Henry Kravis, the king of rough-and-tumble leveraged buyouts, picked up a phone at his home in Palm Beach, Florida, and called the chief executive officer of one of Spain’s biggest producers of building materials.
It was March 2013, and Uralita SA (URA), 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 Madrid-based Uralita a 320 million euro ($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’s private-equity firm, KKR & Co. (KKR:US), and turn down other offers, including one from Blackstone Group LP (BX:US), trusting KKR wouldn’t pull out or change its terms.
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, Bloomberg Markets magazine will report in its July/August issue.
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“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 overlooking a fog-shrouded Central Park. “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 Inc. earned him a reputation as a corporate buccaneer.
At 70, Kravis, who’s worth $4.8 billion according to the Bloomberg Billionaires Index, 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 Inc., minus the sales and trading, before regulators curtailed their reach.
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 Corp., 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. He has adorned KKR’s offices around the world with works from his art collection, including two large-format Cindy Sherman clown photographs that hang in a conference room in New York.
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. In the euro area alone, banks have shrunk their balance sheets by 3.5 trillion euros since 2009 as they’ve cut lending, according to Standard & Poor’s. They will get rid of an additional 2.4 trillion euros during the next 10 years, PricewaterhouseCoopers LLP estimates.
Private-equity and hedge-fund managers led by Leon Black’s Apollo Global Management LLC (APO:US), Marc Lasry’s Avenue Capital Group LLC and Stephen Schwarzman’s Blackstone have scooped up tens of billions of dollars in existing European bank loans at discounted prices since 2008. As banks take flight, companies hungry for capital are turning to firms such as KKR for loans, spurring a surge in unfettered nonbank lending that regulators are watching closely as they contemplate how to respond.
“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, New Hampshire. “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.
With $10 billion of assets for loans, KKR isn’t the deepest-pocketed of this new breed of lender. Ares Management LP, a Los Angeles–based firm with $74 billion of managed capital, says it has gathered $27 billion to make corporate loans. GSO Capital Partners LP, Blackstone’s $66 billion credit arm, has sunk more than $20 billion since 2007 into direct loans, about 10 percent of it in Europe, and has an additional $6 billion of dry powder ready for new deals.
KKR also faces competition from about 75 publicly traded U.S. credit and lending funds known as business development companies, many tied to private-equity firms. Since 2003, their combined assets have ballooned to $67.4 billion from $5 billion, according to the U.S. Securities and Exchange Commission.
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 AB, Europe’s largest mattress maker, and Excelitas Technologies Corp., a Waltham, Massachusetts–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. The mezzanine, or junior debt, fund returned 19.2 percent, and the senior buyout loan fund delivered 16 percent. The first two funds use no leverage to juice returns, while the senior loan pool does.
The firm has recruited 40 capital-markets employees to offer customized debt packages to companies and mid-tier buyout firms. 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 LP, 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 first cousin, and their former Bear, Stearns & Co. boss, Jerome Kohlberg. Three years later, they captivated Wall Street with a $380 million purchase of industrial pumps maker Houdaille Industries Inc. 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.”
A decade later, the firm had fallen behind. By then, Carlyle Group LP (CG:US) and Blackstone were hatching real estate and credit businesses, and Blackstone had pulled even with KKR in size. In a 1998 Businessweek story, Blackstone’s Schwarzman slammed KKR as a “one-trick pony.”
The label no longer fits. During the past decade, KKR and other major private-equity houses have branched out. The race to go public, starting with Fortress Investment Group LLC (FIG:US) and Blackstone in 2007, spurred firms to add new businesses as shareholders demanded diversified earnings streams. The thrashing of their leveraged buyouts during the financial crisis only hastened the trend.
KKR shares have trailed those of competitors because the firm was slower to diversify. The shares are down 2 percent this year, compared with a 5 percent gain for Blackstone. The lag has persisted even as KKR’s flagship $17.6 billion private-equity fund, raised in 2006, has lodged annual average net returns of 8.5 percent, beating Blackstone’s $21.7 billion fund raised the same year, which has posted average net gains of 7 percent.
Stockholders, unlike investors in the firm’s funds, have a stake in the company, whose earnings derive from incentive and management fees the funds generate. Adam Goldman, a managing director at Red Rocks Capital LLC, which owns KKR and Blackstone shares, says Blackstone’s broader business platform gives it an edge over KKR in fund gathering and fee production.
“I like how KKR is diversifying,” says Goldman, who’s based in Golden, Colorado. “We’ll see down the road if this strategy it has embraced is the right one. It’s a marathon.”
Frustrated by KKR’s underperforming stock price, Kravis says he’s focused on making the firm’s profits more consistent to boost payouts to shareholders.
“People are starting to figure out that we’re much more diversified than they thought,” he says.
Kravis traces his campaign to change KKR to 2002. Williams Cos. (WMB:US), 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 LLC, in 2004. The reinvention kicked into high gear in 2007, after Kravis and Roberts recruited Farr, Citigroup Inc.’s co-head of North American equity underwriting, to head its fledgling capital-markets operation.
A lanky, 42-year-old Canadian, Farr was promoted last year to run KKR’s asset-management unit, which includes the credit funds. While at Citigroup, he helped craft and syndicate KKR Financial’s $900 million initial public offering in 2005. The next year, he helped KKR raise $5 billion for a fund listed on what was then the Euronext Amsterdam stock exchange, KKR Private Equity Investors LP, which invested in takeovers alongside KKR’s main buyout pool.
Given room to run, Farr and Scott Nuttall, the global capital and asset-management group chief, decided to move into bond and stock underwriting. At first, the unit, KKR Capital Markets LLC, took bit parts in the offerings done each year by the firm’s private-equity portfolio companies, such as hospital owner HCA Inc. and chipmaker Avago Technologies Ltd. (AVGO:US)
“We didn’t want to go down the path of being an investment bank with sales and trading desks and research,” Farr says.
KCM grew into a potent fee machine. Although Apollo and Blackstone followed KKR into the capital-markets business, no firm has assembled a staff the size of KKR’s or comes close to matching KKR in volume or revenue. Last year, KKR syndicated $1.1 billion of capital in 16 equity and 112 debt offerings, garnering $146 million in fees. In the first five months of this year, it was the only private-equity firm to rank among the top 25 underwriters of U.S. buyout loans, according to data compiled by Bloomberg.
Three executives at top banks say they initially viewed KKR’s muscling into their turf with alarm. At times, KKR has demanded a big cut, says one, who asked not to be identified because he does business with KKR. A case that stands out for him was KKR’s taking more than $75 million in underwriting fees when it exited its investment in discount retailer Dollar General Corp. (DG:US) through public stock offerings from 2009 to 2013.
The bankers say they’ve learned to live with KKR and are even grateful. It was the firm’s $7.4 billion buyout of Dollar General that gave rise to a bonanza of fees in the first place, allowing banks to earn more from KKR than KKR’s thrust into underwriting has cost them, the executives say. Farr says KKR earned its keep by valuing and marketing the Dollar General offering before banks came onboard.
KKR also is playing a valuable role with underwriting and lending for smaller companies, says John Eydenberg, Deutsche Bank AG’s co-head of investment banking for the Americas. “Banks have pulled back, and KKR is clearly filling a niche in the market that matters,” Eydenberg says.
In 2009, KKR moved full tilt into lending to companies it didn’t own. The firm squared off against Blackstone’s GSO, Ares and others with lending franchises by creating a suite of financing choices for midsize companies. That year, KKR began gathering what would swell into a $6 billion special-situations pool to bail out cash-strapped companies and to buy distressed corporate debt. In 2010, it added a $1 billion mezzanine fund, and in 2011, a $1.2 billion fund to provide middle-market private-equity shops and companies with senior financing.
The following 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. It teamed up with private-equity firm Stone Point Capital LLC, led by former Goldman Sachs Chairman Stephen Friedman, to form Merchant Capital Solutions LLC, a $300 million underwriting joint venture, to serve companies outside KKR’s private-equity universe. Canada’s biggest public-pension manager, Canada Pension Plan Investment Board, kicked in an additional $50 million.
KKR has clout in the underwriting business because of its balance sheet. It created the trove as a result of the unusual way it went public: In 2010, following a more than 50 percent plunge in the value of KKR Private Equity Investors’ portfolio and an even steeper dive in its stock, KKR offered to absorb the traded fund’s assets onto its own balance sheet and not simply manage them. The firm has used this war chest, whose value mushroomed as markets rebounded, to seed or acquire hedge funds, real estate and energy-investing businesses and credit funds.
Not all of 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, a Dublin-based 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.”
Private-equity firms lending to already overleveraged companies suggests that credit markets may be too hot, says Jon Moulton, founder of London–based Better Capital LLP, a turnaround specialist. The firms “are undoubtedly buying a lot of risk at the moment,” he says. “There’s a lot of debt out there and people chasing returns.”
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.”
KKR has landed deals from private-equity clients. This year, KKR’s Merchant Capital helped hawk loans for New York–based private-equity firm Sycamore Partners LLC’s $2.2 billion purchase of clothing designer and retailer Jones Group Inc., whose brands include Nine West and Anne Klein. KKR kicked in $60 million of equity, and it supplied 70 million pounds ($118 million) of secured debt for Sycamore’s ensuing spinoff of Jones’s Kurt Geiger label in the U.K. Trilantic’s Mattson says KKR’s approach to mid-tier buyout firms is unusual.
“KKR isn’t sharp elbowed,” he says. “They’ve given us advice on debt deals even when they weren’t involved, and they took no fees. They’ve pointed us to attractive deals too small for KKR’s private-equity fund.”
KKR is trying to turn itself into a one-stop adviser. At an April meeting of the firm’s top 440 executives in Rancho Palos Verdes, California, Kravis and Roberts urged everyone to use the “whole brain” of the firm when they talk to clients. “If you’re seeing a company, think in terms of what the company needs,” Kravis says he told the group. “Maybe it’s a growth equity investment. Maybe it’s some specific type of financing.”
Kravis and Roberts have set up a compensation system that encourages deals that pull in multiple arms of KKR. Rejecting the “eat-what-you-kill” culture Kravis says they experienced at Bear Stearns, they have made sure pay isn’t based just on what business an executive brings in. Instead, KKR has a single pot, where profits from funds and capital-markets fees are pooled and then shared among executives who are rewarded for kicking ideas to other parts of the firm.
“I’d rather be in a collaborative place,” says Jamie Weinstein, co-head of special situations. “At the end of the year, people are judged on performance and how they support other parts of the firm.”
KKR has seized the opportunity created by European banks retreating from company financing. Its biggest direct loan in the region grew out of its relationship with Arle Capital Partners LLP, a midmarket private-equity firm based in London.
Last year, Arle spoke with KKR when it was pondering whether to sell or refinance Hilding Anders, one of its portfolio companies. With 800 million euros of debt and a syndicate of bank lenders wanting to cut their exposure, Malmoe, Sweden–based Hilding got a 350 million-euro loan from KKR in September. KKR got warrants that convert into 30 percent of the mattress company’s equity.
“It’s given us breathing space,” says Alex Myers, Hilding’s CEO.
KKR drew on experience from its $1.6 billion 2004 buyout of Sealy Corp., then the largest U.S. mattress manufacturer. The private-equity firm bolstered Sealy in 2009 with additional equity after sales fell and sold it four years later for about a 30 percent profit. That deal gave KKR a knowledge base to advise Hilding. KKR tapped its special-situations and mezzanine funds to finance the Hilding loan. KKR’s capital markets-arm worked alongside Deutsche Bank to negotiate an amendment and extension to the company’s remaining bank debt.
“We threw the kitchen sink at this one,” says Marc Ciancimino, KKR’s global head of mezzanine debt. “Every part of the firm got involved.”
KKR’s hybrid equity and loan deals of $50 million to $500 million are of a size big banks are now shunning.
“If you have flexible capital, you can earn outsize rates of return for a creative solution,” says Zilkha, the co-head of credit.
For Uralita CEO Serratosa, KKR’s willingness to provide long-term financing without demanding an equity stake won him over. The private-equity firm also arranged a bridge loan of 10 million euros, backed by receivables, to tide the company over until the deal got done.
“They were the most flexible,” Serratosa says. “KKR was maybe hungry for this deal.”
As it scours the market, KKR is even making bets on the Bundesliga, Germany’s soccer league. In January, its special-situations fund took a 9.7 percent stake in Hertha BSC, a Berlin soccer club, as part of a 61.2 million-euro investment. KKR has an option to buy an additional 23 percent stake in the club at any time.
The financing allowed Hertha to pay down 37 million euros of loans from Deutsche Bank and Deutsche Kreditbank AG and buy back TV, marketing and catering rights it had sold when the club was relegated to the Bundesliga’s second tier in the 2012-to-2013 season. “KKR is helping develop Hertha as a brand off the pitch,” says Ingo Schiller, Hertha’s chief financial officer. “They support us in improving our international marketing and sponsoring strategy.”
Now back in the Bundesliga’s first division, Hertha, like any club, faces the risk of getting demoted again, making it hard for KKR to predict future revenue. Ciancimino says he isn’t worried: “Football clubs have ups and downs, but over the years we think we’ll be invested, we’re happy with where we’re sitting.”
In KKR’s hunt for deals in Europe, Kravis flew to Milan in March to meet with Federico Ghizzoni, CEO of UniCredit SpA, and Intesa Sanpaolo SpA CEO Carlo Messina to talk about a possible joint venture with KKR and restructuring specialist Alvarez & Marsal Inc. The talks center on taking a portfolio of loans from the banks and restructuring them to share the upside.
KKR might not be able to sustain its returns. Competition has driven down borrowing rates as others stampede into the middle market. Farr says the firm is still able to reap interest rates on mid-tier buyout loans 2 to 3 percentage points higher than for large companies.
“We won’t take on greater risk to chase returns,” he says.
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.”
To contact the reporters on this story: Stephanie Baker in London at firstname.lastname@example.org; David Carey in New York at email@example.com
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