KKR & Co. L.P. — Form 10-Q Summary
Reporting period: Quarter ended September 30, 2011; comparative results are for the three and nine months ended September 30, 2010. The filing registrant is KKR & Co. L.P. (rather than Inc.). Unless noted otherwise, dollar figures below are in U.S. dollars.
Business context
KKR is a global investment firm, earning management, monitoring, transaction and incentive fees, capital-markets fees, and investment income including carried interest. Its reportable segments are Private Markets, Public Markets, and Capital Markets and Principal Activities. At quarter-end, AUM was $58.7 billion; the filing reports $43.7 billion in Private Markets and $15.0 billion in Public Markets.
KKR consolidates certain investment funds despite holding minority economic interests. Consequently, consolidated assets, investment results and cash flows include substantial amounts attributable to outside investors; consolidated totals should not be read as wholly attributable to KKR.
Financial performance and liquidity
| Metric | Q3 2011 | Q3 2010 | Nine months 2011 | Nine months 2010 |
|---|---|---|---|---|
| Fees | $164.8 million | $96.0 million | $514.3 million | $289.1 million |
| Net gains (losses) from investment activities | $(3,339.0) million | $1,450.1 million | $467.3 million | $4,768.2 million |
| Net income (loss) attributable to KKR | $(243.4) million | $8.9 million | $(44.2) million | $152.6 million |
| Economic net income (loss) (non-GAAP) | $(592.1) million | $317.3 million | $465.5 million | $1,425.2 million |
| Fee-related earnings (non-GAAP) | $98.2 million | $69.5 million | $300.6 million | $223.2 million |
Q3 2011 investment losses were driven primarily by a $3.9 billion decline in unrealized private-equity gains/losses, reflecting the sharp deterioration in equity markets. Consolidated net loss was $3.196 billion for the quarter, but most of that loss was allocated to noncontrolling interests; KKR-attributable loss was $243.4 million.
- Cash flow: For the first nine months of 2011, operating cash flow was $892.1 million, investing cash flow $(35.8) million and financing cash flow $(773.2) million; cash and cash equivalents increased $83.1 million to $821.8 million. Consolidated-fund activity materially affects reported cash flows.
- Financial position: At September 30, 2011, total assets were $38.634 billion, total liabilities $2.719 billion, and total equity $35.914 billion. Cash held at consolidated entities was a further $439.3 million and restricted cash was $91.5 million.
- Debt and liquidity: Debt obligations were $1.565 billion, including $1.067 billion of investment financing arrangements and approximately $498.1 million carrying value of 6.375% Senior Notes due 2020. KKR reported approximately $0.8 billion of available cash and said it expected liquidity sources to meet working-capital needs for the next 12 months. Corporate and capital-markets revolving facilities had no borrowings outstanding; stated availability included $750 million under the corporate facility and a $500 million KCM facility.
- Distributions: Distributions declared were $0.10 per common unit for Q3 and $0.42 per unit for the first nine months, compared with $0.15 and $0.31, respectively, in 2010. A further $0.10 distribution was announced November 4, 2011.
Material changes versus prior comparable periods
- Q3 fees rose $68.8 million year over year, principally from higher transaction activity and monitoring/consulting fees. Nine-month fees rose $225.1 million, including $76.6 million in monitoring-fee termination payments associated with portfolio-company IPOs or sales; management said such payments are infrequent.
- Q3 investment results swung from a $1.450 billion gain to a $3.339 billion loss. Nine-month investment gains fell from $4.768 billion to $467.3 million. Volatile markets and declines in portfolio-company valuations were central drivers.
- Q3 fee-related earnings increased to $98.2 million, while economic net income fell to a $592.1 million loss. For the nine months, fee-related earnings increased to $300.6 million, while economic net income declined to $465.5 million.
- Reported expenses fell year over year, mainly because equity-based compensation and carry-pool expense were lower; cash-based compensation and costs associated with business expansion increased.
- Private Markets AUM declined to $43.7 billion from $47.1 billion at June 30, primarily due to valuation declines and distributions. Public Markets AUM was approximately $15.0 billion, broadly stable quarter over quarter.
Outlook, risks and unusual items
No specific earnings or revenue guidance was provided. Management described highly volatile global equity and credit markets, sovereign-debt concerns and uncertainty about economic growth. It noted that these conditions can affect portfolio valuations, realizations, financing access, capital-markets fee activity and portfolio-company performance. Market levels had rebounded after quarter-end, but management cautioned that actual outcomes may differ materially from forward-looking statements.
- Valuation estimation is a significant risk: 62.1% of investments measured at fair value were Level III, relying on significant unobservable inputs and management judgment. KKR stated that an immediate 10% decline in fund investment values would generally produce a similar percentage change in fund investment gains/losses, with a substantially smaller impact on KKR-attributable net income because most fund economics belong to noncontrolling investors.
- Potential clawback exposure was $73.5 million using September 30 fair values, including $6.4 million identified as KKR’s obligation; the hypothetical amount subject to clawback was $791.0 million if applicable funds were liquidated at zero value. Net-loss-sharing exposure was nil at reported fair values but approximately $1.096 billion under a zero-value liquidation scenario.
- Unconsolidated unfunded commitments to funds were $746.1 million, alongside $80.8 million of lending commitments and $54.9 million of underwriting commitments. Consolidated contractual obligations include substantial fund and investor commitments and are not equivalent to KKR’s own obligations.
- Significant litigation and investigations include matters relating to Bruno’s, PRIMEDIA, private-equity antitrust allegations and the Del Monte transaction, plus SEC and DOJ inquiries. No loss contingency was recorded; management said potential loss ranges could not be estimated and had not concluded whether resolution would materially affect the financial statements.
- KKR reported compliance with debt covenants. Regulatory capital requirements restricted approximately $49.8 million of broker-dealer cash from distributions or advances. The principal-protected product arrangement had no liquidity shortfall and no current purchase obligation at quarter-end.
Important facts for investors to verify
- How the Q3 market decline and subsequent market movements affect portfolio valuations, carried interest and realizations, especially for Level III investments.
- How much of reported cash, operating cash flow, debt and commitments belongs to consolidated funds rather than KKR itself.
- The assumptions and allocation of the $73.5 million fair-value clawback estimate and the much larger stressed clawback and net-loss-sharing scenarios.
- Whether recurring management and fee-related earnings can offset the volatility and infrequency of transaction, termination and performance-related fees.
- Developments in the disclosed litigation and regulatory investigations, and any effects on KKR, its funds or portfolio companies.
- Future distributions, unit issuance and exchanges, and the potential cash obligations under the tax receivable agreement.