KKR & Co. L.P. — Form 10-Q Summary
Reporting period: Three months ended March 31, 2015; comparisons are with the three months ended March 31, 2014 unless stated otherwise. The filing is for KKR & Co. L.P., the publicly traded partnership. KKR operates a global investment management and capital markets business across private equity, real assets, credit, hedge funds and related activities.
Financial performance and liquidity
| Metric | Q1 2015 | Q1 2014 / prior date |
|---|---|---|
| Fees and other revenue | $291.3 million | $302.9 million |
| Total expenses | $515.0 million | $473.2 million |
| Total investment income | $2.183 billion | $2.196 billion |
| Net income | $1.943 billion | $2.004 billion |
| Net income attributable to KKR & Co. L.P. | $270.5 million | $210.0 million |
| GAAP diluted earnings per common unit | $0.57 | $0.65 |
| Economic net income (non-GAAP) | $599.4 million | $630.3 million |
| Fee-related earnings (non-GAAP) | $117.3 million | $151.7 million |
| Total distributable earnings (non-GAAP) | $516.5 million | $446.8 million |
| Cash and cash equivalents, March 31 | $1.307 billion | $918.1 million at Dec. 31, 2014 |
| Total debt obligations, March 31 | $11.718 billion | $10.838 billion at Dec. 31, 2014 |
Cash flow: Operating activities provided $943.4 million, versus $903.4 million used in Q1 2014. Investing activities provided $7.9 million, while financing activities used $562.4 million. Consolidated cash flows include substantial fund and CLO activity; they should not be read as cash flows solely attributable to KKR’s own operations.
Balance sheet and liquidity: Total assets were $67.287 billion and total liabilities were $15.129 billion at March 31. Cash and cash equivalents held at consolidated entities were an additional $1.335 billion, and restricted cash was $53.4 million. KKR reported $1.454 billion of segment cash and short-term investments. Management said available liquidity was expected to meet working-capital requirements for at least 12 months. The reported $11.718 billion of debt includes $7.158 billion of consolidated CLO debt, which is supported by CLO assets and is non-recourse to KKR; KFN debt is also non-recourse beyond KFN’s assets.
Margins: A conventional operating margin is not especially informative for this investment manager because GAAP results include investment gains and losses and gross consolidation of funds. Fee-related earnings declined to $117.3 million from $151.7 million; the filing does not present a directly comparable GAAP operating-margin measure.
Distribution: KKR announced a $0.46 per-unit distribution on April 23, payable May 18, 2015. The distribution for Q1 2014 was $0.43 per unit. Q1 2015 distributable earnings per eligible unit were $0.60; the reported payout ratio was 76.4%.
Material changes versus the prior period
- KKR-attributable net income rose to $270.5 million from $210.0 million, principally because KKR’s share of the KKR Group Partnerships increased to approximately 53.6% from 42.4%, primarily following the 2014 KFN acquisition. Diluted earnings per unit nevertheless declined, reflecting a larger weighted-average unit count.
- GAAP net income declined modestly as expenses increased and investment income and fees decreased. Investment gains remained substantial, but their composition shifted: realized private equity gains increased while other investment gains were lower. Q1 2015 gains included significant private equity realizations and valuation increases.
- Fees and other declined $11.6 million. Lower transaction and incentive fees were partly offset by higher monitoring fees, including $81.7 million of termination fees connected with exits from Alliance Boots and Big Heart Pet Brands. Management characterized these termination payments as infrequent.
- Expenses increased $41.9 million, including higher compensation and benefits, primarily from greater carry-pool allocations, and additional costs associated with acquired businesses.
- Net investment gains were affected by market and valuation movements. The private equity portfolio increased 5.1% in value during the quarter, while Public Markets reported lower investment income, including unrealized losses in CLOs, specialty finance and other credit holdings.
- Private Markets economic net income increased to $568.5 million from $485.4 million; Public Markets fell to $2.8 million from $97.8 million; Capital Markets declined to $28.1 million from $47.1 million.
Outlook, risks, contingencies and unusual items
- Outlook: The filing provides no specific earnings or revenue guidance. Management described plans to grow Public Markets and to deploy capital across strategies, while cautioning that investment results, realizations, fundraising and fees vary with market conditions.
- Market and valuation risk: KKR noted sensitivity to equity and credit markets, interest rates, foreign exchange and energy prices. Approximately 60.9% of investments measured at fair value were Level III, using significant unobservable inputs; valuations may differ materially from eventual realizations. A hypothetical 10% decline in the fair value of specified energy investments would reduce investment income by an estimated $68.4 million and KKR-attributable net income by $36.7 million.
- Commitments and leverage: Unfunded commitments included $1.193 billion to investment vehicles, $374.6 million related to capital markets, $128.6 million for Merchant Capital Solutions and $157.2 million of other commitments. Consolidated-fund commitments and debt are much larger but generally relate to fund or CLO assets and obligations. KKR reported compliance with debt covenants in all material respects, except for a non-material fund-level instance that had been cured or waived.
- Carried-interest clawbacks: No carry was subject to clawback assuming relevant funds were liquidated at March 31 fair values; under a zero-value liquidation scenario, the estimated obligation would be $2.487 billion. Certain legacy funds also had an estimated $115.8 million net-loss-sharing exposure under a zero-value liquidation scenario.
- Legal matters: KKR agreed to settle Primedia shareholder claims, subject to court approval; the payment was not expected to materially affect results. A separate private-equity antitrust settlement received final approval in March 2015. An appeal remained pending in litigation relating to the KFN merger. KKR was also discussing a potential resolution with the SEC concerning historical expense allocations between flagship funds and co-investment and employee vehicles; no resolution was assured. The filing estimated approximately $25 million of aggregate losses for matters that were probable and reasonably estimable, while noting actual outcomes could vary.
- Accounting change: KKR early adopted ASU 2014-13 for consolidated CLOs on January 1, 2015. The modified-retrospective adoption reduced equity by $17.2 million and changed the measurement and hierarchy classification of CLO debt; it does not represent ordinary-period operating performance. KKR expected ASU 2015-02 to result in deconsolidation of certain funds, vehicles and entities upon adoption.
- Distribution and dilution: The distribution policy is discretionary and may change. Common units outstanding increased during the quarter, and equity awards and exchangeable securities create potential dilution.
Most important facts for investors to verify
- Whether Q1’s increase in KKR-attributable income and distributable earnings can be sustained, given the greater ownership share after KFN and the non-recurring nature of portfolio realizations and monitoring-fee termination payments.
- How much of reported investment income and carried interest reflects realized cash versus unrealized fair-value marks, and how sensitive Level III valuations are to key assumptions.
- The economic exposure of KKR itself to reported debt, unfunded commitments, CLOs, KFN obligations, and potential carry clawbacks, distinguishing recourse obligations from fund-level or CLO-level liabilities.
- Progress and potential financial effects of the SEC expense-allocation inquiry, KFN merger appeal and other litigation.
- The impact of future consolidation changes on reported assets, liabilities, revenue and cash flows, and the extent to which those presentation changes affect KKR-attributable economics.
- The coverage and sustainability of distributions, including the role of realized carry, KFN investment income and the larger diluted unit base.