KKR & Co. L.P. — Q1 2018 Form 10-Q
Reporting period: Three months ended March 31, 2018. The filing is by KKR & Co. L.P.; the company announced after quarter-end that it planned to convert to KKR & Co. Inc., effective July 1, 2018. Unless noted, financial amounts below are in U.S. dollars.
Business context and operating scale
KKR is a global alternative investment firm with private markets, public markets, capital markets and principal activities businesses. At March 31, 2018, reported segment AUM was $176.4 billion and fee-paying AUM was $119.7 billion. New capital raised was $10.6 billion in Q1, versus $8.5 billion a year earlier; capital invested was $3.7 billion versus $5.4 billion, and syndicated capital was $0.6 billion versus $1.2 billion.
Financial results and liquidity
| Metric | Q1 2018 | Q1 2017 |
|---|---|---|
| Total revenue | $472.6 million | $767.8 million |
| Net income | $602.9 million | $797.9 million |
| Net income attributable to KKR common unitholders | $170.1 million | $259.3 million |
| Basic / diluted earnings per common unit | $0.36 / $0.32 | $0.57 / $0.52 |
| Economic net income (ENI; non-GAAP) | $465.3 million | $668.5 million |
| Fee-related earnings (FRE; non-GAAP) | $223.4 million | $222.0 million |
| After-tax distributable earnings (non-GAAP) | $303.5 million ($0.37 per adjusted unit) | $346.5 million ($0.43 per adjusted unit) |
Fees and other revenue rose 3.7% to $394.4 million, but capital allocation-based income fell to $78.2 million from $387.6 million, primarily reflecting lower carried-interest and general-partner capital-interest gains. Total expenses were $436.6 million, down from $540.0 million, mainly because performance compensation was lower. Investment income was $584.5 million, compared with $610.7 million; net gains from investment activities were $472.8 million, including $442.4 million of unrealized gains.
Operating cash flow was a use of $2.16 billion, compared with a use of $1.15 billion in Q1 2017, largely reflecting investment purchases exceeding proceeds. Financing activities provided $1.22 billion. Cash, cash equivalents and restricted cash totaled $2.81 billion at quarter-end, down from $3.74 billion at year-end 2017; some cash held at consolidated entities is not available for KKR’s general liquidity needs.
Total assets were $47.58 billion and total liabilities $25.81 billion. Reported debt obligations were $22.04 billion, up from $21.19 billion; much of this is debt of consolidated funds and collateralized financing entities that is non-recourse to KKR or limited to the relevant entity’s assets. KKR’s segment balance sheet showed $2.51 billion of cash and short-term investments and $3.26 billion of KKR and KFN debt. KKR said it was in material compliance with debt covenants and had $1.0 billion available under its undrawn corporate credit agreement.
Changes versus the prior period
- Common-unitholder net income declined 34%, primarily because of lower carried interest and investment gains; ENI also declined, while FRE was broadly stable.
- Management fees increased to $187.7 million from $161.2 million. Transaction fees decreased to $158.7 million from $243.7 million, partly offset by lower fee credits.
- Private Markets AUM rose to $102.2 billion from $80.2 billion year over year; Public Markets AUM rose to $74.1 billion from $57.4 billion. Private Markets FPAUM increased to $61.5 billion and Public Markets FPAUM to $58.2 billion.
- The 2018 financial statements include a retrospective accounting presentation change: carried interest and general-partner capital interest are presented together as capital allocation-based income.
Outlook, material events and risks
- Conversion and distributions: KKR announced a planned conversion to a corporation effective July 1, 2018. It anticipated an initial annual dividend of $0.50 per share, compared with the partnership’s $0.68 annual distribution per common unit, subject to board discretion. Management expects corporate taxation to increase after-tax tax expense; its illustrative estimate of the Q1 effective tax rate had the company been a corporation was approximately 9%, versus the reported 2.84%.
- Tax receivable agreement: The recorded payable was $83.7 million. KKR expects payments relating to future exchanges to increase materially after conversion; the agreement generally provides for payment of 85% of realized tax savings.
- Subsequent events: The FS Investments BDC partnership closed April 9, 2018. KKR also reported the sale of its controlling interests in four consolidated CMBS vehicles; it expected second-quarter deconsolidation to reduce reported investments by about $4.1 billion and debt by about $4.0 billion.
- Commitments and contingencies: KKR reported $5.72 billion of unfunded commitments to its active investment vehicles, plus $275.1 million of principal-activities purchase commitments and $1.11 billion of capital-markets commitments. Carried-interest clawback exposure was $12.6 million assuming funds were liquidated at reported fair values, but approximately $1.8 billion under a zero-value liquidation scenario.
- Valuation and market risks: 55.3% of investments measured at fair value were Level III and rely on significant management judgment. KKR cited sensitivity to equity and credit markets, interest rates, foreign exchange and commodity prices. No material change in market risks was reported for the quarter.
- Legal matters: KKR disclosed litigation relating to Kentucky Retirement Systems and ongoing potential regulatory examinations and investigations. Management could not estimate a loss range and had not concluded that resolution would materially affect the financial statements, while noting an adverse outcome could affect results in a particular period.
- Guidance: The filing provides no quantified earnings guidance. Management said approximately $650 million of investment losses were expected to be realized in Q2 ahead of conversion; because the investments had largely been written down previously, it did not expect significant impact on total investment income or cash flows and expected to exclude the realized losses from Q2 distributable earnings.
Important facts for investors to verify
- Whether the planned July 1 conversion was completed as announced, and the resulting tax, governance and dividend arrangements.
- How much of Q1 investment gains and carried interest was realized in cash versus unrealized, and the sensitivity of Level III valuations to changed assumptions.
- The nature and recourse of reported debt, especially fund and CFE obligations, and the availability of cash held at consolidated entities.
- Funding needs and timing for unfunded commitments, underwriting exposures, clawbacks and tax-receivable-agreement payments.
- Whether the BDC partnership and CMBS deconsolidation produced the expected operating and balance-sheet effects.