Bull of the Day: KKR & Co. (KKR)


December 20, 2013 |

Asset managers and private equity firms may not come to mind when you think of the hottest industries this year, but this week they notched higher again in the Zacks Industry Rank into the top 6%. And since these masters of investing are a group I really enjoy researching and investing in, I had a hard time choosing which #1 Rank company to write about.

I decided to go with the firm that started it all: Kohlberg Kravis Roberts & Co., now simply called KKR (KKR - Free Report) . As the company says, "The story begins on May 1, 1976, when KKR opened its doors as a firm specializing in management buyouts, a unique approach to investing that pioneered an entire industry: private equity."

KKR provides a range of asset management services to its investors and delivers capital markets services to its firm, its portfolio companies and its clients. The company operates private equity funds that take either controlling or strategic minority ownership positions for long-term appreciation.

They are also very active in the debt and credit markets, investing in leveraged loans, high-yield bonds and less liquid credit products. And, on behalf of portfolio companies, KKR arranges equity and debt financing and offers capital market advice.

Money Flows to Expertise

With a market cap of $7 billion, KKR grew its assets under management (AUM) to $90.2 billion as of September 30, 2013, up from $83.5 billion in the June quarter.

Asset managers and private equity (PE) firms do especially well in bull markets as the value of their investments rise, more dollars are attracted to them, and more revenue is generated from fees. The leading PE firms like KKR, Blackstone (BX - Free Report) , and Apollo Global (APO - Free Report) leverage specialized areas of research around the globe to find undiscovered opportunities in non-public companies and debt markets.

Institutional investors such as pension funds, endowments, foundations, insurance companies, and sovereign wealth funds allocate to these "money masters" because they trust their unique expertise in diverse corners of global financial markets. And a KKR can often provide the non-correlated investment exposure that these big funds need but can't find on their own.

But as you may know, Blackstone has been a big buyer of single family homes in the past two years with a special fund that they allocated over $13 billion to. And the old pro KKR has not been resting on its laurels either, noting recently...

"Our expanded focus encompasses exciting and growing areas for KKR: energy & infrastructure, real estate, growth equity investments, and a range of debt and public equity investing."

And another thing to keep in mind about the pursuits of PE firms is that they generally have some of the longest time horizons on Wall Street. They develop and nurture their non-public investments over many years before harvesting the gains. They are the steady elephants in a world of frenetic, high-frequency chimps.

Rising Estimates, Favorable Acquisition

After KKR's 3rd quarter earnings report, where they beat the Zacks consensus EPS by 50%, analysts scrambled to raise estimates. The full year 2013 consensus went from $2.19 to $2.53 and 2014 was bumped from $2.35 to $2.50.

GAAP net income was $204.7 million for the quarter ended September 30, 2013, up from $127.4 million in the comparable period of 2012. And over half of this haul was due to fees with fee-related earnings of $106.0 million and $292.2 million for the quarter and nine months, respectively, up from $90.7 million and $233.8 million in the comparable periods of 2012.

For the quarter and nine months ended September 30, 2013, the carrying value of KKR's private equity investment portfolio appreciated 5.9% and 12.5%, respectively.

And this week, KKR announced a deal to acquire KKR Financial Holdings LLC (KFN) in an all-stock deal worth $2.6 billion. KKR Financial is currently managed by a subsidiary of KKR Asset Management, a subsidiary of Kohlberg Kravis.

Based in San Francisco, KKR Financial was founded in 2004 as a mortgage real estate investment trust (REIT) but later turned into an investor in corporate debt after being hit by the sub-prime mortgage crisis in 2007. Being a specialty finance company, it operates a wide range of asset portfolios and primarily invests in financial assets including private and public equity investments, high yield bonds and distressed securities.

The purchase will be funded from a proposed new issue of 100 million shares. The deal, which is subject to a vote by shareholders of KKR Financial, is expected to close by the first half of 2014.

According to Kohlberg Kravis, upon closure the deal is expected to pave the way for a 2% accretion on Kohlberg Kravis' total distribution per unit basis while its balance sheet is expected to grow from $7.2 billion as of Sep 30,2013 to $9.3 billion. Further, it is expected that the acquisition will enhance liquidity, increase return to shareholders and build capital.

Private equity firms are often structured as limited partnerships where a certain percentage of earnings are distributed to partners and shareholders through regular and special dividends. According to analysts at Wells Fargo...

"The deal is accretive to most of KKR’s metrics with the biggest positive being a bump-up in cash flow and the dividend. Even though the metrics look good in our view, we are a bit surprised by the deal given KKR IPO’d KFN as recently as 2005."

But overall, the analysts felt that this was another positive step in KKR's continued transformation beyond traditional PE roles. They reiterated their Outperform rating and a $26-29 valuation range for KKR shares.

Whether or not you find KKR to be an worthy investment opportunity at this point, be sure to check out the whole Investment Management industry group on our site. With asset managers like Artisan Partners (APAM - Free Report) and Virtus (VRTS) also holding the Zacks #1 Rank, while BlackRock (BLK - Free Report) and Affiliated Managers Group (AMG) carry the #2 Rank, there are plenty of solid financial companies to choose from if you want exposure to the "money masters" in this persistent bull market.

Kevin Cook is a Senior Stock Strategist for Zacks where he runs the Follow The Money portfolio.

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