KKR & Co LP (KKR.N) bucked a declining trend among alternative asset companies to report a 73.4 percent jump in quarterly earnings on Friday, driven by successful exits from private equity investments and a rise in the value of its portfolio.
Fears over the euro zone's debt crisis and faltering global economic growth have weighed on the valuation of private equity portfolios of firms such as Blackstone Group LP (BX.N) and Carlyle Group LP (CG.O), often mirroring stock market declines. KKR's portfolio has proved more resilient.
KKR's private equity portfolio appreciated 5.1 percent in the second quarter, while Blackstone's portfolio lost 4.2 percent of its value and Carlyle's portfolio depreciated 2 percent.
"Against a challenging economic and capital markets backdrop, we are pleased with our results," KKR co-founders and co-chief executives, Henry Kravis and George Roberts, said in a statement.
A major driver of KKR's gains was Walgreen Co's WAG.N investment in pharmacy group Alliance Boots GmbH. The biggest U.S. drug store chain said last month it would pay $6.7 billion for a 45 percent stake in the KKR portfolio company.
Although KKR has yet to book the money to be paid by Walgreen, the deal resulted in a huge mark-up of Alliance Boots in its portfolio, with the company's value on its balance sheet jumping from $391.7 million as of the end of March to $650.6 million as of the end of June.
KKR's 11 billion pound buyout of Alliance Boots in 2007, at the height of the credit boom, later raised concerns among investors that the firm fell into the same trap many private equity firms found themselves, overpaying and borrowing heavily for megadeals that have since dropped in value.
Walgreen's investment in Boots was therefore celebrated last month, not just by KKR, but by the wider private equity industry and referenced by Blackstone CEO Stephen Schwarzman on his firm's earnings conference call last week.
The deal raised KKR's valuation of Boots in its portfolio from 1.1 times its investment cost to 1.9 times, KKR said. Should Walgreen follow through with its plan to buy the remainder of Boots, KKR stands to earn 2.7 times its initial investment, a person familiar with the situation told Reuters last month.
"People were pleasantly surprised. It's a 2007 investment, a very large investment, and we have been saying for several years to our investors that we actually feel quite good about the investments we made in the 2006-2007 period," Scott Nuttall, head of KKR's Global Capital and Asset Management Group, told analysts on a conference call.
Were it not for the Boots deal, KKR said its private portfolio would have been relatively flat to slightly down. Its public portfolio was up 0.3 percent, outperforming a 2.8 percent drop in the S&P 500 Index .INX, the firm added.
INVESTMENT INCOME GAINS
KKR said second-quarter economic net income (ENI), a measure of profitability taking into account the mark-to-market valuation of its assets, rose to $546.1 million in the second quarter from $315 million a year ago.
This significantly exceeded analysts' expectations, beating even the highest of estimates from major brokerages. After-tax ENI per adjusted unit was 74 cents, compared with the average forecast of analysts polled by Reuters of 16 cents.
Gains came mostly from investment income, originating from balance sheet investments, rather than its funds. KKR does not distribute investment income to public shareholders, so distributed earnings were up only 1 percent to $104.5 million.
The second-quarter distribution per common unit was 13 cents, compared with 11 cents a year ago.
KKR, whose investments include retailer Toys R US Inc, Internet domain registration company Go Daddy Group Inc and hospital operator HCA Holdings Inc (HCA.N), said assets under management dropped to $61.5 billion at the end of June from $62.3 billion at the end of March due to payouts to investors.
KKR was founded in 1976 by Kravis, Roberts and Jerome Kohlberg. The firm gained fame through its $25 billion leveraged buyout of RJR Nabisco in 1988, a battle that was immortalized in the 1990 bestseller, "Barbarians at the Gate."
While private equity still accounts for most of KKR's assets under management, the firm has been diversifying into credit and hedge funds and last month announced the acquisition of Prisma Capital Partners LP, a hedge fund of funds manager with $7.8 billion of assets under management as of April 1.
On Friday, KKR said it would start a new capital markets business in joint venture with Stone Point Capital LLC will target middle-market and private equity-backed companies as well as make principal investments.
KKR gave few new details on fundraising. During the quarter it closed on $4 billion of energy and infrastructure fund commitments and raised more than $3 billion for its second Asian fund.
But it offered no new update on its North American XI Fund, which secured $6 billion in investor commitments last February. Nuttall said the fund was due to wrap up fundraising by February 2013.