KKR & Co. L.P. — Q2 2015 Form 10-Q
Reporting period: Three and six months ended June 30, 2015; comparison is with the same 2014 periods unless noted. Amounts below are in U.S. dollars. KKR is a global alternative investment firm spanning private equity, real assets, credit, hedge funds and capital markets. Its consolidated statements include funds and collateralized financing entities (CFEs), so reported assets, debt, income and cash flows include substantial amounts attributable to outside investors.
Financial results and liquidity
| Metric | Q2 2015 | Q2 2014 | Six months 2015 | Six months 2014 |
|---|---|---|---|---|
| Fees and other (GAAP) | $255.9m | $249.4m | $547.2m | $552.3m |
| Net gains from investment activities | $3,110.6m | $1,971.9m | $5,030.4m | $3,944.0m |
| Net income attributable to KKR & Co. L.P. | $376.3m | $178.2m | $646.8m | $388.3m |
| Diluted earnings per common unit | $0.78 | $0.43 | $1.35 | $1.06 |
| Economic net income (ENI, non-GAAP) | $839.9m | $501.6m | $1,439.4m | $1,131.8m |
| Fee-related earnings (FRE, non-GAAP) | $105.5m | $93.7m | $222.8m | $245.4m |
| Total distributable earnings (non-GAAP) | $491.4m | $701.0m | $1,007.9m | $1,147.8m |
- Q2 consolidated net income was $3.306bn, of which $2.930bn was attributable to noncontrolling interests and appropriated capital. KKR-attributable earnings therefore should not be confused with consolidated net income.
- Q2 GAAP expenses were $554.2m, down from $585.3m; higher compensation, mainly carry-pool allocations, was more than offset by lower general, administrative and other expense. The filing does not present a single comparable GAAP operating-margin measure.
- Q2 investment gains were led by private equity. The six-month investment gain included $3.311bn realized and $1.719bn unrealized gains; fair-value changes, especially in private equity, were a material earnings driver.
- Cash and cash equivalents at June 30 were $1.825bn, plus $2.085bn held at consolidated entities and $157.9m of restricted cash. On a segment basis, cash and short-term investments were $2.026bn.
- Six-month operating cash flow was $999.3m, versus $1.867bn in 2014; investing cash flow was negative $130.7m and financing cash flow positive $38.0m. Cash-flow totals include consolidated funds and CFEs and are affected by investment purchases, sales and fund activity.
- Total consolidated debt obligations were $15.890bn, up from $10.838bn at year-end 2014. This includes $10.411bn of CFE debt, generally supported only by the related vehicle assets, and fund financing. Segment balance-sheet debt was $2.000bn for KKR excluding KFN and $657.3m for KFN.
- Total assets were $71.694bn, including $64.515bn of investments; total liabilities were $19.578bn. About 57.6% of fair-value investments were Level III, using significant unobservable inputs.
Material changes and operating trends
- Q2 KKR-attributable net income more than doubled year over year, primarily from higher investment income and KKR’s increased average ownership of the KKR Group Partnerships. Private equity net gains rose to $2.836bn from $1.891bn, with substantial unrealized appreciation.
- For the first half, fees and other edged lower despite higher monitoring fees: transaction fees, incentive fees, oil and gas revenue, and management fees declined. Monitoring-fee increases included infrequent termination payments of $114.1m in the first half, versus $8.7m in 2014; recurring monitoring fees weakened.
- First-half ENI rose, but FRE and distributable earnings fell. Distributable earnings decreased mainly because realized cash carry and KKR ex-KFN realized investment income were lower.
- Private Markets AUM was $63.1bn and fee-paying AUM (FPAUM) $46.8bn at June 30. Public Markets AUM was $38.4bn and FPAUM $37.0bn. Private Markets had $21.1bn of uncalled commitments; Public Markets had $4.8bn.
- Private Markets’ six-month ENI increased to $1.235bn from $861.6m; Public Markets’ fell to $139.4m from $203.4m; Capital Markets’ was $65.3m, slightly below $66.9m. Capital Markets syndicated capital increased to $680.8m from $258.1m.
Outlook, risks and unusual items
- No specific earnings or revenue guidance is provided. Management said available liquidity sources should meet working-capital requirements for at least the next 12 months. A $0.42 per-unit distribution was announced July 23, payable August 18, 2015; the distribution for Q2 2014 was $0.67.
- Management cited market sensitivity in investment valuations and realizations, financing costs, foreign exchange and commodity prices. It noted China-market volatility, uncertainty around Greece, widening credit spreads and rising government bond yields. The 2017 WTI and natural-gas price assumptions had declined by August 4; sustained declines could pressure energy investment values. A hypothetical 10% decline in specified energy assets would reduce KKR-attributable net income by an estimated $39.7m.
- Fair-value estimates are judgmental: Level III investments were $36.8bn, and reported values could vary materially with assumptions and market conditions. Carried interest is recognized as if funds were liquidated at period-end values and can reverse if performance deteriorates.
- KKR early adopted ASU 2014-13 for consolidated CFEs, recording a $17.2m cumulative-effect reduction to equity. KKR expects ASU 2015-02, effective for periods beginning after December 15, 2015, to result in deconsolidation of a significant number of funds and entities, potentially changing statement presentation and comparability.
- At current fund valuations, no carried interest was subject to clawback; under a zero-value liquidation stress case, the potential clawback was $2.433bn. A separate net-loss-sharing obligation would be about $92.4m under a zero-value liquidation scenario. These are contingent stress cases, not amounts currently payable.
- KKR settled the Primedia shareholder litigation without admitting wrongdoing; the payment was not material. It also settled an SEC inquiry on fund expense allocation; payments were not expected to be material. A separate appeal in the KFN merger litigation was scheduled for September 16, 2015. Management estimated approximately $25m of losses for matters it considered probable and reasonably estimable; outcomes of other proceedings could not be estimated.
Most important facts for investors to verify
- How much of reported earnings and investment gains reflects realized cash results versus unrealized Level III valuations, and how sensitive those valuations are to market, discount-rate and commodity assumptions.
- Whether the lower FRE and distributable earnings trend persists, given the variability of carried interest, one-time monitoring-fee termination payments and investment realizations.
- The composition and recourse of the $15.9bn consolidated debt balance, and the distinction between KKR corporate obligations and non-recourse fund/CFE debt.
- The practical effects of expected deconsolidation under ASU 2015-02 on reported assets, liabilities, revenue, earnings and cash flows.
- Progress on unfunded commitments, fund netting holes, contingent clawback exposure, litigation matters and the distribution policy’s dependence on board discretion and available cash.