KKR & Co. L.P. — Form 10-Q Summary
Reporting period: Quarter and nine months ended September 30, 2012. The filing is for KKR & Co. L.P., a global investment firm, and its consolidated subsidiaries. Consolidated results include investment funds in which outside investors hold most of the economic interests; accordingly, reported totals can differ substantially from amounts attributable to KKR.
Financial performance
| Metric | Three months ended September 30 | Nine months ended September 30 |
|---|---|---|
| Fees | $162.2 million, versus $164.8 million in 2011 | $390.8 million, versus $514.3 million in 2011 |
| Net investment gains (losses) | $2.31 billion, versus a $3.34 billion loss in 2011 | $7.00 billion, versus $467.3 million in 2011 |
| Net income (loss) attributable to KKR | $127.4 million, versus a $243.4 million loss in 2011 | $464.1 million, versus a $44.2 million loss in 2011 |
| Basic / diluted earnings per common unit | $0.53 / $0.49, versus $(1.09) in 2011 | $1.98 / $1.86, versus $(0.20) in 2011 |
| Fee related earnings (FRE; non-GAAP) | $90.7 million, versus $98.2 million | $233.8 million, versus $300.6 million |
| Economic net income (ENI; non-GAAP) | $509.9 million, versus a $592.1 million loss | $1.78 billion, versus $465.5 million |
KKR’s profit recovery was driven principally by private-equity portfolio appreciation and realized gains, not higher fees. The filing reports no conventional consolidated operating margin; FRE and ENI are management-defined non-GAAP measures and are not directly comparable to GAAP net income.
- Revenue and expenses: Q3 fees edged down 2%; nine-month fees declined 24%. Nine-month monitoring fees fell partly because 2011 included $76.6 million of monitoring-agreement termination payments, while transaction fees also declined with smaller deal activity. Total expenses rose to $446.5 million in Q3 from $128.8 million, mainly reflecting carry-pool compensation as investment performance improved. Nine-month expenses increased to $1.24 billion from $883.9 million.
- Investment performance: Q3 private-equity investment activity generated $2.36 billion of gains versus $3.38 billion of losses a year earlier. Nine-month private-equity gains were $6.95 billion. These totals include significant unrealized fair-value changes and may reverse; roughly 66% of investments measured at fair value were Level III at quarter-end.
- Cash flow: For the nine months, operating cash flow was $4.62 billion, investing cash outflow was $8.4 million, and financing cash outflow was $4.18 billion; cash and cash equivalents ended at $1.28 billion. Operating cash flow is heavily affected by consolidated funds’ investment purchases and sales and should not be read as cash generated solely by KKR’s management business.
- Balance sheet and liquidity: Total assets were $43.65 billion and total liabilities $3.01 billion at September 30, 2012. Debt obligations were $1.315 billion, down from $1.565 billion at year-end 2011, including $498.3 million of Senior Notes and $816.5 million of investment financing arrangements. No borrowings were outstanding under KKR’s $750 million corporate revolver or $500 million capital-markets facility. KKR reported $1.438 billion of segment cash and short-term investments; this is a management measure and differs from GAAP cash.
- Scale and distributions: AUM was $66.3 billion at quarter-end; FPAUM was approximately $50.3 billion. The declared distribution was $0.24 per common unit for Q3, versus $0.10 a year earlier. A further $0.24 distribution was announced after quarter-end, payable November 20, 2012.
Material changes and business developments
- Compared with 2011’s sharply negative Q3 investment marks, 2012 benefited from rising public markets and gains in both public and private portfolio holdings. Nine-month investment gains also rose substantially year over year, while fee revenue and FRE declined.
- Private Markets AUM increased to $49.8 billion, supported by $6.4 billion of new capital raised and portfolio appreciation, partly offset by distributions and a lower fee base as the 2006 Fund entered its post-investment period. Private Markets FPAUM was $40.4 billion.
- Public Markets AUM rose to $16.5 billion. Capital Markets and Principal Activities fees fell year over year, and syndicated capital declined to $24.7 million in Q3 from $846.0 million.
- On October 1, 2012, KKR completed its acquisition of Prisma Capital Partners, which had approximately $8.1 billion in AUM. The initial purchase price was paid in cash; additional payments may be due in 2014 and 2017 if performance targets are met. Purchase accounting was still being determined.
- KKR and Stone Point Capital formed Merchant Advisors, each committing $150 million of equity to the venture.
Outlook, risks, and contingencies
- Management described global conditions as uncertain, citing European sovereign-debt concerns, slower Asian growth, cautious U.S. spending and fiscal-policy uncertainty. KKR reported lower 2012 transaction volume, which reduced transaction fees and can constrain investment gains.
- Results remain sensitive to equity and credit markets, interest rates, commodity prices, portfolio-company performance, realizations and investor flows. Carried interest and unrealized investment gains can reverse; KKR noted that certain funds’ carried interest was accrued but not yet distributable in cash because of “netting holes.”
- Management stated that existing liquidity sources should be sufficient for working-capital needs for at least 12 months. Unfunded commitments included $802.7 million to active funds, $125.0 million to Asian Fund II and $163.9 million related to capital-markets lending commitments; KKR also earmarked approximately $540 million for new strategies and initiatives.
- At quarter-end, a hypothetical liquidation of applicable funds at zero value would imply $1.06 billion of potential clawback exposure and approximately $653.5 million of net-loss-sharing exposure. At reported fair values, the filing stated there would have been no clawback or net-loss-sharing obligation.
- KKR disclosed ongoing litigation and regulatory inquiries, including matters concerning Bruno’s, Primedia, private-equity antitrust allegations, SEC inquiries related to Del Monte and sovereign wealth funds, a DOJ investigation and a New York Attorney General subpoena concerning management-fee waivers or deferrals. For matters assessed as both probable and reasonably estimable, KKR estimated aggregate losses attributable to it at approximately $32.5 million, which it believed could be partly or fully covered by insurance or indemnity; management had not concluded whether final resolutions would materially affect the financial statements.
- KKR reported effective disclosure controls and no material changes in internal control over financial reporting during the quarter. No earnings or AUM guidance was provided in the filing text.
Important facts for investors to verify
- How much of the reported earnings improvement reflects realized cash proceeds versus unrealized, Level III portfolio revaluations—and how sensitive those valuations are to market assumptions.
- Whether fee revenue and FRE can stabilize given lower transaction activity, the 2006 Fund’s reduced fee base and the decline in nine-month fees.
- The cash timing and implications of fund “netting holes,” potential clawbacks, unfunded commitments and the post-quarter Prisma acquisition and contingent purchase payments.
- The status and potential financial impact of disclosed litigation and regulatory investigations, including the basis for the $32.5 million loss estimate and expected insurance or indemnity recovery.
- The distinction between consolidated fund cash flows and liquidity available to KKR itself, and the terms and availability of its credit facilities.