Bloomberg News

KKR Gathers $1 Billion for Mezzanine Fund to Finance Buyouts

September 16, 2011

(Updates with comment about special situations group in 15th paragraph.)

Sept. 16 (Bloomberg) -- KKR & Co., the private-equity investor behind three of the four biggest leveraged buyouts in history, has raised more than $1 billion for its first fund to originate debt for takeovers.

KKR Mezzanine Partners I aims to finance private-equity investments and corporate acquisitions, the firm said today in a statement. The mezzanine business will finance mostly third- party transactions.

KKR Co-Chairmen Henry Kravis and George Roberts have charged William Sonneborn, chief of KKR Asset Management, with adding products and exploiting investment opportunities beyond traditional leveraged buyouts as the 35-year-old firm seeks new sources of revenue. The mezzanine fund, managed by Frederick Goltz, will try to take advantage of a climate in which financial turmoil has crimped bank lending.

“The fact that firms like KKR and others are able to successfully raise mezzanine funds demonstrates that investors are increasingly looking to alternative credit for returns,” said Leon Wagner, who co-founded GoldenTree Asset Management LP, a New York hedge fund focused on debt markets.

Diversification has become a driving theme at the biggest private-equity firms, especially those seeking to woo public shareholders. Blackstone Group LP, the largest firm by assets, has expanded non-LBO businesses in real estate, hedge funds and debt investments. Carlyle Group, which filed to become a listed company this month, has diversified its non-LBO business beyond its original focus on illiquid credit by buying a stake in hedge funds that trade equities.

Blackstone’s Fund

Blackstone, based in New York, is raising its second mezzanine fund and told investors in July it had an initial close of $1.5 billion earlier that month. Mezzanine at Blackstone is managed through its GSO Capital Partners business, which was acquired in 2008 and forms the core of the firm’s credit unit. The overall credit business had $34 billion in assets under management as of June 30.

KKR Asset Management’s biggest business is its bank-loan and high-yield debt funds, which have combined assets of about $12.7 billion. The unit has grown to 57 employees making investments from San Francisco, London and New York, up from 32 at the end of 2009.

Investors in earlier funds include the state of Oregon’s employee pension plan, a longtime backer of KKR that put money into the firm’s first private-equity pools in the 1980s.

Mezzanine Financing

As of the end of July, Oregon had about $2.3 billion invested in KKR’s credit funds, according to a report on the pension’s assets. The investment had a one-year return of 13 percent and averaged 12 percent over three years, beating Oregon’s benchmarks of 9.6 percent for both periods, according to the document.

Mezzanine loans are often used in leveraged buyouts, as part of the debt paired with buyout funds’ equity to takeover a company. KKR Asset Management provided financing for Advent and Bain’s 2009 purchase of payment processor WorldPay Ltd. as well as last year’s acquisition of Marsh & McClennan Cos.’ Kroll consulting operation by Altegrity Inc., a company backed by Providence Equity Partners.

Similar opportunities are likely to arise as private-equity managers seek to buy companies at attractive prices, Sonneborn said. A lack of financing from traditional lenders means the managers increasingly may turn to the mezzanine market.

“These are the times when you want to be active in mezzanine,” Sonneborn said in an interview. “Mezzanine tends to do well when the credit markets and economic activity are OK, but not great.”

Special Situations

KKR also is working the market through its special- situations team designed to do deals involving debt, usually with companies smaller than those the private-equity group would target for investments.

The special-situations group led a $235 million investment last year in Harden Healthcare, the Austin, Texas-based manager of senior-care facilities.

“There are periods in private equity when there are very few opportunities to do traditional buyout transactions,” Sonneborn said. “Special situations gives us a way to actively invest during those periods.”

Hedge Fund

KKR is also courting outside investors for its first hedge fund, and earlier this year hired a group of former Goldman Sachs Group Inc. traders led by Bob Howard. KKR has told investors it seeded the team with capital. The firm declined to comment on fundraising.

Howard’s team, now known as KKR Equity Strategies, left Goldman in part due to new regulatory restrictions that limit Wall Street banks’ ability to trade their own money, and began investing in August. Washington-based Carlyle has entered the equity trading business with the purchase of majority stake in a $1.6 billion hedge fund that focuses on emerging markets, and it plans to make additional purchases. Carlyle raised a mezzanine debt fund in 2004.

KKR is counting on businesses such as hedge funds and mezzanine lending to convince public investors that it’s more than a buyout shop whose fortunes rest on acquiring companies, holding them for three to five years and selling them. Because of the unpredictability of when managers buy and sell their private-equity targets, public investors often don’t model buyout profits, known as carried interest, into their valuations.

‘Misunderstood’ Market

“We find the alternative managers intriguing because we believe they are misunderstood by the market,” Roger Freeman, a Barclays Capital analyst, said in a Sept. 9 note to clients initiating coverage of KKR and Apollo Global Management LLC. He rated KKR shares “overweight,” saying he expected them to reach $22 apiece within 12 months.

KKR, which closed yesterday at $11.98 a share, gained a listing on the New York Stock Exchange in 2010 after combining with its European publicly listed fund a year earlier. That fund, known as KPE, went public in 2006 in Amsterdam for $25 a share.

KKR, which Kravis and Roberts created with Jerome Kohlberg in 1976, has participated in some of the largest deals in private-equity history, including the record-setting takeover of energy producer TXU Corp. for $43.2 billion in 2007. That followed the 2006 acquisition of hospital operator HCA Inc. in 2006, the third-biggest deal, at $32.2 billion, and the fourth- largest, the $30.1 purchase of RJR Nabisco Inc. in 1988, according to data compiled by Bloomberg.

--With assistance from Mary Childs in New York. Editors: Josh Friedman, Christian Baumgaertel, Anthony Palazzo

To contact the reporters on this story: Jason Kelly in New York at jkelly14@bloomberg.net; Cristina Alesci in New York at calesci2@bloomberg.net

To contact the editor responsible for this story: Christian Baumgaertel at cbaumgaertel@bloomberg.net


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