KKR & Co. L.P. — Q1 2016 Form 10-Q Summary
Reporting period: Three months ended March 31, 2016; balance-sheet comparisons are with December 31, 2015. The filing is for KKR & Co. L.P., the publicly traded partnership. Unless stated otherwise, financial amounts below are in U.S. dollars.
Business context and reporting period
KKR is a global investment firm managing private equity, real assets, credit and hedge fund strategies, and operating a capital markets business. It earns management, transaction and monitoring fees, carried interest, and investment returns on its own capital. Results are highly affected by investment valuations and realizations.
KKR adopted new consolidation guidance (ASU 2015-02) on January 1, 2016. Most investment funds previously consolidated were deconsolidated. This reduced reported assets, liabilities and noncontrolling interests, and changed the presentation of fees and investment results; prior-year GAAP figures were not restated. KKR stated that adoption did not affect net income attributable to KKR or partners’ capital.
Key financial results and liquidity
| Metric | Q1 2016 | Q1 2015 |
|---|---|---|
| Fees and other revenue | $162.8 million | $291.3 million |
| Total expenses | $308.3 million | $515.0 million |
| Net gains (losses) from investment activities | $(735.2) million | $1,919.8 million |
| Net income (loss) attributable to KKR | $(329.9) million | $270.5 million |
| Basic and diluted loss (earnings) per common unit | $(0.73) | $0.62 basic; $0.57 diluted |
| Economic net income (loss) (non-GAAP) | $(506.9) million | $599.4 million |
| Fee-related earnings (non-GAAP) | $141.0 million | $158.5 million |
| After-tax cash earnings (non-GAAP) | $168.7 million | $487.7 million |
| Cash provided by (used in) operating activities | $(738.8) million | $943.4 million |
Q1 2016 investment losses included $691.9 million of net unrealized losses and $43.3 million of net realized losses. The filing attributes unrealized losses mainly to direct private equity holdings, credit and CLO portfolios, and energy investments, partly offset by gains in consolidated CMBS structures. Investment losses drove the GAAP net loss; comparable-period results included substantial investment gains.
Cash and cash equivalents were $1.281 billion at quarter-end. KKR reported $1.537 billion of cash and short-term investments on a segment basis, including approximately $0.2 billion of liquid short-term investments. Operating cash flow was negative, while financing activities provided $909.3 million, including $333.0 million from preferred-unit issuance and $195.0 million of unit repurchases. Investing activities provided $62.6 million.
Reported consolidated debt obligations were $16.827 billion, down from $18.715 billion at year-end. This total includes substantial debt of consolidated CLO and CMBS entities, which is supported by those vehicles’ assets and is generally nonrecourse to KKR. KKR’s segment balance sheet separately showed $2.0 billion of KKR debt and $657.3 million of KFN debt. KKR reported compliance with material debt covenants and no borrowings under its $1.0 billion corporate revolver; its $500 million capital-markets revolving facility was also undrawn at quarter-end.
At March 31, total assets were $34.429 billion versus $71.042 billion at December 31, 2015, primarily reflecting fund deconsolidation rather than a comparable-period operating contraction. Book value on a segment basis was $9.118 billion, or $11.33 per outstanding adjusted unit.
KKR’s reported segment AUM was $71.1 billion in Private Markets and $55.3 billion in Public Markets; corresponding fee-paying AUM was $46.0 billion and $47.7 billion. Private Markets AUM rose year over year, while its fee-paying AUM declined; Public Markets AUM and fee-paying AUM increased. These measures are company-defined and should not be treated as GAAP revenue or assets.
Material changes versus the prior comparable period
- KKR moved from attributable GAAP income of $270.5 million to a loss of $329.9 million, principally due to the reversal from investment gains to investment losses.
- Economic net income fell to a loss of $506.9 million from income of $599.4 million. Private Markets ENI declined to a $14.0 million loss from $349.4 million of income; Principal Activities ENI declined to a $569.4 million loss from $176.0 million of income. Public Markets ENI was $32.5 million and Capital Markets ENI was $44.0 million.
- Fee-related earnings fell to $141.0 million from $158.5 million. After-tax cash earnings decreased to $168.7 million from $487.7 million.
- Fees and other declined despite $108.1 million more management fees, primarily because the 2015 period included $81.7 million of one-time monitoring-fee termination payments and Q1 2016 included $117.0 million of carried-interest losses. The new consolidation rules also changed fee presentation.
- Compensation and benefits fell by $239.5 million, mainly due to reversals of carry-pool allocations following carried-interest losses. General, administrative and other expense rose $32.0 million, primarily due to expenses at consolidated CLOs.
- KKR issued 13.8 million Series A preferred units for approximately $333.0 million and repurchased 14.2 million common units for approximately $195.0 million in the quarter.
Outlook, management commentary and risks
KKR provided no specific quantified earnings or revenue guidance in the supplied filing text. Management described a volatile investment environment, citing weak U.S. and European growth, slowing Chinese growth, market volatility, currency uncertainty and commodity-price weakness. It noted that lower oil and gas prices adversely affected energy valuations and that future recurring monitoring fees could decline as investments are realized, absent replacement portfolio companies. Results remain sensitive to public-market prices, credit spreads, foreign exchange, investment exits and subjective Level III valuations.
KKR intended to make equal quarterly common-unit distributions of $0.16 per unit, subject to board discretion and partnership-agreement limits. It issued 6.75% Series A preferred units; their distributions are discretionary and noncumulative. The preferred terms restrict common distributions and repurchases if preferred distributions have not been declared and paid or set aside. A $0.16 common distribution and the first preferred distribution of $0.4125 per unit were declared after quarter-end.
Unfunded commitments included $1.922 billion to active investment vehicles, $77.8 million of capital-markets lending commitments, $128.6 million for Merchant Capital Solutions and $128.1 million of other investment commitments. KKR also disclosed $8.760 billion of contractual obligations on an unconsolidated basis; the consolidated schedule is larger and includes fund and CFE obligations. Fund-level and CFE debt generally has limited or no recourse to KKR’s general assets.
Although no carried interest was subject to clawback assuming funds were liquidated at quarter-end fair values, a zero-value liquidation scenario would imply a potential clawback of $2.449 billion. KKR disclosed no further net-loss-sharing obligations based on realizations to date. Legal proceedings and regulatory inquiries are ongoing or may arise; management had not concluded that their ultimate resolution would materially affect the financial statements, but noted that adverse outcomes could materially affect results in a particular period.
Additional risks included a proposed compensation rule that could require changes to compensation practices, and a court ruling concerning private-equity funds’ potential responsibility for portfolio-company pension liabilities. KKR cautioned that applying the ruling’s rationale more broadly could expose it or its funds to ERISA pension liabilities.
Most important facts for investors to verify
- How much of the Q1 GAAP decline reflects underlying investment performance versus the consolidation-accounting change, and how reported fees and investment income will trend under the new presentation.
- The portfolio’s valuation sensitivity, especially the 54.3% of fair-value investments classified as Level III, and the effect of market prices, credit spreads and energy assumptions on marks and carried interest.
- Cash available to the management company after excluding fund/CFE cash, restricted or regulated cash, and the cash needs for commitments, distributions, repurchases and debt service.
- The performance and realization progress of funds with significant netting holes, including North America Fund XI, European Fund II and European Fund III, and the potential for carry reversals or clawbacks.
- Whether the $0.16 common distribution policy can be sustained alongside preferred-unit obligations, unfunded commitments and ongoing unit repurchases.
- Developments in litigation, regulatory matters, the proposed incentive-compensation rules and potential pension-liability exposure.