Rodrigo Lopez Buenrostro of KUE Capital presented his in-depth investment thesis on KKR & Co. (NYSE: KKR) at Best Ideas 2018.
KKR & Co. is one of the most successful private equity firms. It turns out managing money for external clients and investing it alongside yours in alternative, long-term compounding vehicles is a great business. KKR manages $153 billion, mostly from large pension funds and endowments. The market cap stands at $17 billion, of which 40% is owned by management. KKR makes money essentially from a recurring revenue stream of management fees, volatile yet profitable incentive income, and income from GP investments. The cost side is quite straightforward as well: the main expense is attracting and retaining talent. KKR is one of a few PE shops that have the scale to absorb large limited partner checks and the track record (brand) for CIOs to sleep well at night: no CIO will be fired for investing in KKR. Add this all up and you have a business that generates 17% ROEs. When you buy a share of KKR you are essentially partnering with the managing partners that own most of the business, raise the capital, and invest in attractive opportunities.
As the GP, KKR invests in its own funds and co-investments. On average, KKR has contributed about 7% of the AUM raised in their funds. This has translated into close to $11 billion on their balance sheet in a diversified mix of fund investments, co-investments, and outright control positions. These investments are also diversified in vintages, asset classes and geographies essentially providing a long term, compounding portfolio of great businesses. If we add net cash and accrued incentives to this investments account, after-tax value amounts to close to $10 billion, or ~60% of the recent market cap. This provides a significant margin of safety for KKR shareholders.
The most attractive attribute of the income statement is the fee-related earnings, which consist of stable, predictable management fees, after expensing for talent salaries, G&A, and placement fees. The value of this consistent stream of earnings comes at ~$8 billion for KKR, which accounts for more than the remaining 40% to reach the market cap, assuming after-tax earnings and a multiple that is lower than where the market has been recently.
In sum, at ~$20 per share, we are paying for the embedded value on the balance sheet plus a fair value for the recurring revenue business only. The gravy that the market has not priced in yet includes (i) value of the carried interest from current AUM and any additional AUM raised in the future; (ii) AUM that has been committed by LPs but are still not generating management fees; and (iii) any management fees above a growth rate of 6% into perpetuity.
About the instructor:
Rodrigo Lopez Buenrostro works at Kue Capital where he invests to preserve capital over time. He currently pioneers the asset management division within the firm and divides his time between equity research and manager selection with a global mandate. Previously, Rodrigo worked as a summer equity analyst at SW Investments, a value-focused hedge fund in Chicago. He began his professional career as an Investment Banker at BBVA. Rodrigo is a recent MBA graduate from Chicago Booth ’15 where he earned a concentration in Analytic Finance and was actively involved in the IM / HF community. He studied Business and Accounting at ITAM (Mexico Institute of Technology) for undergrad where he wrote his thesis on hedge funds and started to invest personally. Rodrigo has always had an interest in finding the real value of assets, reading, and volunteering at NGOs to teach basic concepts related to investing.
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