KKR & Co.

Moat: 2/5

Understandability: 4/5

Balance Sheet Health: 3/5

A global investment firm that manages a diverse array of alternative assets including private equity, credit, real estate, and infrastructure.

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The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

KKR is a leading global investment firm that specializes in alternative assets. It operates as a multi-faceted platform, acting as both an asset manager (raising capital and generating fees) and as a significant investor itself (deploying capital and generating investment income). KKR’s diverse investment portfolio spans across private equity, credit, real estate, and infrastructure, which are known as “alternative” assets as opposed to traditional investments like stocks or bonds.

Business Explanation

  • Revenues: KKR’s revenues stem from two primary sources:
    • Asset Management Fees: Fees generated from managing capital for investors, typically structured as a percentage of assets under management (AUM). This provides relatively steady income, though it can be affected by changes in AUM due to market performance or investor behavior.
    • Investment Income: Income and gains generated from KKR’s own capital deployed in various investments. This income stream is more volatile and depends on the success of KKR’s investments.
  • Industry Trends:
    • Growing Interest in Alternatives: Investors increasingly allocate capital to alternative assets due to their ability to generate high returns, low correlation with public markets, and to diversify portfolios. This trend has created a tailwind for KKR and similar firms, though increased competition may compress fees.
    • Increased Regulations: Regulations that have come up following the 2008 financial crisis have increased capital requirements and have introduced more disclosure requirements. This makes the industry more complex and makes small companies less profitable and have limited growth.
    • Industry Consolidation: The private markets industry is continuing to consolidate as the cost and complexity for capital deployment has been increasing, with large firms expanding and many smaller players fading out.
  • Competitive Landscape:
    • Competition: The alternative asset management space is highly competitive, including rivals such as Blackstone, Carlyle, Apollo Global Management, and other traditional asset managers. Competition is intense for fundraising, deal sourcing, and talent acquisition.
    • Differentiation: KKR seeks to differentiate itself through its diverse product offerings, operational expertise, established relationships, and a strong focus on value creation. They also highlight its long history, global footprint, and an ability to deliver strong performance over many market cycles.
  • What Makes KKR Different:
    • Operational Expertise: KKR is uniquely differentiated in its approach to Private Equity by not just doing deals and deploying capital, but working with the management of the acquired companies to drive value creation through improving their efficiency, revenue growth, and operational excellence.
    • Broad Platform: The breadth of KKR’s investment platform, ranging from private equity to credit to infrastructure, allows it to capture opportunities across diverse asset classes.
    • Global Reach: With offices in more than 20 countries, KKR has a significant global reach, providing it with access to deal flow and capital across different markets.
    • Long-Standing Relationships: Over decades, KKR built strong relationships with both capital providers and companies that they operate or invest in. The more relationships that they have, the stronger they get.

Financial Deep Dive

  • Revenue Volatility:

KKR’s revenues can fluctuate significantly due to its reliance on carried interest and investment income. These can vary widely depending on the timing of deal exits, the performance of invested assets, and the health of the financial markets.

  • Fee-Related Earnings (FRE): One useful metric for understanding their business is Fee-Related Earnings (FRE), which reflects the cash flows generated from management and incentive fees and is not significantly affected by market fluctuations.
  • Assets Under Management (AUM): The level of AUM is crucial as a driver of management fee revenues. However, remember that AUM does not represent profitability. AUM is more related to the size of the business, and there may be companies with higher profitability while having a lower AUM.
  • Net Accrued Performance Fees: When analyzing KKR, you might also see a line item for accrued incentive fees. These are potential future profits from investments, and are not real cash until KKR liquidates the investments. Do not count these as cash flows.
  • Debt: KKR utilizes debt for its day-to-day operation and for managing its own investments. It is important to evaluate whether these loans are sustainable.
  • Capital Allocation: As a highly profitable business, it’s also important to consider what management does with all the cash that the company generates, and are they using it in a value creating manner.
  • Recent Performance
    • KKR reported a strong Q1 2024 earnings, with Fee-related earnings (FRE) at $0.67, a 17% increase YOY, while investment income increased by 12%, with all strategies performing well. KKR also successfully raised $10 billion of capital in the quarter and is on track to raise $50 to $60 billion this year.
    • Net income increased by 21%, reaching $841 million.
    • Strong fundraising activities in the current quarter.
    • They also emphasized their operational improvements and a move to focusing on more permanent capital rather than private capital.

Moat Assessment

Rating: 2/5 (Narrow Moat)

Justification: KKR has built a narrow moat through its:

  • Reputation and Track Record: A long history of successful investments gives KKR a competitive advantage because they are known for generating higher than average returns on investments and their fund managers have a higher chance of being picked compared to an inexperienced firm.
  • Established Relationships: KKR’s expansive network and deep connections within industries also help them maintain a moat, as this provides them access to more deals and capital.
  • Intangible Asset - Brand: KKR’s recognizable name and reputation can provide a form of moat, but the brand itself does not do that much unless you are a institutional investor. A retail investor is unlikely to use KKR just for its name.
  • Business Complexity The business model of KKR is complex which is a high barrier for entry and that protects the company from smaller players.

However, these advantages don’t create a wide moat because:

  • Competition: The industry is characterized by intense competition and numerous participants who can erode returns on capital.
  • Dependence on Market Cycles: KKR’s profitability is sensitive to market fluctuations, which makes the moat vulnerable to market conditions. For instance, KKR’s performance is particularly sensitive to changes in credit markets, which directly affects its credit portfolio.
    • Dependence on Market cycles: A sudden shock to the market can erode the value of its assets.
    • Dependence on capital cycles: Changes in capital flows may limit the size of investment or lead to less investment overall, directly impacting revenue.

Risks to the Moat and Business Resilience

  • Increased Competition: Continued competition may compress fees and returns, weakening their overall advantage.
  • Market Downturns: If there’s a bear market or recession, investment income, fees, and AUM can substantially decline. This will put immense stress on KKR and they may even fail.
  • Regulatory Changes: Increased regulation of the alternative investment sector has the potential to increase costs and restrict operational flexibility.
  • Loss of Key Personnel: KKR’s success heavily relies on the expertise of their deal teams. The departure of key managers might impact future performance and the ability of the company to maintain its moat.
  • Inability to Maintain Capital: If the company fails to raise additional capital, they will have to cut into their investment business, which might erode the overall profitability.
  • Excess Leverage: Because the company uses debt, they might face trouble if they take on too much of it.
  • Reputational Damage: Any scandal that affects any of KKR’s managers or deals will result in an immediate and severe damage to the company’s reputation, which could significantly lower the company’s future profits.

Understandability Rating Rating: 4/5

Justification: While the core business model of an asset manager (raising capital, investing it and then getting fees) is straightforward, KKR is far from a simple business. What complicates understanding the business are:

  • Variety of Investment Vehicles: Navigating the various asset classes and structures where KKR invests requires expertise and understanding, especially because these are alternative and more complicated investments.
  • Complexity of Valuations: Because many investments are in private assets, valuation depends heavily on estimates. In addition, the investment income of KKR will fluctuate as the assets may be volatile. These can be difficult to understand.
  • Financial Reporting: The intricacies of KKR’s financial statements, with items like carried interest, and the impact of changing fair value of assets makes it difficult to understand the business quickly.

Balance Sheet Health Rating: 3 / 5

Justification: KKR’s balance sheet health is mixed:

  • Asset Strength: KKR holds a large amount of diverse assets that are very profitable and generate substantial cash flows.

  • Debt: KKR does use debt which is also not uncommon. They need to pay close attention to management of those debts.

  • Intangibles: The balance sheet includes a significant amount of goodwill and intangibles, which require careful monitoring.

  • Risk: Given the nature of KKR’s business, and the financial structure that is common in the alternative assets space, there are risks that are often seen in the company’s balance sheet, however, they can also be sources of additional profits. Therefore, overall, we have given the balance sheet an average score and believe that the balance sheet requires careful monitoring.

The data and trends suggest that KKR is well-positioned to take advantage of the increasing importance of private markets, and the company’s management is focused on maintaining the company’s profitability through the market cycles, however, the stock is still subject to market volatility. The management needs to remain diligent and needs to make sure the company is not over leveraging or taking too much risks. While the company has a narrow moat and solid financials, the nature of the market can still put the company at risk.