KKR & Co. Inc. (KKR, Financial) is one of the largest private equity companies in the world with a staggering $519 billion in assets under management. The private equity sphere is punctuated by outperformance (16% to 20% returns) over the past 20 years, compared to the public markets (around 9%), according to data from the private equity barometer.
In this analysis, I will break down one of the greatest publicly traded private equity companies. Let's dive in.
Business model
KKR’s business model involves identifying private companies with value uplift potential through strategic initiatives, operational improvements and growth strategies. The company has access to a global network of experts across various industries to help execute on the actions. This is generally done over a short three- to five-year value creation period, though some investments are held longer.
Generally an “exit plan” is set up prior to a company purchase. This identifies opportunities to realize gains either through the enabling of one of its portfolio companies to be acquired or taking the company public via an initial public offering. The private equity firm can also implement “financial engineering” such as a recapitalization. This involves restructuring the debt-to-equity structure. The company can then use debt to pay out distributions (dividends) to itself and investors without needing to exit the entire investment.
Capital raising and investment areas
Generally, KKR raises its capital from a variety of institutional investors, which include pension funds, university endowments and sovereign wealth funds. These investors then invest via a limited partnership across a specific fund. For example, KKR’s funds include a tech growth fund, a health care fund, an industrial fund and many more. This is generally split between the U.S. as well as Europe and Asia.
The company is also a large investor in real estate, which involves purchasing, managing and developing physical properties, in addition to renewable energy infrastructure projects. Credit and debt is also a service KKR invests in via corporate loans, distressed debt, high-yield bonds and much more. For example, in August, the company purchased a $373 million portfolio of auto loans from Synovus Bank. KKR earns a fee based on assets under management, which is based on a percentage of total capital committed.
Financial performance
KKR reported strong financial results for the second quarter of 2023. Its revenue of $4.5 billionrose by 40% sequentially. This is an incredible result given the tough economic environment. A large portion of this revenue ($3 billion) looks to have been driven by interest paid on its asset under management. The company has felt the benefit of this as interest rates have risen.
Its management fees captured in the quarter was $749 million, with capital markets generating approximately $150 million in revenue. Overall fee-related revenue was $967 million, up 25% year over year. Fee-related revenue was $967 million. This was up 7% from last quarter and up 25% year over year. KKR’s fee-related earnings were $602 million at a healthy 62% FRE margin, which is one of the highest in the industry.
Performance of various segments
Its insurance segment generated $170 million in earnings, while its Global Atlantic brand continues to perform strong. During the second-quarter earnings call, management forecasted a solid return on equity of between 14% and 15%.
Its real estate portfolio did see its value decline by 11% over the trailing 12 months. This was expected due to the rise of remote working, which has impacted the value of office blocks, in addition to the higher mortgage servicing costs, which makes capital less readily available. A positive with KKR is it owns a number of cash-flowing properties in growing areas such as data centers, student housing, self-storage and rentals.
Despite the challenges, its capitalization rate has increased over the last 12 months. This is a figure derived as properties value divided by its net operating income. In this case, its NOI has grown, which has increased the overall cap rate. Infrastructure value increased by 10% year over year, driven by its inflation-hedged assets.
Investment performance and capital raised
KKR reported just a 2% year-over-year increase in its private equity portfolio value. A positive is its value has increased by 5% sequentially, which is not bad given the tough economic environment. If we zoom out, its internal rate of return for its flagship funds (Americas XII, Europe V and Asia IV) remains a solid 22%, which is fantastic given an investment in the MSCI world index has yielded a 9% return.
In the second quarter, KKR raised a further $13 billion in capital. This was driven by tapping into the lucrative private wealth market. The company has also continued to deploy its capital and invested a staggering $10 billion in the quarter across a variety of areas, from private equity to credit and even real estate.
Valuation
KKR trades with a price-sales ratio of 9.54, which is cheaper than its five-year average. The stock also trades at a price-earnings ratio of 24, which is not really cheap, but, given the quality of the company, this is expected.
Conclusion
KKR is an extremely diversified and thriving fortress. Its internal rate of return has beaten the public markets most years and the company is in a strong position to continue to expand, especially in Asia. Private equity is still a lucrative asset class and given the volatility of public markets, it is not a surprise it continues to attract capital.
