KKR & Co. L.P. — Q1 2017 Form 10-Q
Reporting period: Three months ended March 31, 2017; balance-sheet comparisons are with December 31, 2016. The filing is for KKR & Co. L.P. and its consolidated subsidiaries. Amounts below are U.S. dollars; consolidated GAAP results include certain funds and collateralized financing entities (CFEs), often with substantial noncontrolling interests.
Business context and key metrics
KKR is a global investment firm spanning private equity, real assets, credit, hedge funds and capital markets. It reported four segments: Private Markets, Public Markets, Capital Markets and Principal Activities.
| Metric | Q1 2017 | Q1 2016 / prior date |
|---|---|---|
| Fees and other revenue | $716 million | $163 million |
| GAAP net income (loss) | $798 million | ($760 million) |
| Net income (loss) attributable to KKR common unitholders | $259 million | ($330 million) |
| GAAP earnings (loss) per common unit | $0.57 basic; $0.52 diluted | ($0.73) basic and diluted |
| Economic net income (ENI), non-GAAP | $669 million | ($507 million) |
| Fee related earnings (FRE), non-GAAP | $222 million | $141 million |
| After-tax distributable earnings, non-GAAP | $346 million; $0.43 per adjusted unit | $169 million; $0.21 per adjusted unit |
| Cash and cash equivalents | $2.76 billion | $2.51 billion |
| Operating cash flow | ($1.12 billion) | ($739 million) |
| Total assets / total liabilities | $41.64 billion / $23.35 billion | $39.00 billion / $21.88 billion |
| Total investments | $34.23 billion | $31.41 billion |
| Total reported debt obligations | $19.63 billion | $18.54 billion |
| AUM / fee-paying AUM | $137.6 billion / $107.1 billion | December 31, 2016: $129.6 billion / $101.5 billion |
Reported debt includes substantial fund and CFE obligations that are generally non-recourse beyond the relevant entity’s assets. KKR’s segment balance sheet separately reported $3.38 billion of cash and short-term investments, $2.00 billion of KKR debt excluding KFN, and $755 million of KFN debt. The filing does not present a comparable consolidated operating margin.
Changes versus the prior comparable period
- Revenue and earnings rebounded sharply from Q1 2016, when market-value declines produced significant losses. Q1 2017 results benefited from carried-interest gains and investment gains, as well as higher transaction fees.
- Net gains from investment activities were $558 million, versus losses of $735 million a year earlier; Q1 2017 included $412 million of unrealized gains and $146 million of realized gains. Gains were concentrated in credit and other investments, private equity and securities sold short.
- Fees and other rose by $553 million. Carried interest changed from a $117 million loss to $336 million of revenue; transaction fees increased to $244 million from $97 million. Fee credits also rose, to $88 million from $22 million.
- Cash compensation and benefits increased to $403 million from $125 million, mainly reflecting higher carry-pool allocations and activity-related compensation. General, administrative and other expense declined to $122 million from $166 million.
- Operating cash flow remained negative and worsened year over year, reflecting investment purchases exceeding proceeds and the effects of consolidated funds’ activity. Financing provided $1.31 billion; cash increased by $249 million during the quarter.
- AUM increased from year-end, led by new capital raised and portfolio appreciation. Private Markets AUM was $80.2 billion and Public Markets AUM was $57.4 billion at quarter-end.
Outlook, commentary, risks and unusual items
- Distribution: KKR said it intended to make equal quarterly common-unit distributions of $0.17 per unit, or $0.68 annually, beginning with Q1 2017 results. The board retains discretion; a $0.17 distribution was announced for payment in May 2017. Preferred-unit distributions were also declared after quarter-end.
- No earnings guidance: The filing does not provide a specific earnings or revenue forecast. Management cautioned that interim results are not necessarily indicative of full-year results and that forward-looking statements are subject to risks and uncertainties.
- Fundraising and deployment: Private Markets had $35.1 billion of uncalled commitments and Public Markets $6.2 billion. KKR also reported $1.40 billion of Principal Activities purchase commitments and $1.03 billion of capital-markets underwriting, debt-financing and syndication commitments; actual funding depends on contractual conditions.
- Liquidity and obligations: Unconsolidated commitments included $3.52 billion of fund commitments. Consolidated contractual obligations totaled $36.14 billion, including debt and interest; much of the fund and CFE debt is supported only by those entities’ assets. KKR reported compliance with material debt covenants. Approximately $148 million of broker-dealer cash could be restricted from dividends or advances.
- Valuation and performance volatility: 53.1% of investments measured at fair value were Level III, relying on significant unobservable inputs and management judgment. Carried interest is estimated as if funds were liquidated at reporting-date fair values and may reverse. No carry was subject to clawback assuming liquidation at reported fair values; a zero-value liquidation scenario would imply a $2.19 billion clawback.
- Market exposures: Management highlighted sensitivity to equity and credit markets, foreign exchange and energy prices. Long-term WTI crude assumptions declined about 8% during the quarter. A hypothetical 10% decline in the fair value of segment energy investments was estimated to reduce investment income by $57 million and KKR-attributable net income by $32 million.
- Strategic and financing developments: KKR announced a proposed combination of KKR Prisma and PAAMCO, with KKR to retain a 39.9% stake, subject to closing conditions and regulatory approvals. KFN issued $375 million of 5.5% notes due 2032 in March and redeemed its $115 million of 7.5% notes due 2042 in April. A KKR Capital Markets subsidiary borrowed approximately $486 million under a 75-day, non-recourse credit agreement in April; about $157 million remained outstanding as of May 3.
- Contingencies: KKR described routine litigation and regulatory inquiries; management could not estimate a loss range and had not concluded pending matters would materially affect the financial statements. The filing also discusses guarantees and indemnities whose maximum exposure is unknown.
- Accounting and controls: KKR adopted the equity-method transition and share-based compensation updates on January 1, 2017; the equity-method update had no material impact. Management expected to adopt the new revenue standard in 2018 and was still evaluating its impact on other revenue streams. Disclosure controls were assessed as effective.
Important facts for investors to verify
- How much of the earnings rebound reflects recurring fee generation versus carried interest, fair-value marks and realized investment gains; review non-GAAP reconciliations alongside GAAP results.
- The composition and recourse of the $19.63 billion reported debt balance, and the distinction between consolidated fund/CFE obligations and debt borne by KKR or KFN.
- Whether reported portfolio marks—particularly Level III valuations and energy valuations—are supported by realizations, market evidence and subsequent events.
- Whether announced transactions and anticipated realizations closed as expected, including the PAAMCO–Prisma combination and the private-equity transactions cited by management.
- Whether cash generation, uncalled commitments, underwriting exposures and the proposed $0.17 quarterly common distribution remain sustainable under less favorable markets.
- Potential downside from fund clawbacks, litigation, guarantees, restricted cash and other commitments that may require funding.