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Monday, August 21, 2006

Henry Kravis on Private Equity

From Value Discipline

The Philadelphia Inquirer published an interesting Bloomberg News item regarding the leveraged buyout market in Friday's paper:


Leveraged Buyout Market Hot


Kravis is quoted, "We continue to be very active and optimistic about our ability to close large transactions...I have never seen a market with this much liquidity and capital available."

Back in May, KKR raised $5 billion in an IPO of KKR Private Equity Investors LP which has certain commitments for takeovers of HCA, the French yellow pages publisher PagesJaune Groupe, and Phillips Electronics semiconductor subsidiary.


The first financial statements of this public entity were released earlier this week. KKRPEI Link


As of June 30th, the quarter end of this initial stub period, the firm had invested only 3.2% of its net assets. Subsequent to the quarter through August 16th, KKR has invested another $818 million including $419.5 million in secondary purchases of limited partner interests in other KKR sponsored private equity funds. I find it interesting to note that when other "ground floor" private investors are looking for liquidity, this publicly traded ( on Euronext Amsterdam) entity is there as the "bank." Though representing less than 10% of the total assets, this action does bother me. After all, valuations of private companies have a lot of uncertainty associated with them and there appears to be little third party ratification of value.


Among the other investments that make up this $818 million, is "an opportunistic investment in a publicly traded security" of $194.6 million. Again, though clearly allowed within the mandate, I think most of us find it a little unusual that a public company find its way into the KKR Private Equity Investors LP.


But who can argue with success? According to Chief Executive magazine of March 06:


While pushing through these changes, KKR was helped by successful deals in its current fund. Launched in 2000, the $6.1 billion Millennium Fund has so far produced an unusually high gross return of 71 percent on investments that include PanAmSat, the satellite operator, and utility Texas Genco. These gains add to the staggering amounts KKR has generated: By last September, the firm had invested $22.5 billion, converting it into $61.3 billion. Of the resulting $38.8 billion gross profits (calculated before the billions that KKR partners have taken), $10.6 billion is unrealized, reflecting shareholdings in companies KKR still controls or part-owns. "The bottom line is that they have made a lot of money for us over a long period of time," says Joseph Dear, executive director at Washington State Investment Board, one of the world's biggest private-equity investors.
No argument with past success. But financing costs have risen, on virtually every currency one can imagine. LIBOR is close to its highest since 2001. Valuations, Kravis claims have come down sufficiently to offset these higher funding costs.

I remain skeptical. My guess is that the returns on private equity in aggregate, in the next five years will hug the returns on public equity. There is simply too much capital chasing these deals, and far too much belief in spreadsheets that extrapolate past returns into eternity.


As I said before, the smartest way to be involved in private equity investing at this point may well be as a seller.


Disclaimer: Neither I, my family, or clients have a current position in any of the securities mentioned in this post.

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