KKR

Business Context and Reporting Period

Company: KKR & Co. Inc. (KKR)

Filing Type: Form 10-K (Annual Report)

Reporting Period: Fiscal year ended December 31, 2010

Overview: KKR is a leading global investment firm with a 34-year history, led by Henry Kravis and George Roberts. The firm operates through three primary segments: Private Markets (private equity, infrastructure, natural resources), Public Markets (fixed income, credit strategies), and Capital Markets and Principal Activities. As of December 31, 2010, KKR reported $61.0 billion in Assets Under Management (AUM), a significant increase from $15.1 billion in 2004. The firm completed its reorganization and combination transactions in October 2009 and began trading on the NYSE on July 15, 2010.

Key Financial Metrics

Note: Net Income Attributable to KKR & Co. L.P. reflects only the 31.15% interest held by the public entity. The majority of consolidated net income is attributable to noncontrolling interests (third-party fund investors and KKR Holdings).

Material Changes vs. Prior Period

• Fee Revenue Growth: Fees increased 31.4% to $435.4 million in 2010 compared to 2009. This was driven by a $71.2 million increase in capital markets fees (underwriting/syndication) and a $57.4 million increase in gross transaction fees. However, monitoring fees decreased by $55.2 million due to the absence of one-time termination fees received in 2009 related to IPOs.
• Expense Increase: Total expenses rose 47.4% to $1.76 billion. The primary drivers were non-cash equity-based charges ($261.8 million increase) and increased allocations to the carry pool ($278.7 million increase) as the firm recognized higher gross carried interest in 2010.
• Investment Income: Net gains from investment activities increased slightly by 3.3% to $7.76 billion. This was largely due to unrealized gains from changes in fair value ($10.0 billion) offset by unrealized losses ($2.5 billion). Dividend income surged to $1.25 billion in 2010 from $186.3 million in 2009, primarily due to distributions from two portfolio companies.
• Net Income Attributable to KKR: Despite a strong consolidated net income of $7.78 billion, the portion attributable to KKR & Co. L.P. decreased to $333.2 million from $849.7 million in 2009. This decline is attributed to the full-year impact of the carry pool allocation and other structural adjustments following the 2009 Transactions.

Guidance, Outlook, Risks, and Contingencies

Guidance and Outlook: KKR explicitly states it does not intend to provide earnings guidance due to the high variability of its earnings, which are driven by the timing of investment realizations and market conditions. The firm expects to continue growing AUM through new capital raising and value creation in existing portfolios.

Management Commentary: Management highlighted a strong performance in global equity and credit markets in 2010. The firm completed IPOs for three portfolio companies (NXP Semiconductors, China Modern Dairy Holdings, and TDC). The firm emphasizes a disciplined investment approach and alignment of interests with investors.

Key Risks:

• Market Conditions: Difficult market conditions can reduce investment values, limit exit opportunities, and impact the ability to raise new capital.
• Clawback and Net Loss Sharing: The firm faces contingent obligations to return carried interest or contribute capital to funds if performance deteriorates. As of Dec 31, 2010, if funds were liquidated at zero value, the clawback obligation would be $697.0 million and the net loss sharing obligation would be $1,094.0 million.
• Regulatory Changes: The firm is subject to extensive regulation, including the Dodd-Frank Act, which may impose new reporting requirements, capital standards, and restrictions on compensation.
• Valuation Subjectivity: A significant portion of investments (65.5%) are Level III assets valued using unobservable inputs, introducing subjectivity and potential volatility in reported earnings.

Unusual Items: The 2010 results include significant non-cash charges related to equity awards and carry pool allocations. Additionally, the firm has a Tax Receivable Agreement with KKR Holdings, requiring the payment of 85% of cash tax savings resulting from basis step-ups upon unit exchanges.

Important Facts for Investor Verification

• Ownership Structure: Verify the distinction between consolidated net income and the net income attributable to KKR & Co. L.P. (approx. 31% of the combined business). The majority of economic interest is held by KKR Holdings (principals) and third-party fund investors.
• Carried Interest Volatility: Understand that a significant portion of investment income is carried interest, which is highly variable and dependent on realization events (exits) rather than steady cash flow.
• Clawback Exposure: Review the magnitude of potential clawback and net loss sharing obligations ($697M and $1.1B respectively in a zero-value liquidation scenario) as a measure of downside risk.
• Fee Revenue Composition: Note the reliance on transaction fees and capital markets activity, which can be lumpy and dependent on market liquidity, versus the more stable management fees.
• Debt and Liquidity: Confirm the firm's ability to meet its $923.7 million in uncalled capital commitments to its own funds using available cash ($756M) and credit facilities ($1.0B corporate, $500M capital markets).