KKR & Co. L.P. — Form 10-Q Summary
Reporting period: Quarter and nine months ended September 30, 2017; comparisons are with the corresponding 2016 periods unless stated otherwise. The filing identifies the registrant as KKR & Co. L.P. and presents unaudited consolidated results. Amounts below are in U.S. dollars.
Business context and reporting period
KKR is a global alternative investment firm operating across private markets, public markets, capital markets and principal activities. Its revenue includes management, transaction and monitoring fees, carried interest, and investment income. Consolidation of investment funds and collateralized financing entities (CFEs) materially increases reported assets, liabilities and cash flows; significant portions belong to third parties and are non-recourse to KKR.
At September 30, 2017, KKR reported $87.6 billion of Private Markets AUM and $65.7 billion of Public Markets AUM. The filing reports approximately 78% of fee-paying AUM was not subject to redemption for at least eight years from inception.
Financial performance and position
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Fees and other | $692.9 million | $687.1 million | $2,340.6 million | $1,426.6 million |
| Net investment income | $234.7 million | $809.6 million | $1,482.2 million | $322.5 million |
| Net income attributable to KKR common unitholders | $153.6 million | $352.2 million | $818.6 million | $116.1 million |
| Diluted net income per common unit | $0.30 | $0.73 | $1.63 | $0.24 |
| Economic net income (ENI), non-GAAP | $395.0 million | $669.3 million | $1,893.8 million | $411.2 million |
| Fee related earnings (FRE), non-GAAP | $191.9 million | $142.3 million | $628.2 million | $421.0 million |
| After-tax distributable earnings, non-GAAP | $464.5 million | $461.5 million | $1,132.8 million | $1,137.8 million |
The filing does not provide a conventional operating-margin measure. ENI, FRE and distributable earnings are non-GAAP measures and should not be treated as substitutes for GAAP results.
- Cash flow: For the first nine months, operating cash flow was negative $2.219 billion, investing cash flow was positive $96.1 million and financing cash flow was positive $2.050 billion. Cash and cash equivalents ended at $2.437 billion, down $72.3 million from year-end 2016. Operating cash flow included substantial fund investment purchases and proceeds and is affected by consolidated funds.
- Assets and equity: Total assets were $44.306 billion, up from $39.003 billion at December 31, 2016. Investments were $37.252 billion, up from $31.410 billion. Total equity was $19.295 billion, versus $16.486 billion.
- Debt and liquidity: Consolidated debt obligations were $20.291 billion, compared with $18.544 billion at year-end. This includes $15.901 billion of CFE debt, generally supported only by the relevant vehicles’ assets. On the segment balance sheet, debt was $2.000 billion for KKR (excluding KFN) and $639.8 million for KFN; segment cash and short-term investments were $3.624 billion. KKR reported $4.267 billion of financing availability across listed facilities, with no corporate revolver borrowings.
- Commitments: KKR had $2.937 billion of uncalled commitments to its active funds, plus $93.4 million of principal investment and purchase commitments and $255.7 million of capital-markets underwriting, debt-financing and syndication commitments. These differ from the much larger gross consolidated commitments, some of which relate to funds and CFEs and are not general KKR obligations.
Material changes versus the prior comparable period
- Q3 common-unitholder net income declined to $153.6 million from $352.2 million, mainly reflecting lower investment and carried-interest gains. Q3 investment gains were $108.8 million versus $735.1 million a year earlier; carried interest in fees and other was $337.5 million versus $414.9 million.
- For the nine-month period, common-unitholder net income rose to $818.6 million from $116.1 million. KKR cited higher carried interest and investment gains, along with increased fee income. Net gains from investment activities were $1.086 billion versus $9.1 million.
- Nine-month fees and other increased $914.0 million, including higher carried interest, transaction fees, management fees and monitoring fees. Transaction fees rose $303.6 million and carried interest rose $621.5 million; higher fee credits partially offset fee growth.
- Nine-month total expenses increased $457.3 million, primarily from higher compensation and benefits, including carry-pool allocations and equity-based compensation. Nine-month FRE improved, while after-tax distributable earnings was broadly flat.
- KKR completed the PAAMCO/Prisma combination on June 1, 2017. It contributed net assets in exchange for a 39.9% interest in PAAMCO Prisma and reports the investment using the equity method, changing the presentation of Public Markets revenues and expenses.
- At September 30, 2017, Level III represented 54.4% of investments measured at fair value, involving significant management estimates and unobservable inputs.
Outlook, management commentary, risks and unusual items
- Distributions: KKR stated its intent to make quarterly common-unit distributions of $0.17 per unit. A $0.17 distribution was declared after quarter-end for payment November 21, 2017. The board retains discretion; future distributions are not assured. Preferred distributions were also declared after quarter-end.
- Investment activity: Management described generally positive equity and credit markets during Q3, while emphasizing that market conditions, financing costs, foreign exchange and commodity prices can affect asset valuations, realizations, fundraising and earnings. KKR provided no formal earnings or AUM guidance in the supplied filing text.
- Performance variability: Carried interest is recognized using estimated fund values as if investments were realized at the reporting date, and may be reversed if performance declines. KKR reported $47.3 million of carried interest subject to clawback based on September 30 valuations; under a zero-value liquidation scenario, the stated exposure would be $1.991 billion.
- Valuation sensitivity: KKR estimated that an immediate 10% decline in the fair value of its segment energy investments would reduce investment income by $55.0 million and net income attributable to KKR by $32.0 million. Management noted that long-term commodity-price assumptions may differ from quoted prices.
- Other risks and contingencies: Market volatility, credit and interest-rate changes, foreign-exchange movements, energy prices, fund redemptions, regulatory matters, litigation, and the ability to realize investments are key risks. KKR said it could not estimate potential losses for certain legal matters; based on information then known, management had not concluded their final resolution would materially affect the financial statements. KKR reported compliance with debt covenants in all material respects.
- Subsequent event: KKR expected to acquire an additional 5% interest in Marshall Wace in Q4 2017 using cash and common units, subject to the relevant conditions.
Important facts for investors to verify
- Separate recurring fee growth from volatile carried interest and unrealized investment gains when assessing earnings quality.
- Review the reconciliation and definitions of ENI, FRE and distributable earnings, and distinguish these non-GAAP measures from GAAP net income and cash flow.
- Assess the valuation assumptions and downside sensitivity of Level III investments, including private equity, credit and energy holdings.
- Distinguish KKR’s corporate and KFN debt from consolidated fund/CFE debt, and confirm which commitments and guarantees are recourse to KKR.
- Track fund netting holes, carried-interest clawback exposure, unfunded commitments and the cash timing of realizations.
- Confirm the sustainability of the $0.17 quarterly common-unit distribution against cash generation, investment needs and board discretion.
- Monitor the PAAMCO Prisma and Marshall Wace transactions, including their effects on reported AUM, fee-paying AUM and earnings presentation.