KKR & Co. L.P. — Q2 2012 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2012. Amounts below are in U.S. dollars; financial-statement amounts are rounded to millions unless noted. KKR is a global investment firm spanning Private Markets, Public Markets, and Capital Markets and Principal Activities. Its consolidated statements include investment funds whose results are substantially attributable to noncontrolling interests, so consolidated totals are not equivalent to earnings retained by KKR.
Financial highlights
| Metric | Q2 2012 | Q2 2011 | Six months 2012 | Six months 2011 |
|---|---|---|---|---|
| Consolidated fees | $112.4m | $117.6m | $228.7m | $349.5m |
| Total expenses | $348.7m | $331.3m | $794.0m | $755.0m |
| Net gains from investment activities | $1,601.7m | $1,319.1m | $4,688.6m | $3,806.3m |
| Consolidated net income | $1,505.1m | $1,182.4m | $4,477.1m | $3,499.8m |
| Net income attributable to KKR & Co. L.P. | $146.3m | $39.6m | $336.7m | $199.2m |
| Diluted earnings per common unit | $0.58 | $0.18 | $1.37 | $0.92 |
| Distributions declared per common unit | $0.13 | $0.11 | $0.28 | $0.32 |
- Revenue and operating earnings: Q2 consolidated fees fell 4% year over year; first-half fees fell 35%, largely because the prior year included substantial one-time monitoring-fee termination payments and higher transaction and incentive fees. Segment fee-related earnings (FRE), a non-GAAP measure, were $69.8m in Q2 versus $76.1m, and $143.1m for the half versus $202.3m. Q2 FRE was about 37% of segment fees of $188.5m, compared with about 39% a year earlier; these are non-GAAP segment figures, not consolidated margins.
- Investment performance: Higher private-equity appreciation and larger dividends drove gains. Q2 dividend income was $79.9m versus $31.2m; first-half dividend income was $252.9m versus $36.0m, including a $168.9m HCA dividend. Q2 investment gains included $1.42bn of realized gains and $146.5m of unrealized gains; valuations and realizations can reverse in later periods.
- Assets under management: Total AUM was $61.5bn at June 30. Private Markets AUM was $45.5bn and fee-paying AUM (FPAUM) $37.9bn; Public Markets AUM was $16.0bn and FPAUM $9.3bn. KKR reported a $3.0bn first close on Asian Fund II during Q2, not yet included in reported AUM under its definition.
- Cash flow and liquidity: For the first half, consolidated operating cash flow was $2.74bn, investing cash flow $39.0m, and financing cash outflow $2.88bn; cash and cash equivalents declined $104.3m to $739.0m. These cash flows include consolidated funds and are heavily affected by fund investment purchases, sales, contributions, and distributions. KKR reported $1.206bn of segment cash and short-term investments, a management liquidity measure that differs from GAAP cash.
- Debt: Consolidated debt obligations were $1.121bn at June 30, down from $1.565bn at year-end, chiefly following repayments. This includes fund-level financing; KKR’s segment balance sheet showed $500m of Senior Notes. The $500m notes bear 6.375% interest and mature in 2020. Corporate and capital-markets revolving credit facilities had no borrowings outstanding at quarter-end.
- Other balance-sheet measures: Total assets were $42.61bn, investments $40.44bn, and total equity $39.44bn. Approximately 66% of investments measured at fair value were Level III, involving significant unobservable inputs. KKR reported $457.6m of redeemable noncontrolling interests.
Material changes and management commentary
- KKR-attributable Q2 net income rose to $146.3m from $39.6m; for the first half it increased to $336.7m from $199.2m. The improvement primarily reflects investment gains, not stronger fee revenue. Consolidated net income is mostly allocated to noncontrolling interests.
- Private Markets first-half FRE declined to $74.0m from $128.4m, principally due to lower monitoring and transaction fees after unusually large prior-year termination fees. Public Markets first-half FRE fell to $27.7m from $35.3m, mainly due to lower incentive fees at KFN. Capital Markets and Principal Activities first-half FRE increased to $41.5m from $38.6m.
- Management described global conditions as volatile: European sovereign-debt concerns and austerity, slower Asian growth, and uncertainty around U.S. fiscal tightening could weigh on growth and transaction activity. KKR said transaction volume declined in the first half, tending to reduce fees. Equity, credit, interest-rate, and commodity-market movements affect investment values, realizations, and portfolio-company financing.
- KKR completed a strategic sale of 45% of its Alliance Boots interest on August 2, 2012, after quarter-end; the buyer may, but need not, acquire the remaining 55%. The sale helped fill a netting hole in one vehicle and enabled carried-interest distributions there; it did not eliminate the netting hole in the 2006 Fund.
- KKR agreed to acquire Prisma Capital Partners, with approximately $7.8bn of AUM as of April 1, 2012. Closing was expected in Q4 2012, subject to customary conditions; the initial price is payable in cash, with possible additional payments tied to 2014 and 2017 performance metrics.
- After quarter-end, KKR and Stone Point Capital formed a capital-markets joint venture, each committing $150m. KKR announced a $0.13-per-unit distribution payable August 21, 2012 to holders of record August 6.
- Unfunded commitments included $594.5m to active investment vehicles, $370.0m to funds whose investment periods had not begun, $103.1m of lending commitments, and $96.3m to other strategies. KKR had also earmarked about $550m for new strategies and initiatives, subject to revision or cancellation.
Risks, contingencies, and unusual items
- Carried interest is estimated using fund fair values as though investments were realized at the reporting date and may be reversed if performance deteriorates. Fee refunds to fund investors may also reduce future revenue; approximately $49m was potentially refundable, with no liability recorded for amounts not yet triggered.
- At June 30 fair values, KKR reported no clawback or net-loss-sharing obligation. Under a zero-value liquidation stress scenario, potentially affected carried interest subject to clawback was $885.7m, and net-loss-sharing exposure was approximately $886.8m. These are contingent scenarios, not amounts then due.
- KKR disclosed multiple legal and regulatory matters, including the Bruno’s, Primedia, private-equity antitrust, Del Monte, and sovereign-wealth-fund matters. For matters considered probable and reasonably estimable, estimated aggregate KKR losses were approximately $32.5m, which management believed may be partly or wholly covered by insurance or indemnity; outcomes remain uncertain.
- Level III valuations rely on models and management judgments, including comparable-company multiples, discount rates, and illiquidity discounts. KKR stated that a 10% immediate decline in fund investment fair values would generally cause a comparable change in investment gains, with carried interest potentially more affected; KKR’s own attributable earnings impact would be lower because of noncontrolling interests.
- KKR said it was in material compliance with debt covenants, had effective disclosure controls, and expected available liquidity to meet working-capital requirements for at least 12 months. No formal earnings guidance was provided.
Important facts for investors to verify
- How much of reported earnings and cash generation is attributable to KKR itself versus consolidated funds and other noncontrolling interests.
- Whether investment gains, dividends, and carried interest convert to realized cash, and how much remains exposed to Level III valuation assumptions or possible carry reversals.
- The sustainability of fee revenue and FRE after the prior-year termination-fee comparison, alongside fund fundraising, redemptions, and deployment activity.
- Completion and economics of the Prisma acquisition, the Alliance Boots transaction and any remaining-stake sale, and the Stone Point joint venture.
- Funding requirements for commitments and potential changes in clawback, net-loss-sharing, litigation, and regulatory exposures.
- Distribution capacity and policy: declared distributions are discretionary, and total distributable earnings is not a calculation of actual distributions.