KKR's Nice Safe Bet on Sun
Posted by: Peter Burrows on January 29, 2007
Kohlberg Kravis Roberts, the original Barbarian at the Gate when it bought RJR Nabisco in the late 1980s, did a very different kind of deal the other day: it invested $700 million in Sun Microsystems, on extremely unthreatening terms.
KKR gets just one board seat, and the deal gives it the right to convert the $700 million in loans into an equity stake of just 5% of SUNW shares. In other words, this isn't the prelude to any explosive takeover battle, so there's no need to start casting anyone to play the role of Sun CEO Jonathan Schwartz or KKR co-founders George Roberts and Henry Kravis in the movie. (or, for that matter, new KKR partner Michael Marks. Industry watchers believe Marks, who dealt for years with Sun's top executives in his former job as CEO of contract manufacturer Flextronics, had a major role in driving this deal. They wouldn't be surprised if Marks ends up filling that seat on Sun's board).
Why this kindler, gentler approach from KKR? In large part, it's because this investment was done by the one piece of KKR that is actually publicly-held. Last April, the legendary buyout firm raised $5 billion to set up KKR Private Equity Investors LP on Amsterdam's Euronext stock exchange.
So how does a swaggering private equity firm invest when it's handling Joe Q. Public's money? Much more safely, it seems. By KKR standards, the Sun deal looks about as risky as a certificate of deposit at your local bank. For starters, KKR looks to have no downside. Zip. That's because unless Sun goes totally kaplooey (now highly unlikely, given the computer makers' turnaround in recent quarters), KKR will get back the principal on its loans, plus interest--even if Sun's stock goes into the dumper. Says one rival buyout exec, "There’s almost no way they can lose their money. In most [private equity] deals, there’s tons of ways to lose your money.”
Of course, KKR is betting that Sun will continue to rise. But KKR can't really start making money until Sun shares pass $7.21 per share. That's the conversion price at which KKR can get its Sun shares. But that's 25% higher than the $5.75 shares sold for on the day the deal was done, Jan. 23. So far so good. In part because of KKR's endorsement, Sun shares are at o $6.33 today.
Still, Schwartz & Co. will have to really go on a tear for KKR to get anything approaching the returns KKR is used to. "Even if Sun stock does great, they're not going to make a ton of money,” says the KKR rival. While Sun's future stock performance is a huge wild card, this source figures KKR is looking for a 10-12% return. Not bad by most standards, but less than half of what top buyout firms expect of themselves.
Still, it's a smart deal for other reasons. Buyout firms have been calling on Sun for years, hoping to take it private. While Sun's resurgence makes that too expensive (and still too risky, given that Sun still hasn't proven it can make consistent profits), KKR's board seat will give it a far better view of Sun and its challenges and opportunities. Says Kathy Coffey, a partner with investment bank Seven Hills, "With a board seat, it gives them an insiders perspective." And it raises the odds that Sun would choose KKR over its rivals, should Sun ever want to take all or part of the company private in the future.
The question is whether KKR's investment signals the start of a new trend. Last year, there was much talk of buyout firms using their billions of raised capital to buy well-known tech firms. But with today's buoyant stock market, most of those companies are too expensive. As such, these PIPES (private investment in public equity) may represent a good way to get a foot in the door with these companies. Such deals are common with smaller firms that need the cash and lack sufficient coverage from stock analysts. A few big companies have done PIPES, as well, including Flextronics and Lenovo. But Coffey, for one, believes more buyout firms will now look at this route to formalizing their relationships with large cap tech companies--and put some of their overflowing coffers of capital to useful work in the process. "I would not be at all surprised to see other private equity firms make other large investments in $20 billion companies [that are too big to be taken private],” says Coffey.