KKR & Co. L.P. — Q1 2014 Form 10-Q
Reporting period: Three months ended March 31, 2014; filed May 6, 2014. KKR is a global alternative investment manager with private equity, real assets, credit, hedge fund and capital markets businesses. Consolidated GAAP results include funds and CLOs in which outside investors hold most of the economic interests, so consolidated totals are not equivalent to earnings or assets attributable to KKR.
Key financial metrics
| Metric | Q1 2014 | Q1 2013 | Change / context |
|---|---|---|---|
| Fees | $302.9 million | $151.2 million | Up 100%, driven mainly by transaction fees. |
| Total expenses | $473.2 million | $439.3 million | Up $33.9 million; higher general, administrative and other costs were the main driver. |
| Net gains from investment activities | $2.0 billion | $2.3 billion | Lower by $297.6 million; predominantly private equity gains, including unrealized marks. |
| Income before taxes | $2.026 billion | $2.108 billion | Down about 4%. |
| Net income attributable to KKR | $210.0 million | $193.4 million | Up 9%; higher KKR ownership of the Group Partnerships contributed. |
| Net income per common unit | $0.72 basic; $0.65 diluted | $0.75 basic; $0.69 diluted | Per-unit earnings declined despite higher attributable net income, reflecting a larger unit count. |
| Fee related earnings (non-GAAP) | $151.7 million | $88.0 million | Up 72%; segment fee-related earnings margin was about 46% of segment fees, versus about 40%. |
| Economic net income (non-GAAP) | $630.3 million | $647.7 million | Down 3%. |
| Total distributable earnings (non-GAAP) | $446.8 million | $290.6 million | Up 54%, with higher fees, realized cash carry and realized principal investment income. |
| Operating cash flow | $(903.4) million | $1.510 billion | Negative, chiefly reflecting investment purchases exceeding sale proceeds in consolidated funds and CLOs. |
| Cash and cash equivalents | $1.325 billion | $1.306 billion at Dec. 31, 2013 | Separately, segment cash and short-term investments were about $2.1 billion. |
| Total assets / total liabilities | $56.4 billion / $6.9 billion | $51.4 billion / $4.8 billion at Dec. 31, 2013 | Growth reflects, in part, Avoca acquisition and consolidated CLO balances. |
| Debt obligations | $3.242 billion carrying value | $1.909 billion at Dec. 31, 2013 | Includes $1.153 billion of newly consolidated CLO debt; such CLO debt is supported by CLO assets, not KKR’s general assets. |
| AUM / fee-paying AUM | $102.3 billion / $83.6 billion | Prior-period comparable total not clearly stated in the filing excerpt | Segment AUM: Private Markets $60.5 billion; Public Markets $41.8 billion. |
Material changes and operating performance
- Fees more than doubled, principally as Private Markets transaction fees rose with larger and more numerous deals. KKR reported eight fee-generating Private Markets investments with combined transaction value of about $8.5 billion, versus six totaling about $0.8 billion in Q1 2013.
- Private Markets fee-related earnings increased to $53.6 million from $40.7 million; Public Markets rose to $53.6 million from $37.2 million; and Capital Markets and Principal Activities rose to $44.5 million from $10.1 million.
- Investment gains remained substantial but declined year over year. Private equity fair value increased approximately $1.8 billion during the quarter; investment gains included both realizations and significant unrealized valuation changes.
- Private Markets AUM decreased to $60.5 billion from $61.2 billion at year-end, as $2.2 billion of distributions outweighed new capital and portfolio appreciation. Public Markets AUM rose to $41.8 billion from $33.1 billion, primarily due to Avoca and new fundraising.
- KKR’s investment portfolio totaled $51.4 billion fair value at quarter-end. About 74% of investments measured at fair value were Level III, dependent on significant unobservable valuation inputs. Alliance Boots was a $4.8 billion investment and exceeded 5% of total investments.
Outlook, management commentary, risks and unusual items
- Avoca: KKR acquired the European credit manager on February 19 for $83.3 million in cash and $56.5 million in exchangeable securities. Avoca added approximately $8.2 billion of AUM. Purchase accounting recorded a $13.0 million gain; Avoca contributed $5.5 million of fees and $(0.7) million of net income attributable to KKR from acquisition through quarter-end.
- KFN: The merger closed April 30, after the reporting date, and issued 104.3 million KKR common units. KKR expected future Public Markets AUM and FPAUM to exclude $7.5 billion and $2.7 billion, respectively, related to KFN and certain CLOs; it also expected to earn investment income from KFN rather than report management and incentive fees from it. Purchase accounting and possible consolidation of certain KFN vehicles were still under evaluation.
- Near-term fee pressures: European Fund III’s investment period ended March 31, reducing its fee rate and changing its fee base; KKR expected lower fees beginning in Q2. Energy Future Holdings filed for Chapter 11 on April 29; KKR said it did not expect to collect approximately $3 million of quarterly management fees associated with its investment going forward. KKR reported its EFH investment at zero carrying value at March 31.
- Distribution: KKR announced a $0.43 per common unit distribution on April 24, payable May 23 to holders of record May 9. Management described its distribution policy as targeting substantially all cash earnings of the investment management business plus 40% of net realized principal investment income, subject to board discretion and other needs. The filing gave no formal earnings guidance.
- Liquidity and commitments: KKR stated that its liquidity sources should cover working capital needs for at least 12 months. It had $1.25 billion of revolving credit availability, with no borrowings outstanding under the facilities at quarter-end (other than a letter of credit). KKR had $1.02 billion of uncalled commitments to active funds and a further $479.8 million of capital-markets and other commitments; it had also earmarked approximately $850 million for new strategies and initiatives.
- Contingencies: At quarter-end, management estimated approximately $37.5 million of aggregate losses for matters where loss was considered probable and reasonably estimable, while noting outcomes could differ and other litigation losses could not be estimated. No carry was subject to clawback based on quarter-end fair values, but a zero-value liquidation scenario implied a $1.451 billion clawback; a separate net-loss-sharing obligation would be about $469.9 million in that stress scenario. KKR reported no net-loss-sharing obligation based on quarter-end values.
- Business risks: Management highlighted uncertain global growth, interest-rate and foreign-exchange movements, volatile transaction and exit activity, credit-market conditions, commodity prices and the substantial judgment involved in Level III valuations. KKR cautioned that transaction fees, carried interest, realized gains and distributions can vary sharply between periods.
- Debt covenants were reported as materially complied with. Approximately $72 million of cash at regulated broker-dealer entities could be restricted from dividends or advances. Disclosure controls were deemed effective; Avoca’s internal controls were still being evaluated and excluded from the quarter-end assessment.
Most important facts for investors to verify
- How the KFN acquisition’s purchase accounting, debt, asset consolidation and 104.3 million-unit issuance affect pro forma leverage, earnings per unit, distributions and reported AUM.
- Whether the rise in fees and distributable earnings is sustained, given deal-related volatility, European Fund III’s lower fee base and the expected loss of EFH-related fees.
- The composition and sensitivity of investment gains: fair values rely heavily on Level III inputs, and a significant share of reported gains was unrealized.
- Liquidity available to KKR itself versus consolidated funds and CLOs, and the timing of fund, capital-markets, tax receivable agreement and other commitments.
- Potential exposure to KFN’s below-investment-grade credit and real-asset portfolio, litigation, and carry clawback or net-loss-sharing contingencies.
- That reported consolidated cash flows and balance-sheet totals include fund and CLO activity and should not be read as wholly attributable to KKR.