Description

Elevator Pitch

Investing in KKR today gives the opportunity to invest in a best-in-class alternative asset manager at a discount to peers with reduced fundraising risk having raised its major PE fund prior to 2022. KKR’s slate of credit and infrastructure/real assets funds are well positioned to grow as interest in those strategies become more attractive in a higher yield environment. Additionally, KKR’s Capital Markets business is an innovative new model that vertically integrates the transaction process and enables KKR to capture the typical investment banking advisory fees. We believe that this is >$1B p.a. revenue opportunity at incremental margins >65%.

Company Overview

KKR & Co, Inc (“KKR”) is an alternative asset manager platform that raises capital through limited partnership and perpetual vehicles to invests across private equity, real assets, and credit & liquid strategies. Additionally, KKR acquired Global Atlantic in February 2021, one of the largest fixed rate and fixed annuity providers, which provides a source of management fees and spread-related earnings. 

The company has three sources of earnings (2022 revenue and EBIT share):

Management, transaction & monitoring (“T&M”), and advisory fees (32% and 46%): Management fees are charged as a % of fee-generating AUM (“FGAUM”)  and differ based on strategy (private equity 120bps, real assets 80bps, and credit & liquid strategies 40bps). T&M and advisory fees are earned by KKR’s capital markets teams on the deployment and exit of capital; this team is responsible for the capital structure formation and advisory responsibilities typically held by an investment bank. KKR disintermediates investment banks and charges fees to their investment vehicles, essentially capturing the investment banking fee. These fees are generated at a high ROIC…for example, generated $1B of fees in 2021 with 60-70 professionals. After paying investment professional and operating expenses, KKR’s fee-related earnings (“FRE”) are pure free cash flow at 60%+ pre-tax margins. 

Principal investing income (30% and 49%): Principal investment income (“PII”) is earned through realized performance fees (20% of profits) in excess of a hurdle rate (typically 8%). This carry structure differs from strategy by strategy. Performance fees can be lumpy given volatile market conditions, investment performance, timing of exits, and potential clawback scenarios. The major cost associated with PII is compensation paid to investment professionals, which typically represent ~65% of realized performance fees. While carried interest can be a meaningful contributor to earnings, the lumpiness of realizations makes it difficult to predict when cash is generated, thus is awarded a discounted multiple vs. FRE earnings.

Insurance investment income (38% and 15%): KKR acquired Global Atlantic in 2021 with the hopes of creating a business in which it can grow AUM through non-institutional channels and grow its earnings stream beyond fee income into insurance spread-related earnings (generating a positive spread between cost of insurance liabilities and yield on assets) like APO. KKR generates insurance earnings through two fee streams: 1) management fees charged on insurance yield AUM (~40bps), and 2) spread-related net investment income (targets 15% ROE on book value after management fees paid to KKR). The management fee flows through FRE and is unfettered cash flow, but the spread-related earnings are comped against other insurance companies at MSD earnings multiples. 

KKR has a large balance sheet relative to other alt managers with ~$18B of investments and a book value of ~$24B. The balance sheet investments are comprised of capital commitments into KKR’s private equity ($10B, 56% of BS investments), real assets ($4B, 22%) and credit ($2B, 11%) funds and other investments ($2B, 11%). KKR’s investments do not pay management fees but pay ~15% of profits to investment professionals upon exit, which shows up in the P&L as realized investment income at the time of realization.

Valuation and Returns Discussion

KKR trades at an optically cheap forward P/E multiple of ~13x vs. other alts trading high teens. This discount is mainly driven by KKR’s mix of insurance/spread-related earnings, and its large balance sheet. EPS numbers can vary vs. Street estimates due to lumpy PII as alt asset managers realize their investments. KKR is targeting $7 of EPS by 2026, which we think is achievable. More specifically, we believe KKR can generate ~$5.88 of EPS by 2025 vs. Street at $5.79, driven by better than expected FGAUM growth (12% CAGR vs. 11% Street CAGR). FGAUM growth is the key point of differentiation and we have several reasons to believe KKR could raise ~$578B of FGAUM by 2025. Specifically, there are 3 key fundraising drivers that are impacting FGAUM: 1) KKR is actively fundraising for 30+ strategies with 95% of target AUM being raised in Real Assets and Credit, 2) $37B of AUM not yet paying fees expected to be deployed over the next 3 years. This capital represents raised capital that will start generating fees as soon as deployed, and 3) flagship PE fundraise in 2024 and 2025 that should raise ~$18B of FGAUM. 

We assume that KKR’s flagship strategy can raise a comparable amount to its last PE fund ($18.4B) and ~$25B from other PE strategies,combining for $43B of PE funds raised over the next 3 years. Combined with  KKR’s $37B of AUM not yet paying fees, that accounts for $80B of FGAUM. Within the 30+ strategies out to market, KKR will be fundraising for its Global Core+ Infrastructure (last fund closed in 2021 at $16.5B) and APAC Infrastructure (last fund closed in 2022 at $6B) in 2023 and 2024. Assuming these funds are upsized, and in addition to other infrastructure strategies, we believe KKR could raise ~$35B of total Real Assets capital over the next 3 years. Beyond Real Assets, KKR is also out to market to raise its latest direct lending and private credit strategies. Finally, KKR is benefiting from similar rates tailwinds as APO where annuity retail flows are driving AUM growth in their insurance business. Although KKR’s insurance business is smaller than APO’s, KKR still generates a comparable ~40bps on $142B of insurance FGAUM. All combined, it is reasonable to believe KKR will be able to raise $150-$170B of FGAUM over the next three years.

KKR is best looked at on a SOTP basis. As discussed above, FRE and fee revenue represent the largest value driver of KKR. Comps trade as high as 25x ‘24E FRE (BX and ARES) today, but most alts trade closer to mid-to-high teens FRE today. Historically, alts have traded closer to 20x FRE. We believe KKR’s FRE mid-teen growth over our investment period (margin leverage and FGAUM growth) warrants a high-teen multiple. One could argue that capital markets and T&M fees included in FRE should trade lower due to its lumpiness and lack of contractual cash flows, but we believe its higher growth (33% CAGR between 2019-21) and strong incremental margins justify a higher multiple. Combined with higher quality management fee revenue, KKR should justify a 18x FRE after-tax, SBC adjusted multiple. 

Insurance comps trade in the 6-8x range and the stronger peers generate a ~15% ROE…KKR’s General Atlantic business generates a ~15% ROE AFTER paying KKR’s management fee! We believe KKR should trade at a premium insurance multiple closer to the 8x. Additionally, out of conservatism, we’ve removed FRE related to its insurance business from the FRE earnings stream and have included it into the insurance earnings stream. Given the high ROIC of FRE earnings, it makes sense to apply a premium multiple to KKR’s insurance business. We assigned 8x to the business, but believe it’d be rational to apply an even higher multiple because the insurance-related FRE juices the insurance ROE to >20%. 

To value KKR’s carry earnings stream, we take the net accrued carry from the balance sheet, assume it is realized over a 4 year period, and apply KKR’s marginal tax rate. This provides us with a normalized carry earnings per share that we apply a MSD multiple to. 

KKR differs from peers because they invest their balance sheet alongside their funds via GP commitments. These commitments do not pay management fees, but upon realization, KKR pays realized investment income to professionals representing 10-20% of investment profits. The market applies a discount to KKR’s book value for two main reasons: 1) illiquidity, and 2) uncertainty regarding valuation marks. We believe a discount should be applied for the illiquidity, but believe the valuation marks are reasonable. KKR’s REIT portfolio valuation is led by an independent 3rd party, and its PE portfolio is first marked by an internal valuation committee with subsequent validations by an independent 3rd party. Additionally, given how much enterprise value is derived from FGAUM growth, it doesn’t make sense to actively deceive LPs with faulty valuation marks and jeopardize those relationships. This all being said, we should watch valuation marks closely and see how they compare to the realized valuation of portfolio exits. On the other hand, if one believes in KKR’s ability to grow intrinsic value in their portfolio companies, book value should theoretically grow, thus it’s more appropriate to apply a discount to a growing book value. Given KKR’s strong track record (Exhibit A), an 8% growth in intrinsic value is realistic. Additionally, a meaningful portion of KKR’s balance sheet investments (Exhibit B) is invested into their Core PE strategy (32% of investments on BS). KKR’s Core PE strategy is KKR’s long duration focused on investing into highly cash generative, and non-cyclical businesses (Buffett-esque). Since the beginning of 2017, the 19 Core PE portfolio companies have compounded revenue and EBITDA by 15% p.a. with no down years and a trough year of 6% bottom line growth (2020, impacted by COVID). The Core PE strategy owns high quality businesses including: Arnott’s Group, 1800 Contacts, USI and PetVet Care. More details on Core PE can be found in Exhibit C. Beyond Core PE, KKR has diversified investments across all of its investment strategies. In our base case, we assume balance sheet value grows at 8% annually and apply a 20% discount to our exit date balance sheet value. The balance sheet value is calculated by summing the investments and cash on the balance sheet, and subtracting corporate level debt, taxes and estimated compensation expense on embedded gains.

Today’s stock price implies we are paying ~14x ‘24E FRE (7% yield) for a best-in-class alternative asset manager growing FRE at mid-teens CAGR supported by both FGAUM growth and margin expansion. This is compared to alt peers that either trade at a substantial premium (e.g. BX and ARES) or have lower quality growth trajectories due to overallocation to PE or internal operating issues (e.g. CG and TPG). KKR, on the other hand, is focused on scaling its existing strategies in Real Assets and Credit where institutional investor appetite is strong. Taking a step back, paying 14x for contracted high quality earnings with the runway to grow mid-teens over the next 3 years is an exceptional investment opportunity. Additionally, we get to invest behind KKR, a storied investor with ambitions to be a world class asset manager.

Key Risks

1. Slowing realizations in 2023 vs. Street (1Q23, -25% vs. Street) and management guiding to continued realizations slowdown for rest of 2023. Other prominent alts are also indicating similar sentiment

   1. Realizations drives fundraising, thus a slowdown will negatively impact AUM growth as institutional LPs have weaker capital positions

   2. Stock is down on expectations that realizations would recover in 2H23, but realization delays may not recover until 2024 (or later)

2. 30% and 52% of pension and endowment fund AUM are invested in alternatives, respectively 

   1. Largest competitor (BX) has shifted focus to retail suggesting the institutional channel is becoming more saturated. Retail appetite for Alts is still unclear and unproven beyond REITs

3. Despite base and cap rates increasing over the past few years, KKR has only marked down its balance sheet returns by 5% in the LTM (1Q23). 78% of its balance sheet is invested in real assets and private equity

4. Kravis and Roberts both have >50% voting power through 2026 (or 6 months after death of both) 

5. Pays higher comp ratio for carried interest relative to alternative peers – Will pay out more carry to employees

Exhibit A

Exhibit B

Exhibit C

Catalyst

Continued AUM growth in-line with guidance

Earnings