s post-acquisition results were included only from April 30.
- A $0.67-per-unit distribution was announced July 24, payable August 19 to holders of record August 4. Distributions remain subject to board discretion and may change. KKR also noted subsequent investments in First Data totaling approximately $1.2 billion across KKR and its consolidated funds.
Important facts for investors to verify
- How much of reported earnings and cash flow is attributable to KKR itself rather than consolidated funds, CLOs and other noncontrolling interests.
- Whether private-equity fair values, especially Level III valuations, are realized at amounts consistent with reported gains and carried interest.
- The ongoing effects of KFN and Avoca on fee-paying assets, earnings, debt, integration costs and KKR’s ownership and dilution.
- The composition and recourse of reported debt, available unrestricted liquidity, unfunded commitments and potential acquisition or underwriting cash needs.
- Developments in litigation and the $75 million estimated loss accrual, as well as any change in clawback or net-loss-sharing exposure.
- Whether distributions are supported by recurring fee and yield earnings or depend on variable realizations, carried interest and investment income.