KKR & Co. L.P. (KKR)

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KKR (KKR)

2013 Investor Day

May 23, 2013 8:00 am ET

Executives

Craig Larson - Managing Director of Investor Relations

Henry R. Kravis - Co-Founder of KKR Management LLC, Co-Chairman of KKR Management LLC, Co-Chief Executive Officer of KKR Management LLC, Member of Nominating & Corporate Governance Committee, Member of Executive Committee, Member of Portfolio Management Committee and Member of PE Investment Committee

Henry H. McVey - Managing Director and Head of Global Macro & Asset Allocation

Alexander Navab - Member, Co-Head of Americas Private Equity, Head of Media & Communications Team, Global Co-Chair of Private Equity Investment Committee, Member of Management Committee, Member of Investment Committee and Member of Special Situations Investment Committee

Marc S. Lipschultz - Member and Global Head of Energy and Infrastructure, Member of Infrastructure Investment Committee and Member of Oil and Gas Investment Committee

Ralph F. Rosenberg - Member and Global Head of Real Estate

Scott C. Nuttall - Head of Global Capital and Asset Management Group, Principal and Member of the Management Committee

William Charles Sonneborn - Chief Executive Officer, Member of the Investment Committee, and Member of the Portfolio Management Committee

Girish Venkat Reddy - Chief Executive Officer, Member of the Investment Committee, Co-Founder, Managing Partner, and Director

Craig J. Farr - Member of KKR and Global Head of Capital Markets

Suzanne O. Donohoe - Member and Global Head of Client and Partner Group

William J. Janetschek - Chief Financial Officer of Kkr Management Llc, Member of Other Committee, Member of Risk Committee and Member of Valuation Committee

Analysts

Robert Lee - Keefe, Bruyette, & Woods, Inc., Research Division

Mitch Rubin

Michael S. Kim - Sandler O'Neill + Partners, L.P., Research Division

Christoph M. Kotowski - Oppenheimer & Co. Inc., Research Division

Michael Carrier - BofA Merrill Lynch, Research Division

Marc S. Irizarry - Goldman Sachs Group Inc., Research Division

M. Patrick Davitt - Autonomous Research LLP

Presentation

Craig Larson

.

Okay. If I could ask everyone please to take their seats, we're going to get going. Thank you, everybody for joining us. We really appreciate all of you taking the time. My name is Craig Larson. I'm the head of Investor Relations for KKR. Thank you, also, everyone who's joining us through the live webcast feed.

Before we begin, in earnest, I do need to remind everybody that today's presentations will contain forward-looking statements, which do not guarantee future events or performance. Please refer to our SEC filings for some cautionary factors. And we'll also refer to non-GAAP measures over the course of the day, which are reconciled to GAAP figures that are in the materials that are posted to our website. We are excited to be here. This is our second Investor Day. Our first Investor Day was held a little over 2 years ago in March of 2011 and it's been fun preparing for this event because it's given us an opportunity to look back and think about where we were 2 years ago and what we talked about relative to where we are and how we think we are poised for the future across all of our business segments.

You see on the screen, the agenda for today. Shortly, Henry Kravis is going to begin. Henry McVey is then going to follow with some macro-oriented thoughts and we're then going to walk through the key components first of our Private Markets segment. We'll talk to our Americas Private Equity business, our Energy and Infrastructure business and then our real estate platform. We'll then take a short break. And a little after 10:00 this morning, Scott Nuttall is going to take the stage to talk about our balance sheet as well as some strategy points and we'll then walk through our Public Markets segment. For the first time, Girish Reddy is going to present to this audience. Girish is the founder of Prisma. We'll talk about our Capital Markets business. Suzanne is going to walk through the client and partner group and then Bill and I will wrap up with some thoughts on our financial performance, as well as some perspective that I hear from unitholders.

One final logistical point. Instead of having each of the presenters answer a question or 2 after each of their segments, we'd ask that you hold your questions 'til the very end. We've actually allowed for a pretty lengthy period of time for a group Q&A discussion, so all the presenters are going to join us on stage here. And with that, I'm thrilled to turn the stage over to Henry Kravis.

Henry R. Kravis

Thank you, everyone, and good morning to you. I appreciate you joining us today and I'm also very pleased to [indiscernible] here because a lot has taken place since the last time we met.

The one thing that seems to have remained constant is that for whatever reason, we have a market disruption. 2 years ago, when we had our investor conference, Japan had the tsunami literally, that day. Today, we'll see what happens, given the market turmoil on the Bernanke [indiscernible]. I'll see what happens there.

What you're going to hear about today is a lot about where the strategy is for KKR, what are we focused on going forward, and how will we grow the firm? But the one thing you're going to hear is a consistent theme [indiscernible] is that we're focused very much in growth. We're focused on how we [indiscernible] disciplined in our approach. [indiscernible] franchise that we have remains [indiscernible] something [indiscernible] to focus on very much. And also, you're going to hear quite a bit about our balance sheet. This is a differentiator that we have and very important to the future growth for KKR.

You're also going to hear about our continued diversification and how we are disciplined in that approach.

The one thing we're always focused on is how can we best serve [indiscernible] investors and how can we serve companies. And we come at it, really looking at it as a solutions provider. We're solutions-oriented so everything we do at KKR is focused on can we offer a solution to a company or can we offer a solution to an investor that has a need for a particular type of investment. And this allows us the differentiation that we think is very important.

So what has really changed since the last meeting? Well, last time, I told you that there are 3 legs to the stool. We're in Private Markets, Public Markets and Capital Markets. That has remained very consistent.

But what you will see here is that we have grown out a number of these investments areas and you will hear about those as we go through the morning.

The private equity side continues to be core to KKR. That will continue to grow and we will continue to focus on it as it is central to everything that we do with the firm. Since the last meeting, we have raised quite a bit of money for our North American private equity fund, a China growth fund and quite a bit of money out in Asia for our second Asia fund in private equity.

Energy and infrastructure has grown tremendously and that is on a very fast trajectory right now. Money is coming in. We are investing that money, I think, quite intelligently and quite strategically as we're teaming with various operators here in the States, primarily and some overseas as well. You'll hear from Mark Lipschultz and talking about that. Our infrastructure business is also scaling quite nicely and we've made some terrific investments which you will hear about.

Real estate in the private market side is a new initiative. Ralph Rosenberg is here, who's joined us from previously, had been at Goldman Sachs where he was involved in the real estate operations there. White Hall, one of the early founders of that operation and then we were lucky enough to have him join us now about 2 years ago and we are scaling that business quite quickly and you'll hear about that.

Public Markets, very important. Our tradable credits will continue to scaling very nicely, both leverage loans, high yield. Our private credit is also scaling quite nicely. Direct lending is something that is taking quite a bit of attention now and offers us a real opportunity to be again, a solutions provider, along with Mezzanine. And of course, our special situation opens up a whole broad array of opportunities for investment for us.

In our hedge fund solution, since we last spoke, we have been fortunate to have Girish Reddy and his team at Prisma join us. You'll hear from Girish this morning and we also have estates that we have taken in hedge funds, for example in the filler [ph] which you'll hear about as well.

Capital Markets is very important and that actually spans the whole firm. Craig Farr is going to talk about that. It's a critical part of what we do and how we think about how it fits in. Of course, ties in to the balance sheet as well. But Capital Markets is scaling quite nicely. And the good part about that is that we have that focus both on our portfolio of companies that we have, which are well over 80 companies in the portfolio today, as well as our third-party business there.

The thing that you've seen is in the last roughly, 2 years now, are very good results. The fee paying assets, and I focus on fee paying because that's critical. Having assets for the sake of assets is not what we're all about. But really where are we generating fees and our fee paying assets as you can see, have grown from $46 billion to $62 billion as of our last reporting period. The total distributable earnings that we have, have grown quite nicely as well. They've doubled from $700 million to $1.4 billion and you also see that our book value has increased from $8.38 to $9.89. All moving in clearly, in the right direction.

But we could not have done this without building out our team. And the team has continued to grow significantly over the last 4 years. We put people through a pretty extensive interview process. So it's not hiring for the sake of hiring, but people that we feel could really fit in to the culture that we have at KKR, be good team players and also could play a very critical role as we're expanding into the different businesses.

The last Investor Day that we had, we had 787 people. Today, we have 1014 people at KKR. Many of them come to KKR with a big network of clients, a network of contacts for us, as well as a lot of expertise in their particular business that they have.

Second point that I'd like to say, we could not have done this without having enormous amount of patient capital, something we have focused on. And over 75% of the assets that we have under management today have a life of somewhere between 8 years and 18 years. And it's an important point to remember because that's not fleeting capital but rather, that's capital that will be with us for a long time.

And don't forget, the bottom line of this slide. It's very important that you pay attention to that because that's the balance sheet, and that is a real differentiator, and we're going to emphasize that today. We have a section on that when my partner Scott Nuttall comes up to talk to you. It's critical because the reason it's so important, it has today as of our last reporting period, about $7.1 billion, which is up from around $4.2 billion the last time that we met.

It's a differentiator for a number of reasons. One, keep in mind, our balance sheet are 100-cent dollars. KKR itself and all of you and unit holders of KKR own the balance sheet. And that's 100-cent dollars versus the funds that we have very important also to what we're doing, but the carried interest is somewhere between 10% carried interest depending on the type of fund and 20%. So there's a big difference and we are focusing on that.

It's also a very big differentiator in that it helps us have an alignment of interest, given that the KKR employees own about 64%, KKR in a fully diluted basis. What that means is we're the largest shareholders obviously, in KKR. In addition to that, KKR executives invest alongside the balance sheet in all of the different investments that we make. And as a result of that, that gives us -- we're eating our own cooking and that's very important for us as well.

We also mentioned on the last quarterly call, that we're going to pay out 40% of the earnings off the balance sheet going forward. And so you're going to be getting not only the earnings from carried interest and the fee paying and the fees that we have, but you'll also be getting it from the balance sheet, which is also going to, we think, hold us in very good stead.

Now, we're often ask, how are we different, how are we viewed? And well, this slide, I think, sort of says it all. We're One Firm. What does that mean? Of course, you're One Firm. Well, what it means is that every single person at KKR is paid on how well the firm does. We don't have silos. We work in teams. We work around the world, but every single firm is -- everyone in the firm works together to help make the firm a better place. And this is very important. So we're sharing ideas, we're sharing contacts, we're not afraid to say well, look, I'll get on a plane and I'll help you, I know it's not my deal, but I do you have some expertise so I'm happy to get on a plane or I'm happy to make that call and that's very important.

Another thing that has taken place in our One Firm approach is now that we have a focus on our global macro, as well as on stakeholder issues and public affairs. Brought over to KKR in the last few years, 2 terrific people, Ken Mehlman came with us, now about 4 years ago and heads our public affairs. That has made a huge difference and he has put together and lead for us in 6 different joint ventures we have with organizations like Transparency International, Environmental Defense fund and so forth. And that's made a huge difference and has made one, as better investors. It's made us aware as we invest around the world, of issues that we need to focus on and it also is quite good for all of our investors that are concerned about these issues as stakeholders as opposed to just how much money you're going to make. So it's very much rounded out what we have.

The area that we were missing the last time that we met with you and today, we have solved that problem very much so, is a focus on macro and asset allocation. We're very fortunate to be able to bring Henry McVey over from Morgan Stanley, where he headed Global Macro and Asset Allocation for Morgan Stanley, but he also brought his whole team to take our -- they're now here. You'll hear from him after I finish and that has also made us better investors and has helped us tremendously as opposed to just focusing on the one thing and being micro-focused because that's not what we're focused on today.

The one thing as you see in this one -- on the One Firm approach, which is very much ingrained in all of our DNA at KKR and that's our culture and our values. And I'm not going to go through each one of those. You can read what they are. But I'll just say to you that every firm meeting that we have, there's not a meeting goes by that George or I don't mention the culture and values to everyone at the firm. And we ask people to be -- to remind themselves, to pull out the sheets, to go online and take a look at what they are because that is very much what drives the business.

Another part that helps us a lot in our One Firm approach is our Capital Markets business. KCM today spans the firm and its used in almost every one of our businesses. Whether they be internal for our portfolio of companies or investments we have all the way from Special Situations, Private Equity or external now with the new venture that we have. You'll hear about from Craig Farr, MerchCap Solutions, which is a third-party initiative where we're now building that out and escrowing quite nicely.

I want to give you an example of the One Firm, what it means. A company called Sentinel. Sentinel is a plantation timber business down in Australia. In the end, our Asia fund made the investment in March of this year but it didn't start out that way. It actually started out as an idea that came out of special situations. It was a group out of London, was thinking about the timber industry as something that might make sense for special sits. They identified this company, spent a lot of time talking to them about asset-backed financing because the company needed the capital. And in the end, it turned out that they were actually much better off coming up with an equity solution. And it was the equity solution that drove our final outcome and it ended up being put into Asia Private Equity. It's a company that we now control in conjunction with the management team that had that.

Another example of that is a company called Yuralita [ph]. Yuralita is a Spanish building materials business. Just like Sanoto [ph], we ended up having people from the U.S. We had people from Europe. We had people from Asia who were involved in that because they brought a special expertise. We had people from special sits, private equity and infrastructure in the Yuralita situation, all come together. And again, no one raised their hand and said that's my idea or that's my deal.

Now, how do I measure progress as we go forward? One of the -- the 2 areas that I like to focus on. I like to focus on total distributable earnings and what is our distribution to all of our unitholders. To me, a successful outcome is more cash earnings and that's what we focus on. Long-term cash earnings and short-term cash earnings, both there.

Now as you can see from this slide, what we've been able to do is we've doubled our distributable earnings over the last couple of years. We've gone from $738 million to $1.449 billion, a very good number. Our cash component has also increased dramatically and that is in all of our companies with the exception of -- or our fund with the exception of our China growth fund and our European too. We are now in carry.

But another thing that I like to focus on, what is our distribution per unit? Well, our distribution per unit as you can see, has doubled also from $0.60 to $1.22 there.

Now there's a thing that I also want to focus on and that's on this slide. Investor Day in 2011, we only had 33% of our private equity investments that actually, we're in a position where we could payout cash carry.

Fast-forward to today and we have 84% of our assets in private equity that are now in carry mode, which means that as of the end of the first quarter, which we just finished or now into our second quarter, we have a greater than $30 billion that we are actually are in a position as we recognize the gains there, to pay out the cash carry. And that will make a very big difference as we go forward on the distributable earning. Now, what am I focused on in summation as I think about over the next several years and what am I watching?

There are really 4 areas. Performance being 1. If we don't have performance, all else doesn't really count. We're focused on that very strongly.

Secondly, people. It's one of the things we spend a lot of time. George and I spend enormous amount of time talking to our team, interviewing new people, thinking about how we can bring stronger people onboard to help us grow our business and that's very important to us.

Number three, how do we increase our balance sheet? That's also very important to us both from an organic standpoint and from an acquisition standpoint, and we're going to continue to be very disciplined in our approach to making acquisitions. We're seeing a lot of opportunities, people are coming to us and one thing actually helps another. For example, in Yuralita, a number of calls that we have gotten from people said we'd like to team up with KKR, we'd like to consider either joint venture or merging into KKR because we saw what you did there in Yuralita where you invested over $400 million across a number of your pockets. We can't do that in our organization, but we think teaming with you, that there will be a real benefit to both of us.

We also very much want to broaden our client base. Last time we met, we had a lot of clients, but not nearly the number of clients that we have today. And you're going to hear it from Suzanne Donohoe who will talk to you about how we have focused very strongly on improving our client base.

So when you sum all this up, it's people, it's culture, it's performance and it's our balance sheet that really is a differentiator. And thank you for listening to me this morning, and thank you for showing up so early to listen to what KKR has to say. With that, I'm going to turn it over to my partner, Henry McVey, who is going to talk to you about what we're focused on from a macro standpoint. Thank you.

Henry H. McVey

Thanks, Henry. So my name is Henry McVey. I had our macro in asset allocation effort, we came here about 2 years ago. And what do we do? We work with the deal times, the investment committee, the management committees, the Boards, as well as our portfolio of companies, thinking about how macro influences can invest -- can affect micro investment decisions. We process about 8 deal requests per week. I travel globally. I spend about a week per month on the road, trying to assess the competitive landscape. We also tried to mine all the data that we have out there in terms of our 82 portfolio companies, to make sure that we understand what's going on. So we're still a micro firm, but we want to have a macro overlay. And that's really what is incumbent upon us to do.

I also sit on the balance sheet committee of the firm. If somebody covers financials, actually, asset managers and brokers for 10 years plus, I can't emphasize how important that is in terms of what we're doing for the business model. And as you think about all the people that you hear about today, think about that balance sheet driving the ideas where we can put capital behind it.

So what do I want to talk to you about today? I want to talk to you about what we're seeing out there and how we are thinking about allocating our client's capital and how you should think about that in terms of where KKR is going to be driving the company.

Number one, there's a lot of money on the move right now. The opportunity to earn equity-like returns with credit-like risks that you could do in 2009, '10, '11 and '12, I think that trade is over. And that money is looking for a home. And it wants a solutions provider when it's looking for a home. Sometimes it wants equity, sometimes it wants debt, sometimes it wants bridge financing, sometimes real estate. We're helping our clients find a home for that capital as it's starting to move as spreads have come in.

Second, when you think about Wall Street, you have to have a view. Dealer inventories have dropped 80% since the Great Recession. That has created a tremendous illiquidity premium that's out there. Small and medium-sized businesses around the world can access capital the way they used to. That's driving our Mezzanine business, our Special Situations business, our Direct Lending business. And everyday, we think of a new opportunity or somebody approaches us about a new way to use our balance sheet, use our investor's capital to actually take advantage of this illiquidity premium in a world where real rate is around 0 in the developed market.

Third, I think you got to have a view on the central banks around the world. In my view, they're doing a very correct policy of trying to run nominal GDP above nominal interest rates.

When you think about how you get out of a de-leveraging cycle, you have 3 choices. You can raise taxes to the rich, that's not real popular; you can cut social benefits to the less wealthy, that's not a very popular option; or you can quietly try to make your debt go away by running nominal GDP above nominal interest rates.

We've got game on right now. ECB, Fed, Bank of Japan, Bank of England, they're all doing that. And in that type of environment, we want to find things that have yield growth and inflation hedging. We don't want to put investors in things like TIPS where you have to pay for the right to own inflation protection. When you hear from my colleagues Ralph Rosenberg and Mark Lipschultz, that's exactly what we're doing with the buildout of our real assets franchise. And I think we have one of the leadership positions in this business and you'll hear a lot more about that today. The other thing I would highlight is just in the emerging markets. Today, KKR is a 17-office, global firm. I'm impressed that somebody came from a large global industrial bank, we are in every part of the world right now, providing capital in a solutions-oriented manner to folks who need it.

And what I see out there though, is a world where I think we can all agree the consensus is that 60% to 70% of global growth comes from the emerging markets. The question is are you going to make money in the big public emerging markets? And my view is no. I think they're flawed indexes. I think they're stayed intervention into these companies now, where they're working on behalf of the citizens and not the shareholders. A lot of what we're doing in the private equity side helps to create alpha in that situation. We're going direct, getting consumer businesses and we're trying to create private enterprises that can actually get you leverage to the growth of the emerging markets consumer. And I think it's a very differentiated product and I think our Asia 2 raise is a testament to that.

And finally, I want to just tell you where I think we are in the economic cycle and our base views we're about midway through. And particularly in the U.S., we think some of the cyclical parts of the economy are starting to kick in.

So let's just run through the macro. This is pretty straightforward stuff, 10-year yields right now. On a nominal basis, just under 2%. It's not real hard to sit down and talk to a CIO of any pension or sovereign law fund and say your long-term expected returns given where the starting point is, are pretty dismal.

More importantly on the right-hand side, you see that spreads have stopped coming down with treasuries even with QE. And what does that tell you? It tells you that in the liquid market, there's an absolute rate of yield that investors will no longer accept because of the amount of risk that they're taking and that's where a lot of what we're trying to do, we see opportunity.

Second, I don't know if that happened, the last fall off of Wall Street balance sheets. That must've been the Japan crisis last night, but I think that's an incorrection in the chart.

But the point is still the same, which is dealer inventories have dropped 80%. You may not agree with the KKR view, but you should have a view as an investor. When dealer inventories come down 80%, what's happened? Illiquidity premiums have boomed. Investors were right during the great financial crisis, to run into deflation assets and liquid assets. But what happened is it overdiscounted what the high-yield spread was and then it created a massive illiquidity premium. If you're a pension and you're trying to get 7% in a 0 real rate environment, 2% nominal and we can get you 300 to 500 basis points on an illiquidity premium by using our underwriting expertise, that is an opportunity. And so, it may not be a double or a triple or an internet stock, but if you're looking for a good risk-adjusted return, that is where we're driving a lot of our business. But if in terms of special situations, mezz, direct lending and other opportunistic credit. And I think if somebody comes here and works with our clients a lot on this, people underestimate how much we're doing for our clients in terms of using our opportunistic approach to really generate alpha for our clients.

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