Excerpted From 'The New Tycoons: Inside The Trillion Dollar Private Equity Industry That Owns Everything,' Published By Bloomberg Press/John Wiley & Sons, 2012
Ten thousand bucks.
Henry Kravis and his cousin George Roberts each scribbled out a check in that amount, smaller companions to the $100,000 draft their more established colleague, former boss and partner Jerome Kohlberg, had written.
That formed the entirety of the startup capital for what became Kohlberg Kravis Roberts & Co., known then unofficially, and now officially, as KKR. None of the three men would ever need to put any more money in. The two cousins would become billionaires several times over. Kohlberg would go on to create his own firm, Kohlberg & Co., based in suburban Mt. Kisco, New York, the following decade after disagreeing with the cousins on the strategy of the firm.
Today, the original bank documents hang framed near Kravis’s corner office on the 42nd floor of KKR (KKR:US)’s headquarters at 9 W. 57th St. in Manhattan. A gift from JPMorgan Chase & Co.’s Jimmy Lee, the matting features logos of companies KKR has bought in the intervening years, from Safeway Inc. (SWY:US) to Motel 6. Since Lee tracked down the documents, KKR has gone on to buy everything from Del Monte Foods Co. to Oriental Brewery Co. At three different points, it’s held the title of pulling off the biggest leveraged buyout in history.
By dint of one of those deals, the $30 billion purchase of RJR Nabisco in 1989, KKR is the most famous of all the leveraged-buyout firms, at least by the measure of asking a random passerby or a relative over Thanksgiving dinner. The extraordinary details of that hotly contested deal gave rise to “Barbarians at the Gate,” one of the most compelling business stories of all time. The book, by Bryan Burrough and John Helyar, captured vividly the back-room dealings, egos and gamesmanship that people on Wall Street recognized as being all too accurate and everyone else reacted to with some combination of admiration and horror.
KKR’s New York headquarters are majestic. Security is tight, with a guard posted behind glass before a visitor can pull open the wooden doors that open onto a view of Central Park. The carpeted halls are lined with art from Kravis’s own collection, which tends toward the modern. His wife, Marie-Josée Kravis, curated what’s on display around KKR headquarters, picking from the Kravises’ wide-ranging art collection.
While the corridors have mostly understated modern art, some of the meeting rooms feature more provocative pieces. There’s a small meeting room down the hall from Kravis’s office with two massive Cindy Sherman photographs hanging on opposite walls, from a series the artist did featuring what can only be described as creepy clowns. Vestiges of the earliest days are sprinkled throughout the offices of KKR, beyond the bank paperwork framed in the anteroom to Kravis’s office. In the small library adjacent to his office, where he holds most meetings, there’s a picture of Joe and Rose’s, the restaurant in midtown Manhattan where Kravis and Roberts had dinner right after they left Bear Stearns Cos. The site of the restaurant is now a Dress Barn.
Any conversation with someone who works or has worked at the firm, including the cousins, makes it clear that Henry and George together are running the show. There are no other major investment firms today beyond theirs whose figurative DNA is linked to actual shared DNA.
Henry and George have known each other for 66 years, dating back to a family vacation the Tulsa, Oklahoma, Kravises and the Houston Robertses took to Marblehead, Massachusetts. Not surprisingly, neither remembers the trip, though as the two grew older, and closer, both their parents reminded them of that first meeting. As children, they saw each other frequently, and Kravis is fond of saying their last major disagreement was over a bicycle when they were 7 years old. George was visiting Henry, who’d just gotten a new bike. George wanted to ride it. Henry didn’t want him to. Scolded for not being a better host, Henry got chased into the house, where he promptly ran smack into a wall, injuring his face to the point where he had to go to the hospital. Argument over.
Beyond middle school and summer camp, use of the term “best friend” is limited, and yet Kravis uses it frequently to describe Roberts. For decades, they spoke one-on-one every day by phone or in person. In the modern era, they typically are involved in some sort of meeting or group communication on a daily basis, though they’ve fallen out of the daily check-in habit.
Still, the ethos was set. The two men, known as “HRK” and “GRR” in firm correspondence, are by all accounts inseparable philosophically.
“It’s very clear they have a pact, and it’s very strong,” said Craig Farr, who runs the firm’s capital-markets business.
This partnership pervades every aspect of the firm. While each man speaks for himself, it is clear they’re also comfortable speaking for the other. Any statement to the press or investors of any magnitude comes from both of them.
During our conversations, Kravis constantly referenced “George and I” when describing decisions large and small.
“We’re two people, with one voice,” Kravis said. “If we disagree, we talk it out. If one of is totally against it, it’s not happening.”
In another conversation, he referred to KKR as a football team “with a two-headed quarterback.” When I asked Roberts how it trickles down through the firm, he compared it to a healthy relationship between parents that models behavior for their children.
“There’s no agenda between Henry and me,” he said. “That reinforces everything we’re trying to do at the firm.”
With two long-standing founders so in sync, and still firmly in control of their creation, the culture is thus undoubtedly a reflection of them. And that culture is a serious, driven one, with 9 West, the West Coast outpost in Menlo Park, California, and every KKR office living shrines to over- achievement. They preach discipline, and “relentless” is a word I heard over and over again.
While the RJR deal turned out to be an outlier in terms of size for that period, the notion of Doing The Big Deal is quintessential KKR. The firm has underscored that in the decades hence by buying big-ticket, high-profile companies. Its partners are at times painfully methodical, but ultimately hyper- confident in their strategy. The line between rigor and mania is a thin one, and there’s a drive to be the best that seems to exist in slightly sharper relief in the halls of KKR.
Maybe it’s the art on the walls, maybe it’s that everyone is impeccably dressed. Maybe it’s the lack of irony and sense of absolute focus that pervades every single conversation. It manifests itself mostly in the way KKR chooses who ends up working at the firm. I heard stories of rounds of interviews stretching over months, with meetings that numbered in the thirties or forties. Up until a decade ago, when it became logistically impossible, any candidate of significance met every single partner. Recalling his hiring in 1993, chief administrative officer Todd Fisher said, “The process was shocking in terms of its intensity.”
As is the case at other firms that haven’t gone through any sort of CEO succession (Carlyle Group LP (CG:US) being the other prime example), the chemistry between the founders is seen as a crucial asset. The power of that partnership and the underlying personalities, too, make a multibillion-dollar question mark for all of KKR’s investors, both public and private. Kravis told his public shareholders in 2011 that he and Roberts are keenly aware of succession planning.
“You have to be assured that George and I think about this every day,” he said at the March investor meeting at New York’s Pierre Hotel. “We talk about what will be the future at KKR and you can’t run any company, in our view, unless you build a very deep bench of people.”
The best-known face of the firm beyond the founders is Scott Nuttall, whose title, head of global capital and asset management, gives him a broad portfolio overseeing all of the firm’s money-raising activities and newer lines of business. In addition to sitting on the management committee, he’s also the firm’s primary senior executive voice to public shareholders through the quarterly conference calls with Wall Street analysts and investors.
Nuttall captures the firm’s relentless discipline and Kravis and Roberts’s insistence that KKR wasn’t about one or two men. During one conversation, he parried any attempt to talk about himself, constantly pushing the discussion to the firm. Yet he has quietly gained more and more responsibility since his arrival at KKR in the early 1990s after working for a short stint as an analyst at Blackstone Group LP. (BX:US) His current role makes him among a handful of people who could potentially run the firm, especially since he’s been a deal guy as well as worked in management overseeing some of the newer initiatives as well as an expanded fundraising effort.
Nuttall, 39, is a wunderkind in a house full of them. William Sonneborn, who runs KKR Asset Management, is 42 years old. Frederick Goltz, based in San Francisco like Sonneborn, is 41. Sonneborn arrived at KKR through an approach in early 2008 by Nuttall, who initially wanted to explore a KKR-sponsored employee buyout of money manager TCW Group Inc., where Sonneborn was president. A phone call prompted a visit to 9 West, where Nuttall quickly determined that he didn’t want to buy TCW, but he did want to hire Sonneborn. He introduced him to Kravis and, with his blessing, invited Sonneborn to the firm’s annual firm meeting, which happened to be taking place a couple of weeks later not far from where Sonneborn lived.
That’s where Sonneborn got the full picture of KKR. He arrived at La Costa -- a resort in Carlsbad, California, which KKR owned through a real estate partnership, that was the regular site of the annual meeting -- for more than two dozen interviews with various partners, and his initial meeting with Roberts. One of his most striking impressions was numerous KKR executives in various states of injury incurred through the sports portion of the meeting.
“These were, after all, very competitive, type-A people,” Sonneborn said.
The sports component was relatively new to the meeting, and a brainchild of Goltz, by then a 12-year veteran of the firm who was in KKR’s first analyst class. Looking for a way for himself and his colleagues to blow off steam, he’d cast about for the right sport and chosen soccer. Roberts, perusing the agenda ahead of time and showing how deep he was willing to get into the details, questioned Goltz’s decision, worried about too many people getting injured and insisted he offer volleyball as well. Goltz acceded to the boss, but said later that all the injuries, including broken fingers, came from the ranks of volleyball players.
“The problem is, you can’t really gloat with George,” he told me.
Goltz’s deep affinity for Roberts dated back to a time when he joined a firm that had a total of 22 executives. A native of western Pennsylvania who went to Wall Street after the University of Pennsylvania (he also earned an MBA at INSEAD after joining KKR), he briefly tried to convince Roberts to let him stay in New York. Roberts insisted the job was in California. Goltz joined an office of fewer than 10 people, which at the time had a single laptop that whoever wanted it had to sign out for the weekend. The firm meetings then were held in Vail, since the two dozen participants could stay at some houses there owned by Kravis and longtime KKR partner Paul Raether. A defining moment for Goltz at his first gathering was a high- stakes poker game where “the house” extended him and a few others credit for their bets. Goltz, then a brash young man, lost badly. As he left for home, he wondered if the debt was real. Then he got the bill.
“It wasn’t about the money,” he said. “It was about the lesson. Ultimately, you’re accountable.”
In 2009, Kravis and Roberts decided to elevate Fisher, who joined them in 1993, to the newly created position of chief administrative officer. The process of getting Fisher into the job wasn’t easy. He’d initially led an effort to hire an outsider to fill the job but the two cousins ultimately decided they wanted someone internally to take it.
“It was a bit of a shock to the system,” Fisher said. “I couldn’t tell if it was a promotion or a demotion.”
Kravis separately conceded to me that he and Roberts had a hard time giving responsibility to Fisher and other senior managers, a tendency Fisher was well aware of. “It was not an easy set of conversations,” Fisher said. “It involved a lot of people I was going to have to interact with and that I’d have a say over what got done. They swallowed hard and said, ‘We want to do this.’” Fisher now has responsibility over legal, public affairs, and finance.
Going forward, one potential scenario has Kravis and Roberts ceding the CEO duties to another pair of executives, both of whom would probably be long-time KKR members. The cousins are likely to replicate the bi-coastal scenario that has seemed to help balance their own leadership of the firm and, given the evolution into non-LBO businesses, at least one of the pair would come from outside the private equity group.
Kravis insisted to me that no decision had been made as to what the post-HRK and GRR landscape would look like in terms of organizational structure, specifically whether it would be a single CEO or a couple of chiefs. Even with Kravis’s “deep bench,” there is simply no way any one person, or pair, will bring exactly what the cousins do. For a couple of guys under six feet tall, they cast long shadows.
KKR’s Menlo Park office sits in a tidy low-rise building along Sand Hill Road, the thoroughfare where the world’s best- known venture capital firms are tucked into similarly unassuming structures, minutes from Stanford University, and less than an hour’s drive from San Francisco. The echoes of 9 West are unmistakable throughout, the office itself is the more relaxed California cousin to its New York counterpart. Fruit smoothies are served every afternoon. Roberts, while more reserved than Kravis, has a quiet folksiness to him. Unlike at 9 West, where lunch is consumed in waves (senior partners tend to eat early, younger associates later), the Menlo office is small enough that the group eats together. For a time, to encourage conversation, Roberts handed out a list of recommended books and asked his colleagues to deliver one-page book reports (he borrowed the idea from Britt Harris, the chief investment officer of the Teacher Retirement System of Texas).
Roberts is far more understated, and his desire to move to California more than three decades ago wasn’t just about liking the mild climes of Northern California. He’s much less comfortable in the spotlight, and slower to warm up than his more gregarious cousin.
“He’s intense and much more intimidating at first,” Sonneborn said. “It took me awhile to be myself around him. Now he’s a mentor.” He’s been known to sound the call for a return to basic principles and manners, once reminding the entire firm of the power of a simple hand-written note.
Cousin-to-cousin meetings are where the seminal decisions regarding the firm are made. It was in Kravis’s small meeting room that he and Roberts sat in 1999 and mulled over the future of the firm that bore their names, one of a series of philosophical explorations. At a partners meeting around that time at the Doral near Palm Springs, the two men were visiting when George turned to Henry and said, in his typically blunt way: “Are you having any fun? Because I’m not.”
Kravis acknowledged he wasn’t. Roberts pushed it further. “We’re making a lot of mistakes,” he told his cousin. They both knew instinctively that things were going wrong and they were trying to understand why. As they spent two days talking it over, Kravis zeroed in on something: the closing dinner.
The closing dinner is a tradition in the world of mergers and acquisitions, a fancy meal after everything is documented and signed, to celebrate the consummation. It brings together the deal guys from the private-equity firm, the investment bankers and lawyers and others involved in the transaction, to eat and toast the success of at least getting the deal done. What Kravis started thinking about was what’s become an axiom for him over the past few years: Don’t congratulate me when I buy something. Congratulate me when I sell it.
What he told Roberts back in 1999 boiled down to this: “The team would come out of the closing dinner and start working on the next deal.” It represented a broader mindset that was pulling the firm down. Everyone was everywhere, and therefore nowhere with any focus. That was showing up in the numbers. After the 1986 fund returned a staggering 7 times investors’ money, the 1993 pool had given back 1.7 times what limited partners put in. The 1996 fund’s multiple was 1.8 times.
The firm had made some bad deals in telecommunications as the technology boom heated up. A survey of investors showed that their prized limited partners liked them but had virtually no idea what KKR actually did, beyond give back more money than they’d started with. Kravis and Roberts initiated a multifaceted approach. They decided each investment would have a 100-day plan, like General Electric Co. had for its businesses, forcing the deal makers to think beyond the closing dinner. The pair, who’d been content to have every partner be a generalist, organized executives into industry teams (initially 12 groups, later pared to nine).
“We made it clear that we expected them to understand an industry from the bottom up,” Kravis said. “Go to trade shows, meet with purchasing managers, marketing and sales managers, really get into the flow of whatever the business was.”
Part of making the case for teamwork was to remind each employee of the firm’s pay structure. Kravis described the experience at Bear Stearns as formative in a number of ways, including how the founders decided they would pay their employees. Like many Wall Street firms, Bear Stearns had an “eat what you kill” culture whereby your compensation was largely based on what business you brought in. Kravis described a culture where you locked your office or your desk when you went home at night so no one took clients or business ideas.
The KKR founders decided that everyone would have a piece of the firm, however small. During end-of-year reviews in the early days, Kravis would walk each employee through the compensation, consisting of salary, bonus, and then carried interest. To the rank and file that seemed at best difficult to understand, and at worst, essentially made up. That’s why Kravis and Roberts took to personally walking around the office handing out distribution checks. In one memorable case in the 1980s, the sale of a single portfolio company meant secretaries each got a one-time $80,000 check for their participation in that deal hand delivered by the bosses.
The underlying theory exists today. KKR has one “carry pool,” that is, a single pot where all the profits from its funds pour into each year. While compensation is tied in part to how well an executive did in his or her individual business line, the single pool gives management wide latitude to reward behavior that inures to the benefit of all KKR. “It helps make it feel like it’s bigger than any one person,” Sonneborn said. “It’s the difference between being a firm and a franchise.”
For KKR, nothing illustrated the new world of big takeovers more than its pursuit and ultimate purchase of what was then known as TXU Corp., the biggest power producer in Texas. To win the deal, KKR and TPG employed a small army of outside advisers and relied on their own founders to win over environmentalists, regulators, and legislators. The experience of that deal, and what followed for both the company and private-equity industry, marked the beginning of a new era defined by more publicity and more scrutiny.
Announced with fanfare in 2007, Energy Future was headed toward being a bad deal from an investment perspective within two years, and the biggest deal in history may in fact end up being among the most disappointing for investors. By early 2012, a debt default was seen as virtually certain. Credit-default swaps, a financial instrument investors use to bet on whether a company will meet its debt obligations, put the chances of default at 91 percent within three years.
At issue were natural gas prices, which were central to the business case to buy TXU in the first place. The buyers believed prices for natural gas would continue to rise, driving the price for wholesale power, which the company provides, higher. That would in turn increase the value of TXU. Along the way, they made other changes to the company, including shuttering some coal-fired plants and modernizing other facilities, but this was really a bet on gas prices. Instead, a recession in the U.S. crimped demand and, to make matters worse for Energy Future, huge stores of natural gas became drillable in shale deposits, mainly in Pennsylvania.
It’s worth noting that KKR, ever opportunistic, seized on the shale boom and broader interest in natural resources to great success. Marc Lipschultz built a portfolio of shale- related companies, two of which KKR sold within about a year of buying them. Lipschultz tripled the value of one investment in 2011 through a sale of oil and gas leases in Texas. That followed a deal in 2010 where KKR quadrupled its money on a shale investment.
With default effectively certain and their equity most likely wiped out, the owners sought to accentuate the positive. Even with a crippled balance sheet, TPG and KKR did in fact modernize a number of the facilities. Employment at Energy Future grew.
From a broader perspective, the deal created within both firms a sense of the new world order for their business. TPG and KKR, largely because of Energy Future, now have established executives devoted to environmental and sustainability issues. The deal also precipitated the hiring of senior executives overseeing public affairs.
Even before the TXU deal, Kravis and Roberts were becoming more aware of the increasingly public nature of the business.
“If you want to own the Hiltons and the HCAs of the world, you’re going to bring a lot of scrutiny,” said Kenneth Mehlman, the former Republican National Committee chairman who oversees public affairs at KKR. “You’re going to be the center of attention.”
The process of negotiating for, buying, and winning regulatory approval for TXU only served to underscore all of that, he said. “That made us realize we had to do it in a methodical way.”
All of it speaks to a theme hammered on across the big firms. This is not the same business it was at the outset or even at the turn of the century.
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