Description

KKR today offers a compelling risk/reward opportunity for long term investors. It is most certainly a company that has and will trade based on cyclical factors. This belies the fact however, that most of the value of the business is based on FRE (the company's estimate of the earnings that it derives on a recurring basis) which is both not cyclical (locked in for very long time periods) and growing over time at, frankly, incredible rates. As well, like all investors, periods of volatility such as the current one are necessary to create better opportunities going forward. KKR currently has $112bn of dry powder (up 67% from a year ago!) that it needs to deploy.

Track Record: of course there are two kinds of investment track records for alternative investment managers– fundraising/business building and investment. And of course they are related. 

KKR’s record on both fronts is pretty exceptional although I think you could argue that at this point, the one that matters the most is the fundraising/business building one. Many corners of the investment business have become very winners take all and PE is a great example. KKR and others simply have amazing brands which they leverage to grow AUM at amazing rates. In KKR’s case, they grew AUM 22% (!!) annually from 2004 to 2020, or 19% in organic terms. This is pretty amazing growth and the company believes it can grow FRE at “high teens” rates over the medium term. 

Some of this growth is driven by larger traditional funds (flagship etc) but more is actually the result of the company expanding its business in other ways. KKR has built new business offerings in different verticals such as real estate, credit and infrastructure. It has also built out different channels such as core (longer duration, lower fee) and is investing significantly in building a large AUM base targeted at a more retail customer. In addition, the company has expanded its international footprint over time both as a fundraiser and investor. Its private equity business in Asia has long been a source of underappreciated returns and future potential compared to peers. 

The chart following highlights the number of different ways the company continues to scale:

The company has also shown an ability to grow inorganically. Its $4.7bn acquisition of Global Atlantic Financial Group insurance company in 2021 gave it significant additional AUM and an additional capability to source lower cost liabilities.

In terms of investment track record KKR certainly has a very long history of producing outstanding returns for clients overall. The chart below from their 2021 investor day has the company’s PE track record. Obviously, this business is highly subject to the cycle but over time the company has done extremely well.

Valuation:  Although there are clearly elements of KKR’s business that do not necessarily match up well with the current macro backdrop (rates rising, risk of deglobalization, potential asset disinflation in places), it’s hard to understand the company’s current valuation. If you back out the $23.75 per share in net balance sheet assets ($13.25), Insurance assets ($6.50) and embedded carry ($4.00), you are left with a multiple of after-tax, after stock comp fee related earnings of around $2.15 for 2023 (a year forward since the growth is baked in) of around 15x. 

This simply seems oddly cheap for a business that has grown assets organically 19% a year for the last two decades. In addition, although they pay their people very well, the company’s interest in future carry is most certainly not worth nothing! In a good year for realizations like 2021, the company’s after-tax DE (distributable earnings) was almost double its FRE (earnings based on just recurring fees). The company also has a large and growing capital markets business that could be a hidden gem as well. 

In addition, KKR actually trades cheap on an adjusted FRE multiple to peers having underperformed BX and others by a significant margin of late owing to the perception (and probably reality to some degree) of greater cyclicality. I would just emphasize again however that the FRE earnings are NOT cyclical. In addition, the company has what amounts to a fortress balance sheet. This is a company where many earnings streams are highly leveraged but the company itself is extremely well capitalized.

Considerations: 

– Cycle- of course a significant recession and/or much higher rates would impact the company’s earnings particularly the smaller, more volatile piece which is driven by realizations

–Principal Agent issues- I think it’s probably fair to say that these companies are not run especially for the benefit of public shareholders as compared to companies in other industries although KKR insiders do own a TON of stock

–Regulatory Changes– I don’t think there is anything in particular on the horizon but this sector is always top of mind for certain sets of politicians

–Deglobalization– KKR is a very global business in terms of both fundraising and investments. 

Catalyst

Continued growth!