Legendary KKR dives into lending, shakes up Wall Street
With $102.3 billion in assets under management, the brash buyout firm is underwriting and syndicating debt and equity, lending money directly to distressed companies and financing the deals of midsize private-equity firms.
Henry Kravis, the king of rough-and- tumble leveraged buyouts, picked up a phone at his home in Palm Beach, Fla., and called the chief executive of one of Spain’s biggest producers of building materials.
It was March 2013, and Madrid-based Uralita, reeling from Europe’s credit crisis, had hit a wall. The company faced a loan repayment to five Spanish banks that were reluctant to keep rolling over the debt.
Kravis was offering Uralita a $435 million lifeline from a $2 billion fund that invests in distressed businesses. The catch: CEO Javier Serratosa had to agree to work solely with Kravis’ private-equity firm, KKR and turn down other offers, including one from Blackstone Group.
Serratosa and Kravis spoke for an hour, bonding over people they knew in common and their love of shooting red-legged partridge in the Spanish countryside.
“He was out of ammo, and he wanted to know, ‘If I pick you, will you be there at the finish line?’ ” Kravis says, sitting in his 42nd-floor library at KKR’s Manhattan headquarters. “I tell our guys, ‘Don’t ever go in and bait and switch.’ It’s the worst thing you can do. If we tell you we’re going to do something, we’re going to do it.”
Making a call to rescue Uralita shows how far Kravis has come since his firm’s 1988 bare-knuckle takeover fight for RJR Nabisco earned him a reputation as a corporate buccaneer.
At 70, Kravis shows no sign of getting ready to retire. He and co-founder George Roberts, also 70, are eager to make sure they don’t miss a juicy deal. They have been using their legendary names to open doors and transform KKR into a nimble credit player that can act as lender, investor and syndicator at the same time, making it reminiscent of banks like Goldman Sachs Group, minus the sales and trading.
With $102.3 billion in assets under management, KKR is underwriting and syndicating debt and equity, lending money directly to distressed companies and financing the deals of midsize private-equity firms. That’s on top of KKR’s own private-equity business, which owns or holds stakes in more than 90 companies with combined annual revenue of $200 billion.
Kravis and Roberts have survived at the peak of financial power even after blunders such as the KKR-led $48 billion 2007 takeover of what is now Energy Future Holdings, the Texas utility that filed for bankruptcy in April.
“After nearly four decades, despite some horrendous losses, the dot-com and subprime crises, and vituperation in the media, the firm seems as bold as ever,” says Erik Gordon, a professor of private equity, business and law at the University of Michigan in Ann Arbor.
So does Kravis.
He has defended private equity from attacks that he and his peers are job destroyers and asset strippers. He and his wife, Marie-Josee, president of the Museum of Modern Art in New York, gave $100 million in May to the Memorial Sloan Kettering Cancer Center, matching the size of the gift he made in 2010 to Columbia Business School, from which he earned a master’s degree in business administration in 1969.
KKR has a $10 billion balance sheet at its disposal to support and expand underwriting, far more than any other private-equity firm. It has managed $4.1 billion of debt and equity sales for companies since 2011.
The firm, which listed on the New York Stock Exchange in 2010, has added energy and infrastructure investing, a maritime finance unit and credit and hedge funds to its arsenal.
“Our balance sheet gives us that extra firepower,” Kravis says. “We can provide almost any kind of debt product that a company may need. We can provide equity, and we can take minority or majority positions in a company.”
KKR and other asset managers have stepped into the void left by banks forced to sell assets to meet tough new capital adequacy rules in the wake of the financial crisis.
“They have built a large shadow-banking activity that is beyond the reach of financial regulators,” says Colin Blaydon, a professor at Dartmouth College’s Tuck School of Business in Hanover, N.H. “No one has figured out if this means there is systemic risk that is not getting the same oversight as the risk that brought us 2008.”
Private-equity firms don’t pose dangers unless they are financing long-term lending with high levels of short-term debt, says Adair Turner, a former chairman of the U.K.’s Financial Services Authority. Regulators need to be alert to loan funds transforming into de facto banks with excessive leverage financed by short-term repurchase agreements, he says.
“What things are called and what they do continually mutates,” Turner says. “Nonbank lending will start out like that, but five to 10 years later, it will have replicated the risks of banks if you’re not careful.”
KKR says it isn’t courting the same risks as banks because it doesn’t have deposits and doesn’t rely on short-term borrowing.
“The alternative capital markets are doing exactly what the regulators want, which is to find other sources of lending to middle-market companies to properly finance companies to grow and create jobs,” says Craig Farr, who oversees the firm’s asset-management unit.
What distinguishes KKR isn’t its size as much as its model, clients and bankers say. Since 2009, it has deployed an array of lending vehicles, from bailout loans to those used to fund leveraged buyouts or refinance midsize companies’ debt.
It has lent directly to firms such as Hilding Anders, Europe’s largest mattress maker, and Excelitas Technologies, a Waltham, Mass. — based electronics products provider.
KKR’s debt funds are reaping big returns. Its special-situations fund had a 47 percent gross average annual return as of March 31, according to company filings. About a quarter of the fund has gone into bailout loans, and most of the rest into beaten-down credits.
Like a bank — and rare among major private-equity companies — KKR is able to syndicate, or market, blocks of debt and equity to investors. It’s one of the only firms besides Blackstone and Ares flexible enough to invest across the capital structure of a company, says Jon Mattson, a partner at Trilantic Capital Management, a New York — based buyout firm with $6 billion in assets.
“KKR is much more of a merchant bank,” Mattson says, referring to the practice of advising, investing, lending and underwriting. “They are doing what investment banks in the U.S. did 30 years ago. If you ask who the new Goldman Sachses are going to be, you can see it already.”
Kravis founded KKR in 1976 with Roberts, his cousin, and their former Bear, Stearns boss, Jerome Kohlberg. Three years later, they captivated Wall Street with a $380 million purchase of industrial pumps maker Houdaille Industries.
The deal’s cutting-edge debt architecture, consisting of bank loans and junior debt, became the prototype for every leveraged buyout that followed. KKR dominated the buyout world in the 1980s, even after Kohlberg left in 1987. Its 1988 victory in the $31 billion takeover battle for RJR Nabisco inspired the best-seller “Barbarians at the Gate.”
Kravis traces his campaign to change KKR to 2002. Williams Cos., a pipeline operator that had been talking to KKR about a buyout, suddenly needed $900 million to avert bankruptcy. KKR drew up a deal for Williams that it couldn’t do itself because it involved only debt and no equity. Warren Buffett stepped in, earning a big profit, Kravis says.
“The light goes on,” Kravis recalls. “We had to figure out how we don’t throw these ideas away.”
KKR started its first debt vehicle, KKR Financial Holdings, in 2004. The reinvention kicked into high gear in 2007.
In 2009, KKR moved full tilt into lending to companies it didn’t own. The next year, it became the first big private-equity firm to underwrite and syndicate debt and equity offerings, similar to Wall Street banks, to unrelated buyout sponsors and companies.
Not all its wagers have paid off. In June, KKR announced it was liquidating an equity hedge fund it started after hiring 12 Goldman Sachs proprietary traders.
KKR is betting big on Europe. Kravis, who travels there once a month, says banks in the region are behind the U.S. in ridding their books of bad assets.
“They kicked the can down the road,” he says. “Europe today is where the U.S. probably was a few years ago.”
In February, KKR paid $140 million for Avoca Capital Holdings, an Irish credit-investment manager with $8.4 billion in assets. It will blend Avoca into its lending mix and plans to syndicate European offerings.
Avoca co-founder Alan Burke now oversees KKR’s credit platform with Nat Zilkha.
KKR’s setup resembles some of what banks did before the 2010 Dodd-Frank Act and its Volcker Rule shuttered proprietary- trading desks.
“Banks like Goldman and Deutsche would originate loans on their prop desks,” says Erik Falk, KKR’s co-head of leveraged credit and a Deutsche Bank alumnus. “They’d take some down and syndicate the rest. The difference is, we provide long-term capital that is not backed by deposits or guaranteed by the government.”
Kravis points to differences with banks in scale and cost, starting with KKR’s eschewing an army of traders and salesmen and refusing to leverage its balance sheet by overloading it with debt to magnify profits.
“We’re not going to bet the firm,” he says. “Banks are huge. They’ve got thousands of salespeople, and they can underwrite a lot of things we just can’t do. We are not the next Goldman Sachs or JPMorgan. We are opportunistically doing what they did.”
For his part, Kravis sounds like he’s just getting started.
Sitting next to a photo of Joe & Rose’s, the Manhattan restaurant where he had dinner with Roberts the night before setting up KKR, Kravis says he thinks the firm is as well-positioned now for opportunities as it was 38 years ago.
“I think we’re in the second or third inning,” he says. “I’m working harder today than I’ve ever worked in my life.”