KKR & Co. L.P. — Third-Quarter 2013 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2013; comparisons are with the corresponding 2012 periods. KKR is a global investment manager and capital-markets firm. Its consolidated GAAP results include investment funds in which outside investors hold most of the economic interests, so consolidated income and assets should not be read as amounts attributable solely to KKR.
Key financial results
| Metric | Q3 2013 | Q3 2012 | Nine months 2013 | Nine months 2012 |
|---|---|---|---|---|
| Fees | $220.0 million | $162.2 million | $537.6 million | $390.8 million |
| Investment income | $2.441 billion | $2.397 billion | $5.248 billion | $7.467 billion |
| Net income, consolidated | $2.198 billion | $2.103 billion | $4.574 billion | $6.580 billion |
| Net income attributable to KKR & Co. L.P. | $204.7 million | $127.4 million | $413.3 million | $464.1 million |
| Diluted earnings per common unit | $0.66 | $0.49 | $1.40 | $1.86 |
| Distributions declared per common unit | $0.23 | $0.24 | $0.92 | $0.52 |
- Q3 fee-related earnings (FRE), a non-GAAP segment measure, were $106.0 million, versus $90.7 million; economic net income (ENI), also non-GAAP, was $613.7 million versus $509.9 million. For the first nine months, FRE was $292.2 million versus $233.8 million, while ENI was $1.406 billion versus $1.783 billion.
- FRE was about 38.6% of segment fees in Q3 (41.6% in Q3 2012) and 39.9% for nine months (39.3% in 2012). These are derived ratios using KKR’s non-GAAP segment measures, not GAAP operating margins.
- Q3 revenue growth reflected higher transaction and management fees. For nine months, fees rose 38%, but investment gains fell 34%, mainly because private-equity appreciation was lower than in 2012.
Balance sheet, cash flow and liquidity
- At September 30, 2013, total assets were $48.160 billion, including $44.263 billion of investments; total liabilities were $4.652 billion and total equity was $42.934 billion. KKR & Co. L.P. partners’ capital was $2.495 billion.
- Cash and cash equivalents were $1.112 billion, with another $436.8 million held at consolidated entities and $45.5 million restricted. Management reported $1.901 billion of segment cash and short-term investments, including $788.7 million of liquid short-term investments.
- Nine-month operating cash flow was $1.796 billion, versus $4.619 billion in 2012; investing cash flow was $34.2 million, and financing cash flow was negative $1.948 billion. Consolidated cash flow includes substantial fund activity and is not a direct measure of cash generated for KKR itself.
- Reported debt obligations were $2.027 billion, up from $1.123 billion at year-end 2012. This includes $500 million principal amount each of 2020 notes at 6.375% and 2043 notes at 5.50%, plus $1.034 billion of investment-vehicle financing. The latter is generally tied to specific investments and is not a direct obligation of KKR’s management companies or fund general partners. KKR also reported $1.25 billion available under revolving credit arrangements and no revolver borrowings outstanding, apart from a letter of credit.
- KKR said its available liquidity sources should be sufficient for working-capital needs for at least the next 12 months. It reported $1.165 billion of its own unfunded fund commitments; total consolidated-fund commitments were much larger, at $20.809 billion.
Business trends and material changes
- Assets under management were $90.2 billion at quarter-end. Private Markets AUM was $59.7 billion and Public Markets AUM was $30.5 billion. Private Markets FPAUM was $49.9 billion and Public Markets FPAUM was $23.7 billion.
- Private Markets AUM increased during Q3 through $4.7 billion of new capital and $2.1 billion of valuation gains, partly offset by $1.6 billion of distributions. Public Markets AUM rose to $30.5 billion, supported by $1.8 billion of new capital, partly offset by distributions and redemptions.
- The acquisition of Prisma, completed October 1, 2012, contributed to higher Public Markets management fees and expenses. KKR also acquired a 24.9% interest in Nephila in January 2013.
- Q3 consolidated net gains from investment activities were $2.230 billion, slightly below 2012; nine-month gains were $4.599 billion, down from $6.997 billion. The portfolio’s Level III investments totaled $31.624 billion, and 72.3% of investments measured at fair value were Level III, requiring significant unobservable valuation inputs.
Outlook, risks and unusual items
- KKR provided no specific earnings or AUM guidance. Management described global economic conditions as uncertain, citing European weakness, mixed Asian growth, U.S. fiscal and monetary-policy uncertainty, possible higher interest rates, currency movements, and volatility in equity, credit and commodity markets.
- Management noted that increased interest rates could pressure investment valuations and portfolio-company financing; lower transaction activity could reduce transaction fees and future investment gains. KKR also highlighted foreign-exchange exposure and sensitivity of some real-asset holdings to oil and gas prices.
- Q3 expenses included a $9.7 million one-time Public Markets expense related to launching a closed-end fund. Q3 dividend income included a $104.1 million Visma dividend; significant portfolio-company dividends are variable and generally not recurring quarterly items.
- Carried interest is recognized using estimated fund liquidation values and can reverse if investment values decline. At September 30, no carry was subject to clawback assuming funds were liquidated at reported fair values; a zero-value liquidation scenario would imply a $1.242 billion clawback. Certain legacy funds could also entail up to $574.8 million of net-loss-sharing obligations in a zero-value liquidation scenario.
- KKR disclosed pending litigation and regulatory inquiries, including Primedia shareholder litigation and investigations by the SEC, DOJ and New York Attorney General. For matters where loss was considered probable and estimable, estimated aggregate losses attributable to KKR were approximately $32.5 million; management could not estimate potential losses for other matters and did not conclude that their final resolution would materially affect the consolidated statements.
- Subsequent events: KKR announced a $0.23-per-unit distribution payable November 19, 2013, and agreed to acquire Avoca Capital, a European credit manager with approximately $8 billion AUM, subject to approvals and expected to close in Q1 2014. Consideration is to include cash and KKR units or unit-linked securities.
Important facts for investors to verify
- How much of reported earnings and cash flow is attributable to KKR unitholders rather than noncontrolling fund investors, and how consolidated fund activity affects comparisons.
- The sustainability of fee growth and FRE, given transaction-driven revenues, fee-base changes, incentive-fee variability and the Prisma-related cost base.
- Whether the substantial share of Level III valuations and unrealized gains is supported by realizations and independent valuation procedures; KKR noted that the external valuation firm’s work was limited and not an audit or attestation.
- Liquidity needs and exposure to fund commitments, financing arrangements, the tax receivable agreement, contingent acquisition payments, clawbacks and net-loss-sharing provisions.
- Developments in the disclosed legal and regulatory matters, and the terms, dilution and funding impact of the planned Avoca acquisition.