KKR flotation takes it back to the future

An analysis of the firm's listing documents underlines the way the industry has changed in the years since it was forced to withdraw its 2007 listing as the financial crisis set in.

A comparison of the two documents also shows the changes to the firm's ambitions and the way it does its business as it adjusts to the post-crisis world.

At the time of its first attempt, in July 2007, it was flexing its muscles as the world's largest buyout house. It had just signed the largest buyouts in Europe and the US: in the year to August 2007 it was to deploy more than $20bn (Ä14.7bn) of equity in private equity deals according to research by Private Equity News.

Its prospectus promised access to a firm with “a history of landmark achievements in private equity”.

KKR is returning to New York a second time, yet it is not raising extra capital, unlike the $1.25bn it intended to raise then.

With an eye on current market hostility, the company's historic private equity achievements are relatively downplayed and the firm instead highlights its greater diversification and growing capital markets and public markets' businesses.

This apparent strategic shift and its relocation to New York takes the firm directly head to head with its bigger rival, Blackstone Group.

Its rivals believe KKR may be laying the ground for an attempt to create an opportunity for the founders to exit from some or all of their stake should the company's shares perform well and market appetite for a rights issue increase.

One rival said: “That's something they missed at the top, which Blackstone pulled off.” However, a person close to the listing played down an exit by the founders as the motivation for the float, instead saying it was an attempt to provide capital to grow the firm and incentivise staff.


How the firm has changed since 2007:
Ambition

KKR expects its New York-listed shares to be traded more frequently than its Euronext-listed stock because there are many similar listed management companies in the US, according to a source close to the matter.

The flotation could also help address the low price of its Euronext-listed shares, which trade below book value, the source said. By improving its stock's liquidity and price, KKR will provide founders Henry Kravis and George Roberts with a possible improved exit route.

Unlike last time, the latest plan will not allow the founders to sell stakes at the time of the float. By contrast, Blackstone co-founder Stephen Schwarzman reaped $309m in cash from his firm's IPO and retained 22 percent of its stock. A source close to the matter said the founders' ability to exit was not the primary motivation for the flotation. Rather, the source said, the wish to incentivise staff and provide capital to grow the business.

Strategy
KKR has emerged from the financial crisis bigger and more diversified. Compared with 2007, the firm's assets under management have increased 10 percent to $52.2bn from $47.2bn following a decline in 2008, while its focus has shifted away from mega-buyouts.

The new prospectus suggests the firm is making greater play of its other business lines. Back in the glory days of 2007, as deal sizes hit new highs almost weekly, the firm's prospectus used the words “private equity” 638 times and “buyout” 52 times.

The latest prospectus tones down the emphasis on its core private equity business, with just 436 mentions of “private equity” and 12 of “buyout”. In an economic environment where diversified strategies and other business lines are arguably more highly valued by investors, KKR mentions its now flourishing “capital markets” 118 times in its 2010 document, three times more than in 2007.

Meanwhile, the share of KKR's portfolio accounted for by core private equity fell to 74.3 percent from 77.3 percent between 2007 and 2009, despite a $2.3bn increase in its private equity assets, to $38.8bn. Instead, the firm is focusing more on its nascent capital markets division, which analysts say should generate strong revenues, and its public markets unit, which invests in debt and has assets of about $13.4bn under management.

Structure
The latest prospectus envisages a more complex listed structure than that outlined three years ago. Then, the firm planned to list its management company in New York and a separate funds vehicle on Euronext in Amsterdam. This time, the New York flotation will include exposure to the group's underlying funds as well as its management company.

That means three years ago investors would largely have acquired links to the firm's fee revenues. This time they will get a mix of revenues, including fees from the management company and returns on from the portfolio if its companies increase in value.

The volatility of private equity company fees make the hybrid business model potentially more attractive to public market investors. The new strategy will create a listed firm with a bigger balance sheet than was previously envisaged, according to a source close to the listing. It will also leave the listed company and KKR's executives as the biggest investors in the firm's funds.

Fees
The latest prospectus would appear to raise questions around the viability of KKR's large buyout model. As dealmaking has dried up, fees earned by the firm – including more stable management fees and more volatile transaction fees, have slumped 62 percent from the market peak, to $331m last year, compared with $862m in 2007. Transaction fees alone fell 87 percent to $91.8m last year from $683.1m in 2007, although management fees have increased.

The firm's efforts to diversify may help stymie that decline. According to Sandler O'Neill analyst Michael Kim, the firm's capital markets division might fill the gap. The division's star has risen of late, particularly since it emerged as an underwriter of football club Manchester United's bond issuer earlier this year.

Portfolio companies
The firm's biggest challenge will be to prove it can generate returns from its high spending levels at the top of the market.

KKR was the only private equity firm to deploy more than $20bn in equity in the year to August 2007, according to research by Private Equity News. The firm's 2007 prospectus claimed that it had closed “the largest leveraged buyouts completed or announced in each of the US, the Netherlands, Denmark, India, Australia, Singapore and France”.

New records followed after the firm published its prospectus: its £12.4bn acquisition of UK pharmacy group Alliance Boots was the largest European and UK buyout, while its $45bn purchase of US energy company TXU remains the largest buyout globally. This time the firm is still one of the biggest private equity participants, but its largest deal since the collapse of Lehman Brothers in 2008 is the under-$2bn buyout of Korean company Oriental Brewery, less than a twentieth of the size of TXU.

The firm has since taken markdowns on Alliance Boots and TXU. But a source close to the listing said the firm expected to do better from its boom-time acquisitions than market sentiment might suggest.

Management
Henry Kravis and George Roberts remain the driving force behind KKR. But as top private equity executives begin to make way for the next generation – including Tom Attwood, who stepped down as chief executive of debt specialist Intermediate Capital Group last week – many observers wonder how long the cousins' dominance will last.

The firm has long sought to move towards a more normal corporate structure, giving different executives responsibility for operations in individual countries and sectors. The flotation could simplify that transition by providing the founders with a simple exit route.

But a person close to the company said Kravis and Roberts could be expected to remain at the top for some time. Investors will focus on how KKR manages its succession.

Ownership structure
KKR's ownership has changed since 2007. Once having a reputation for secrecy, the firm is now majority-owned by its staff and public shareholders.

That publicly-held stake is likely to increase after the firm lists in New York.

It is unclear when the firm's partners, who hold the remaining 70 percent of the management company, might sell their stakes, but a person close to the listing said they would look to raise more capital from the public markets over time.

International expansion
Overseas expansion has continued apace since 2007 despite the financial crisis. The firm has doubled its international offices from seven to 14 over the period, according to the latest prospectus. That expansion helped the group seal the $1.8bn acquisition of Oriental Brewery last year.

The overseas drive was made possible by aggressive hiring. The firm boosted its workforce by 50 percent since 2007, to 600 from 399, during a period in which many rivals pared their staff.

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