UPDATE 2-KKR to acquire its specialty finance company for $2.6 bln

Mon Dec 16, 2013 7:57pm EST

* KFN shareholders to get 0.51 KKR shares for each of their KFN shares

* KFN valued at 35 percent premium to Monday's end of trading

* To boost KKR's book value by 13 percent from $10.07 to $11.34 per adjusted unit

By Greg Roumeliotis

NEW YORK, Dec 16 (Reuters) - KKR & Co LP said it would acquire its specialty finance company KKR Financial Holdings LLC (KFN) in a $2.6 billion deal, paid for with KKR shares trading at an all-time high, that will boost the private equity firm's dividends.

Launched by KKR in 2004 to invest primarily in a variety of corporate loan and bond instruments, KFN now has a market value of $1.9 billion, a fraction of KKR's $17.7 billion market capitalization.

By taking over KFN, however, KKR expects to generate additional earnings by substituting fee revenue it receives for managing KFN on behalf of KFN shareholders with investment income to be generated by what it will now be its own assets.

It plans to distribute 100 percent of the investment income it receives from KFN to KKR shareholders. Using a consensus estimate of Wall Street analysts, KKR's total dividend is expected to be 7 percent higher in 2014 as a result.

The transaction has echoes of KKR's merger with KKR Private Equity Investors LP in 2009, a heavily undervalued Amsterdam-listed private equity fund, which led to KKR becoming public and having a much bigger balance sheet than its peers.

While KFN was not as discounted as KPE, it traded at 0.9 times its book value despite its 9.2 percent dividend yield. Its shares are down 9.8 percent year-to-date versus a 64 percent year-to-date rise in the shares of KKR. KKR's offer, which has been approved by the boards of both entities, values KFN at 1.15 times book value.

Unlike KKR's private equity division that buys and sells companies, KFN is managed by KKR's credit investment arm that manages assets such as collateralized debt obligations and mezzanine debt.

"Through this transaction, we are acquiring a business with a fully invested, complementary portfolio of assets while increasing the scale and diversity of KKR's balance sheet," KKR's co-founders and co-chief executives Henry Kravis and George Roberts said in a statement.

KKR had $90.2 billion in assets as of the end of September while KFN's portfolio totaled just $2.9 billion. Yet the impact of the deal on KKR's balance sheet will be substantial, diluting its exposure to private equity from 68 percent to 44 percent.

KKR said the transaction would immediately add to its earnings in addition to boosting its balance sheet, giving it more capital to expand its investment platform further and invest in its funds. KKR's book value per adjusted unit will grow by 13 percent from $10.07 to $11.34, the New York-based firm said.

KKR offered to pay KFN shareholders with 0.51 newly issued KKR shares for each of their KFN shares, equivalent to a 35 percent premium based on Monday's closing prices. The deal is subject to a vote by KFN shareholders and would lead to them owning 13 percent of KKR.

KFN assets are already managed by KKR staff and so the two firms said there was very little integration risk involved. KKR said it expected the deal with KFN to be completed in the first half of 2014.

Goldman Sachs & Co and Simpson Thacher & Bartlett LLP are advising KKR, while Lazard Ltd and Cravath Swaine & Moore LLP are serving as advisors to the independent directors of KKR's board. Sandler O'Neill + Partners LP and Wachtell, Lipton, Rosen & Katz are serving as advisors to the independent committee of the KFN board of directors.

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