Business context and reporting period
KKR & Co. L.P. (NYSE: KKR) filed this Form 10-K for the fiscal year ended December 31, 2011. KKR is a global alternative-asset manager with Private Markets, Public Markets, and Capital Markets and Principal Activities businesses. Year-end AUM was $59.0 billion. Financial statements consolidate certain investment funds, including assets and results largely attributable to outside investors; consolidated totals therefore do not represent amounts economically attributable solely to KKR.
Financial performance and position
| Metric | 2011 | 2010 |
|---|---|---|
| Fees | $723.6 million | $435.4 million |
| Total expenses | $1.214 billion | $1.763 billion |
| Total investment income | $1.456 billion | $9.179 billion |
| Net income | $876.5 million | $7.776 billion |
| Net income attributable to KKR & Co. L.P. | $1.9 million | $333.2 million |
| Fee related earnings (FRE; non-GAAP) | $417.2 million | $318.3 million |
| Economic net income (ENI; non-GAAP) | $750.9 million | $2.140 billion |
Fees increased 66%, reflecting more monitoring, transaction, consulting, and capital-markets activity. Lower total expenses chiefly reflected a $690 million reduction in equity-based compensation charges and lower carry-pool allocations. Investment income fell sharply as appreciation and dividends were substantially lower than in 2010; 2010 results included unusually large investment gains and portfolio-company dividends. KKR’s share of reported earnings was further reduced by noncontrolling interests, equity compensation, taxes, and allocations to KKR Holdings.
- Segments: Private Markets FRE was $226.6 million and ENI $362.8 million; Public Markets FRE was $59.6 million and ENI $58.0 million; Capital Markets and Principal Activities FRE was $130.9 million and ENI $330.2 million. The latter segment’s ENI fell from $1.295 billion as balance-sheet investment income declined.
- AUM and fundraising: Private Markets AUM declined to $43.6 billion from $46.2 billion, mainly due to distributions, partly offset by new capital and valuation gains. Public Markets AUM rose to $15.4 billion from $14.8 billion, despite redemptions. Public Markets redemptions were $801 million. KKR reported more than $5.5 billion of accepted North America Fund XI subscriptions as of February 7, 2012; these were not yet included in year-end AUM.
- Cash flow: Consolidated operating cash flow was negative $208.6 million, versus positive $733.4 million in 2010; investing cash flow was negative $47.6 million and financing cash flow positive $360.7 million. Fund investment purchases and sales materially affect these consolidated cash-flow figures.
- Liquidity and debt: Segment cash and short-term investments were $989.4 million. Consolidated cash and cash equivalents were $843.3 million, with another $930.9 million held at consolidated entities and generally unavailable for KKR’s general liquidity needs. Consolidated debt obligations were $1.565 billion, including $500 million of 6.375% senior notes due 2020 and investment-vehicle financing. KKR reported no year-end borrowings on its principal corporate revolving facilities. Management said available liquidity was expected to meet working-capital needs for at least 12 months.
- Distributions: KKR declared $0.74 per common unit for 2011 and declared a further $0.32 per unit in February 2012, payable March 6. Future payments remain discretionary and depend on cash needs, commitments, debt obligations, and other restrictions.
Changes, outlook, risks and unusual items
- Results were highly volatile: KKR reported a $243.4 million attributable loss in third-quarter 2011, followed by attributable income of $46.1 million in the fourth quarter. Management does not provide earnings guidance.
- 2011 fees included $76.6 million of monitoring-agreement termination fees associated with portfolio-company IPOs or sales; management described such receipts as infrequent. The 2010 comparison included $1.25 billion of dividend income, including $931.1 million from HCA.
- Investment valuations are a material uncertainty: 61.5% of investments measured at fair value were Level III at year-end and rely on significant unobservable inputs and management judgment. KKR stated that a 10% decline in fund investment fair values would reduce investment income, though the impact on KKR-attributable income would be substantially smaller because of noncontrolling interests.
- Potential contingent obligations include $82.7 million of carried interest subject to clawback if funds were liquidated at year-end fair values; the amount would be $800.9 million under a zero-value liquidation scenario. No net-loss-sharing obligation was indicated at current fair values, but the zero-value scenario was approximately $1.007 billion.
- KKR disclosed ongoing litigation and regulatory inquiries, including matters concerning Bruno’s, Primedia, alleged private-equity antitrust conduct, and the Del Monte transaction. The Del Monte shareholder settlement was approved and did not require payment by KKR; SEC inquiries continued. For matters assessed as probable and reasonably estimable, KKR estimated aggregate losses attributable to it of approximately $32.5 million, subject to insurance or indemnity; management could not determine whether final resolutions would materially affect the financial statements.
- Other significant risks include market and credit-cycle exposure, leverage and refinancing risks at portfolio companies and vehicles, fundraising and fee pressure, redemptions, regulatory change, tax treatment of carried interest and partnership status, key-person dependence, conflicts of interest, and limited unitholder voting rights. The 85% tax receivable agreement payment to KKR Holdings may also affect liquidity; approximately $0.2 million had been paid by year-end.
- The independent auditor issued an unqualified opinion and concluded internal control over financial reporting was effective as of December 31, 2011. KKR reported compliance with debt covenants.
Key facts investors should verify
- Reconcile consolidated GAAP earnings and cash flows with KKR-attributable results and the non-GAAP FRE and ENI measures, including their definitions and adjustments.
- Assess the valuation assumptions, concentration, and realizability of Level III investments and their effect on carried interest and future earnings.
- Review fund-level and firm-level liquidity separately, including unfunded commitments, financing maturities, redemption activity, and cash held at consolidated entities.
- Track clawback and net-loss-sharing exposure, management-fee refunds, litigation and regulatory developments, and possible insurance recoveries.
- Confirm subsequent fundraising, capital deployment, distributions, and the effects of unit exchanges, equity awards, and tax receivable agreement payments.